<PAGE> 1
GEMINI II
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)
GEMINI II SEEKS TO PROVIDE LONG-TERM CAPITAL GROWTH FOR ITS CAPITAL
SHAREHOLDERS, AND CURRENT INCOME AND INCOME GROWTH FOR ITS INCOME SHAREHOLDERS.
THE FUND INVESTS PRINCIPALLY IN COMMON STOCKS, SELECTED ON THE BASIS OF
FUNDAMENTAL VALUE, THAT ARE EXPECTED TO CONTRIBUTE TO THE FUND S DUAL
INVESTMENT OBJECTIVES. THE FUND S HOLDINGS ARE USUALLY CHARACTERIZED BY
RELATIVELY LOW PRICE EARNINGS RATIOS AND ABOVE-AVERAGE INCOME YIELDS.
<PAGE> 3
CHAIRMAN'S LETTER
FELLOW SHAREHOLDER:
While the stock market had its share of ups and downs during 1994, most broad
indicators were to end the year just about where they began. In this
environment, the total return of Gemini II was marginally negative, but given
our return of +21.6% in 1993, perhaps not too disappointing an outcome.
The following table compares our total return (capital change plus income)
with our customary benchmark, the unmanaged Standard & Poor's 500 Composite
Stock Price Index. The table reflects the results of the Fund as a whole; it is
followed by a presentation of the financial results of our Capital Shares and
our Income Shares.
<TABLE>
<CAPTION>
- --------------------------------------------------------
Total Return
-----------------
Year Ended
December 31, 1994
- --------------------------------------------------------
<S> <C>
GEMINI II -2.5%
- --------------------------------------------------------
STANDARD & POOR'S 500 STOCK INDEX +1.3%
- --------------------------------------------------------
</TABLE>
The Fund's total return takes into account the increase in our net asset value,
dividends from net investment income, and Federal taxes accrued on net
long-term capital gains realized during the year.
THE CAPITAL SHARE RESULTS
Gemini II's Capital Shares provided a negative capital return of -11.1%
for 1994. The net asset value of each share fell from $22.10 on December 31,
1993, to $19.03 on December 31, 1994, net of our year-end accrual of $.61 per
share for Federal taxes on realized capital gains.
During the year, the capital change (excluding dividends) in the
Standard & Poor's 500 Index was also negative, totaling -1.5%. Thus, the
return on our Capital Shares was distinctly below the capital return of this
widely recognized Index, which depicts the performance of blue- chip stocks
with very large market capitalizations.
The apparent "gap" between our mildly negative total return and our
sharply negative capital return results because our financial structure calls
for us to serve the independent needs of both Capital and Income shareholders.
Thus, the income component of our total return is significantly higher than
that of the Index, and the capital component lower.
You will recall that the Capital Shares provided one-half of the Fund's
assets at our initial public offering on February 15, 1985. Thus, their initial
"capital leverage" ratio was 2.0 times. With appreciation in the Fund's net
asset value over the years, this ratio has now fallen to 1.5 times, meaning
that the Capital Shares' volatility--in both up and down markets--has been
significantly reduced. Nonetheless, it was our total performance--not our
leverage--that primarily accounted for the 1994 shortfall.
THE INCOME SHARE RESULTS
Gemini II's Income Shares received dividends totaling $1.73 per share from net
investment income in 1994, with our first quarter dividend paid at the rate of
$.25 per share, the next three quarters at an increased quarterly rate of $.35
per share, and an "extra" dividend of $.43 per share at year end. This
so-called extra dividend is simply the amount by which our net investment
income earned during the year exceeds the total of our quarterly dividend
payments. Our total
[FIGURE 1]
1
<PAGE> 4
[FIGURE 2]
annual dividend for 1994 represents an increase of 4% over
the 1993 total of $1.66 per share.
Our ability to increase, or even "hold the line," on net income is
limited by the payments that the Fund must make for taxes on realized capital
gains. These payments, of course, reduce the Fund's asset base, meaning that a
smaller amount of assets is available on which to earn income. Since the Fund's
inception, cumulative tax payments have been substantial, totaling $5.03 per
share through 1994. This total is equivalent to fully 27% of the Fund's initial
capital in 1985.
For 1994, our total investment portfolio provided an annual yield of
6.1% after expenses, more than double the 2.9% average dividend yield on the
Standard & Poor's 500 Stock Index. Based on their net asset value of $9.34 at
year end, our Income Shares--benefiting from "income leverage"--provided a
yield of 18.5%; based on their market value of $10.50 per share, the yield was
16.5%.
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 just a notch lower, 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 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.
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 Treasury yields rose from
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 steep 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
2
<PAGE> 5
(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.
As you know, Gemini II falls squarely in the mutual fund "value"
category, and, in general, our returns tend to follow the pattern of returns
earned by other value funds. Last year, value was in the driver's seat; this
year, it was growth. But based on the historical record, such dichotomies are
unlikely to persist. Indeed, as shown in the chart on the facing page, which
compares the returns of growth stocks and value during the past five years,
value stocks lagged during the first two years, then led growth stocks for the
next two years, only to lag again in 1994.
A year ago, talking about the substantial edge earned by value
stocks--the core of Gemini II's investment philosophy--I cautioned that "no
market trend endures forever." That was fair warning of what was in store for
1994. But, for the full five-year period, the returns of both market segments
have been fairly close--an average annual return of +8.8% for the growth
segment and +8.3% for the value segment.
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%. History, it seems clear, has a message to give us about
maintaining realistic performance expectations.
GEMINI II IN 1994
The Fund's shortfall relative to the total return of the Standard &
Poor's 500 Index (-2.5% for the Fund versus +1.3% for the Index) was engendered
almost entirely by a reversal of the factors that helped us prevail over the
Index in 1993 (+21.6% versus +10.1%). First was the moderate lag of value
stocks versus growth stocks (each of which makes up one-half of the market
capitalization of the Index). Second was our large position in financial
stocks. Our weighting in this sector averaged 63% of equities (39% of total net
assets) during the year, compared to the Index weighting of 11%. Thus, when the
financial sector lagged the overall market in 1994, it had a disproportionately
large impact on Gemini II. In addition, our individual financial stocks fell
more sharply than those in the Index, further detracting from our relative
return.
Third, the technology sector, with a total return of +20.3%, was the
year's market leader. Such low-yielding stocks are rarely found in our
portfolio, and we held none during 1994. (The Index weighting for technology
stocks is 9%.) Virtually all other sectors in our common stock portfolio--and
our selection of individual stocks within those sectors--provided a combined
total return quite similar to the market as a whole.
Finally, I would note that our large position in equity-linked
convertible securities and lower-rated bonds was not particularly beneficial in
1994. As you know, such securities, accounting for 41% of our total net assets,
tend to provide yields that represent a much higher proportion of their total
returns than is the case with common stocks. Nonetheless, on balance, the
income from these securities was not sufficient to offset their price declines.
This table presents an overview of our portfolio composition both at
year-end 1994 and year-end 1993:
<TABLE>
<CAPTION>
- ----------------------------------------------------------
Percentage of Net Assets
------------------------
December 31 ,
- ----------------------------------------------------------
1994 1993
- ----------------------------------------------------------
<S> <C> <C>
EQUITY EQUIVALENTS
COMMON STOCKS 62% 61%
CONVERTIBLE SECURITIES 36 28
LOWER-GRADE BONDS 5 10
- ----------------------------------------------------------
SUBTOTAL 103% 99%
- ----------------------------------------------------------
RESERVE EQUIVALENTS
U.S. TREASURY NOTES 0% 3%
OTHER TEMPORARY INVESTMENTS 0 2
NET CASH -3 -4
- ----------------------------------------------------------
SUBTOTAL -3% 1%
- ----------------------------------------------------------
TOTAL PORTFOLIO 100% 100%
- ----------------------------------------------------------
</TABLE>
"A CHANGING OF THE GUARD"
I should note that the renowned Portfolio Manager of Gemini II, John B.
Neff--who has managed the Fund
3
<PAGE> 6
since its inception on February 15, 1985--has decided to retire from
active management one year hence, on December 31, 1995. He will remain
thereafter as a consultant to Wellington Management Company, and, in that
capacity, will work with the firm's investment professionals, including the
portfolio managers of the Vanguard Funds for which Wellington Management
Company serves as adviser.
Mr. Neff will turn his Gemini II responsibilities over to the
professional investment team that he has led and developed over the
years. This team is headed by Charles T. Freeman, currently the Fund's
Assistant Portfolio Manager and a Senior Vice President of Wellington
Management Company. He has worked under Mr. Neff's aegis for 25 years and will
succeed Mr. Neff as Portfolio Manager at the close of 1995. We wish both Mr.
Neff and Mr. Freeman every possible success when they assume their new
responsibilities a year from now.
All of that said, I want to assure you that Gemini II's investment
objectives and policies--its "style," if you will--will remain in place after
Mr. Neff's retirement. You can expect that the Fund will continue: 1) to seek
to achieve both long-term growth of capital as well as current income; 2) to
emphasize stocks believed to be undervalued in the marketplace relative to
their earnings, dividends, and asset values; 3) to retain its "contrarian" bias
in favor of stocks often shunned by other institutional investors; 4) to hold a
relatively concentrated portfolio, in which, for example, the Fund's ten
largest holdings typically represent 30% to 40% of net assets (compared to an
average of about 20% to 25% for most equity mutual funds); and 5) to maintain a
significant position in equity-linked bonds.
A DECADE IN REVIEW
On February 15, 1995, Gemini II will celebrate its tenth anniversary. A mere
two years later--on January 31, 1997--Gemini II will conclude its existence as
a "closed-end" investment company. With close to ten years of history now
behind us, I thought it might be illuminating to review our record so far. The
following table presents Gemini II's total return since our inception, compared
with the returns of the average value (growth and income) mutual fund and the
Standard & Poor's 500 Stock Index:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------
Total Return
-----------------------------------------
February 15, 1985, to
December 31, 1994
-----------------------------------------
Cumulative Annual Rate
- ------------------------------------------------------------------------
<S> <C> <C>
GEMINI II +240% +13.2%
- ------------------------------------------------------------------------
AVERAGE VALUE FUND +190% +11.4%
STANDARD & POOR'S 500 INDEX +250 +13.5
- ------------------------------------------------------------------------
</TABLE>
I would note that these returns are well above historical stock market norms.
In no way should they be considered a prediction of the Fund's future absolute
or relative results.
As our veteran shareholders know, Gemini II went through a "rough
patch" in 1989 and 1990. As a result, from the Fund's inception through
December 31, 1990, our annual rate of return (+10.5%) represented a shortfall
of -4.2 percentage points to the annual return of the Standard & Poor's 500
Index (+14.7%). Since then, we have made a remarkable comeback, recouping all
but 0.3 percentage points of the shortfall, as shown in the table above. We, of
course, hope to make up that gap--and more--during the remaining two years of
our existence.
That said, the Index is always 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. 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, only 13 of the 111 value funds in operation throughout the
period outpaced the Index.
As the table shows, our lifetime performance relative to the average
value fund presents a much more favorable comparison. Despite the "slings and
arrows" of 1989-1990, we have carved out a margin averaging +1.8% annually
(+13.2% versus +11.4%). This is a "real world" comparison. It reflects a
competition with other mutual funds trying to attain the same objectives as
ours (current income and long-term growth of capital and income) via a similar
path
4
<PAGE> 7
(relying most heavily on value stocks rather than growth stocks).
Compounded over a decade, this solid annual margin has resulted in a total
return advantage for Gemini II of 50 percentage points (+240% versus +190% for
the average value fund). We shall strive to enhance this advantage during the
two years that remain before our "closed-end" structure is converted to an
"open-end" (redeemable share) structure.
PREMIUMS AND DISCOUNTS
When Gemini II "matures" on January 31, 1997, the Capital Shares and the
Income Shares will be valued at their actual net asset values on that date.
Thus, for each class of shares, I want to call attention to the difference
between its current net asset value and the price at which it trades on the New
York Stock Exchange. Here are the figures:
<TABLE>
<CAPTION>
- ---------------------------------------------------------
December 31, 1994
-------------------------------------
Net Asset Market
Value Price Difference
- ---------------------------------------------------------
<S> <C> <C> <C>
CAPITAL SHARES $19.03 $17.625 - 7.4%
INCOME SHARES 9.34 10.500 +12.4
- ---------------------------------------------------------
TOTAL $28.37 $28.125 - 0.9%
- ---------------------------------------------------------
</TABLE>
[FIGURE 3]
<TABLE>
<CAPTION>
1985* 1986 1987 1988 1989 1990 1991 1992 1993 1994
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net Income Earned $1.13* $1.23 $1.38 $1.41 $1.58 $1.63 $1.65 $1.66 $1.66 $1.73
Year-End Net Asset Value 9.83 9.73 9.39 9.38 9.37 9.34 9.34 9.33 9.33 9.34
Year-End Market Price 11 5/8 13 5/8 11 7/8 12 1/2 13 11 1/4 13 3/8 12 11 3/4 10 1/2
</TABLE>
<TABLE>
<CAPTION>
2/85 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Adjusted Net Asset Value** $10.00 $11.53 $14.67 $14.89 $18.98 $20.38 $14.65 $20.17 $23.05 $27.38 $24.92
Actual Net Asset Value 10.00 11.47 13.87 12.98 16.56 17.44 11.51 16.28 18.71 22.10 19.03
Year-End Market Price -- 11 12 1/8 10 5/8 12 7/8 15 5/8 9 1/2 13 1/4 14 7/8 19 7/8 17 5/8
</TABLE>
*Represents net investment income earned from February 15, 1985.
**Net asset value plus cumulative short-term capital gains and capital gains
taxes paid by the Fund.
5
<PAGE> 8
In recent years, there has been a remarkable narrowing both of the discount on
our Capital Shares and the premium on our Income Shares. Two years ago, the
Capital Shares sold in the market at a discount of -20.5% to their net asset
value; one year ago, the discount was -10.1%; today it is down to -7.4%. By
contrast, one year ago the Income Shares sold at a premium of +25.9%; today,
the premium is +12.4%. Combining the two classes, their aggregate market price
has remained virtually identical to their combined net asset values.
Both the discount on the Capital Shares and the premium on the Income
Shares should continue to narrow as the Fund approaches its "maturity date" of
January 31, 1997, when, in essence, the market price of each class of shares
will converge with its then- current net asset value. Shareholders should bear
this principle in mind in making their own evaluation of today's "fair market
value" of both classes of shares.
LOOKING AHEAD
In my Chairman's letter one year ago, I noted that "the 1993 rise in the
stock market is its eleventh in the past twelve years. The equity markets have
come a long way since the end of 1981. 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 validated that opinion, and, with stock yields almost as
low today, the possibility of further bumps cannot be ignored.
What should Gemini II investors do in this environment? Because of our
capital leverage, the Capital Shares of Gemini II are apt to be more volatile
than the overall stock market. Because of our income leverage, our Income Shares
should continue to provide higher yields than stocks in general. Your holdings
in either class (or both) should be considered in the light of the exposure of
your total investment portfolio to equities, bonds, and short-term reserves.
Whatever course you choose, we recommend that you focus not on annual
fluctuations in absolute and relative performance, but on the Fund's lifetime
record. Timing the markets is an inevitably fallible endeavor; therefore, we
believe that, provided your overall account is soundly balanced, "stay the
course" is virtually always the best advice. In our remaining two years, we
pledge to do the same.
Sincerely,
/s/ JOHN C. BOGLE
- -------------------
John C. Bogle
Chairman of the Board
January 24, 1995
Note: Mutual fund data from Lipper Analytical Services, Inc.
6
<PAGE> 9
REPORT FROM THE INVESTMENT ADVISER
We finished 1994 quite poorly, not only for the fourth quarter but for the
calendar year as well, as we limped in almost four percentage points behind the
S&P 500. Having said that, the 36 months is 560 basis points annually better
than the S&P, and the five years, which includes our very poor 1990, reflects
an average annual Gemini II total return of +9.8% versus +8.7% for the S&P.
The reason for the disappointment is the shadow of real and/or
perceived interest rate sensitivity in our stock concentrations. In
particular, the marketplace views banks as highly rate sensitive. This reflects
not only the traditional comparison versus bonds as an investment alternative
that all common stocks retain, but also the particular challenge for banks of
managing assets and liabilities capably during the very significant rise in
interest rates experienced over the last year.
Despite our income sympathy in Gemini II, we avoided the dark,
bottomless hole called utilities, as we fortunately chose our equities
importantly outside this area. On the other hand, we have an overlay of
high-yield bonds, and, far more importantly, 36% in convertible securities,
which suffer an obvious pressure from the 200 basis point increase in long
rates. This influence should eventually be overcome by the increase in the
common stocks underlying the convertibles. In the meantime, however, there is an
incubation period during which one is exposed to 1) interest rate vicissitudes
and 2) the potential decline in the premium over conversion parity that the
market is willing to pay as a result of the increase in interest rates.
All this is another way of saying that our convertibles did not serve us
very well in 1994, but should do better in the new year presupposing, as we do,
a more benign interest rate environment. In the interests of candor, though, it
should be mentioned that a couple of convertibles, making up about 5% of Gemini
II, did not measure up fundamentally because we have been wrong, so far, on the
common stock; that is to say, our analysis was faulty. However, convertibles
making up the other 31% of the portfolio are essentially on our fundamental
track.
One aspect of 1994 performance should not be overlooked, that is, our
grinding out a decent increment in the dividend to the income shareholder.
Despite our dilution of 3% from the capital gains tax paid at the beginning of
the year, we were able to increase the dividend from $1.66 to $1.73 in 1994, not
a mountainous increase but an increase of 4% nonetheless.
On a more personal note, I have been managing your Fund since its
inception in 1985 as well as the original Gemini from 1967 on. While my energy
level, prowess, and zest for the business continue on a high level, this will
not last forever. I have seen too many people, notably athletes, but others as
well, who stay "beyond their time." I have always vowed not to do the
aforementioned, as you the shareholders of Gemini II deserve the best.
Accordingly, I am planning to formally retire at the end of this year (December
31, 1995), although I will still be available in an advisory role for Wellington
Management Company and Vanguard.
I will be leaving behind a well-oiled team headed up by Chuck Freeman,
my alter-ego for 25 years, as well as Jim Averill and Jim Mordy, who will have
been part of the Gemini II team for more than ten years when I retire. In the
last couple of years, Dave Fassnacht has been a telling addition.
I am very confident that this group can continue to run Gemini II in an
accomplishing mode, not only because of their obvious skills, but also because
our low P/E, out-of-favor approach has stood the test of time. Also, Chuck
Freeman has often been exposed over these 25 years to, not only the good and bad
in the financial markets, but also to Windsor-Gemini's successful periods as
well as a couple of "rough patches." What is critical is how one conducts
oneself at "inflection points." This ability, along with the better part of the
odds for the low price-earnings side, will continue to be Gemini II Fund's key
advantages versus its brethren.
Respectfully,
John B. Neff, Managing Partner
Charles T. Freeman, Senior Vice President
Wellington Management Company
January 30, 1995
7
<PAGE> 10
FINANCIAL STATEMENTS
December 31, 1994
STATEMENT OF NET ASSETS
<TABLE>
<CAPTION>
Market
Value
Shares (000)+
- --------------------------------------------------------
<S> <C> <C>
COMMON STOCKS (62.2%)
- --------------------------------------------------------
BANKS (23.1%)
BankAmerica Corp. 100,766 $ 3,980
Bankers Trust New York Corp. 254,592 14,098
The Chase Manhattan Corp. 35,631 1,225
Chemical Banking Corp. 396,400 14,221
First Tennessee National Corp. 21,300 868
First Union Corp. 404,000 16,715
KeyCorp 584,189 14,605
NationsBank, Inc. 127,200 5,740
---------
GROUP TOTAL 71,452
---------
- --------------------------------------------------------
ELECTRIC UTILITIES (5.1%)
Unicom Corp. 658,937 15,815
---------
- --------------------------------------------------------
INSURANCE (11.1%)
Aetna Life & Casualty Co. 342,260 16,129
CIGNA Corp. 287,100 18,159
---------
GROUP TOTAL 34,288
---------
- --------------------------------------------------------
OIL (12.5%)
Atlantic Richfield Co. 188,500 19,180
Pennzoil Co. 165,000 7,280
USX-Marathon Group 427,100 6,994
Ultramar Corp. 203,400 5,187
---------
GROUP TOTAL 38,641
---------
- --------------------------------------------------------
RETAILERS (2.7%)
Kmart Corp. 654,800 8,512
---------
- --------------------------------------------------------
SAVINGS & LOAN (7.7%)
H. F. Ahmanson & Co. 703,100 11,337
Great Western Financial Corp. 787,796 12,605
---------
GROUP TOTAL 23,942
---------
- --------------------------------------------------------
TOTAL COMMON STOCKS
(Cost $201,965) 192,650
- --------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS (27.0%)
- --------------------------------------------------------
Advanced Micro
Devices, Inc. $3.00 171,000 8,892
Bethlehem Steel Corp.
$2.50 36,400 937
$3.50 100,000 5,000
$5.00 93,600 4,680
Chrysler Corp. $4.625 71,000 9,709
Citicorp 10.75% 73,000 8,386
Delta Air Lines $3.50 250,000 10,937
Ford Motor Co. $4.20 80,000 7,310
(1)Kaiser Aluminum $.65 1,391,000 11,128
Reynolds Metals $3.31 124,400 6,018
Santa Fe Energy Resources,
Inc. 8.25% 200,000 1,700
Sea Containers, Ltd. $4.00 124,400 5,023
Valero Energy $3.125 65,000 2,714
WHX Corp. 7.50% 30,000 1,275
- --------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(Cost $79,104) 83,709
- --------------------------------------------------------
BONDS (13.6%)
- --------------------------------------------------------
Face
Amount
(000)
-------
CONVERTIBLE (9.0%)
AMR Corp.
6.125%, 11/1/24 $ 4,000 3,200
Conner Peripherals
6.50%, 3/1/02 5,250 3,649
Continental Homes
6.875%, 3/15/02 3,406 2,623
Owens-Corning Fiberglas
8.00%, 12/30/05 3,000 3,300
Seagate Technology
6.75%, 5/1/12 11,000 9,130
Toll Corp.
4.75%, 1/15/04 4,420 3,006
U.S. Home
4.875%, 11/1/05 1,750 1,124
Western Digital
9.00%, 6/1/14 1,500 1,781
---------
GROUP TOTAL 27,813
---------
- --------------------------------------------------------
NON-CONVERTIBLE (4.6%)
Family Restaurants
0.00%, 2/1/04 3,000 1,590
Geneva Steel
11.125%, 3/15/01 7,000 6,580
Ryland Group
9.625%, 6/1/04 2,500 2,100
Weirton Steel Corp.
10.875%, 10/15/99 4,000 3,950
---------
GROUP TOTAL 14,220
---------
- --------------------------------------------------------
TOTAL BONDS
(Cost $41,758) 42,033
- --------------------------------------------------------
</TABLE>
8
<PAGE> 11
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- ------------------------------------------------------------
<S> <C> <C>
TEMPORARY CASH INVESTMENT (.3%)
- ------------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled Cash
Account, 5.90%, 1/3/95
(Cost $936) $ 936 $ 936
- ------------------------------------------------------------
TOTAL INVESTMENTS (103.1%)
(Cost $323,763) 319,328
- ------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-3.1%)
- ------------------------------------------------------------
Other Assets--Notes D and F 9,332
Federal Income Tax Payable (6,615)
Distribution Payable (4,696)
Other Liabilities--Note F (7,524)
--------
(9,503)
- ------------------------------------------------------------
NET ASSETS (100%) $309,825
============================================================
</TABLE>
+ See Note A to Financial Statements.
(1) Mandatory conversion June 30, 1996.
9
<PAGE> 12
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended
December 31, 1994
(000)
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INVESTMENT INCOME
INCOME
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 15,995
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,993
- ----------------------------------------------------------------------------------------------------------------------------
Total Income . . . . . . . . . . . . . . . . . . . . . . 20,988
- ----------------------------------------------------------------------------------------------------------------------------
EXPENSES
Investment Advisory Fee--Note C
Basic Fee . . . . . . . . . . . . . . . . . . . . . . . . . . $1,161
Performance Adjustment . . . . . . . . . . . . . . . . . . . . 319 1,480
------
The Vanguard Group--Note D . . . . . . . . . . . . . . . . . . . 423
Custodian's Fees . . . . . . . . . . . . . . . . . . . . . . . . 14
Taxes (other than income taxes) . . . . . . . . . . . . . . . . . 27
Auditing Fees . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Shareholders' Reports . . . . . . . . . . . . . . . . . . . . . . 39
Annual Meeting and Proxy Costs . . . . . . . . . . . . . . . . . 20
Directors' Fees and Expenses . . . . . . . . . . . . . . . . . . 2
- ----------------------------------------------------------------------------------------------------------------------------
Total Expenses . . . . . . . . . . . . . . . . . . . . . 2,013
- ----------------------------------------------------------------------------------------------------------------------------
Net Investment Income . . . . . . . . . . . . . . . . 18,975
============================================================================================================================
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Realized Net Gain on Investment Securities Sold . . . . . . . . . 18,900
Change in Unrealized Appreciation (Depreciation) . . . . . . . . (45,827)
- ----------------------------------------------------------------------------------------------------------------------------
Net Realized and Unrealized Loss on Investments . . . $(26,927)
============================================================================================================================
</TABLE>
10
<PAGE> 13
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
YEAR ENDED Year Ended
DECEMBER 31, 1994 December 31, 1993
(000) (000)
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCOME AVAILABLE FOR DISTRIBUTION
Balance, Beginning of Year . . . . . . . . . . . . . . . . . . . . $ 363 $ 327
Net Investment Income . . . . . . . . . . . . . . . . . . . . . . 18,975 18,164
Distributions to Income Shareholders
($1.73 and $1.66 per share, respectively) . . . . . . . . . . . (18,893) (18,128)
- ----------------------------------------------------------------------------------------------------------------------------
Balance, End of Year . . . . . . . . . . . . . . . . . . $ 445 $ 363
- ----------------------------------------------------------------------------------------------------------------------------
UNDISTRIBUTED CAPITAL GAINS
Balance, Beginning of Year . . . . . . . . . . . . . . . . . . . . $ 98,408 $ 79,344
Realized Net Gain on Investment Securities Sold . . . . . . . . . 18,900 29,329
Provision for Taxes on Capital Gains Retained . . . . . . . . . . (6,615) (10,265)
- ----------------------------------------------------------------------------------------------------------------------------
Balance, End of Year . . . . . . . . . . . . . . . . . . $ 110,693 $ 98,408
- ----------------------------------------------------------------------------------------------------------------------------
UNREALIZED APPRECIATION (DEPRECIATION)
OF INVESTMENT SECURITIES
Beginning of Year . . . . . . . . . . . . . . . . . . . . . . . . $ 41,392 $ 23,441
End of Year . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,435) 41,392
- ----------------------------------------------------------------------------------------------------------------------------
Change in Unrealized Appreciation (Depreciation) . . . . $ (45,827) $ 17,951
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
STATEMENT OF SHAREHOLDER'S EQUITY
<TABLE>
<CAPTION>
December 31, 1994
(000)
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C>
Income Shares, $1.00 Par Value--Redeemable at $9.30 per Share on January 31, 1997:
Authorized 15,000,000 Shares; Issued and Outstanding 10,920,550 Shares . . . . . . . . $ 10,920*
Capital Surplus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90,641*
Income Available for Distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . 445
- ----------------------------------------------------------------------------------------------------------------------------
102,006
- ----------------------------------------------------------------------------------------------------------------------------
Capital Shares, $1.00 Par Value; Authorized 15,000,000 Shares;
Issued and Outstanding 10,920,550 Shares . . . . . . . . . . . . . . . . . . . . . . . 10,920*
Capital Surplus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90,641*
Undistributed Capital Gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110,693
Unrealized Depreciation of Investment Securities . . . . . . . . . . . . . . . . . . . . (4,435)
- ----------------------------------------------------------------------------------------------------------------------------
207,819
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY . . . . . . . . . . . . . . . . . . . . . . . . . $ 309,825
- ----------------------------------------------------------------------------------------------------------------------------
*No change during year.
</TABLE>
11
<PAGE> 14
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------
For A Share Outstanding Throughout Each Year 1994 1993 1992 1991 1990
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INCOME SHARES
Net Asset Value, Beginning of Year . . . . . . $ 9.33 $ 9.33 $ 9.34 $ 9.34 $ 9.37
Net Investment Income . . . . . . . . . . . . 1.74 1.66 1.66 1.65 1.63
Distributions from Net Investment Income . . (1.73) (1.66) (1.67) (1.65) (1.66)
- ---------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR . . . . . . . . . . $ 9.34 $ 9.33 $ 9.33 $ 9.34 $ 9.34
=====================================================================================================================
CAPITAL SHARES
Net Asset Value, Beginning of Year . . . . . $ 22.10 $ 18.71 $ 16.28 $ 11.51 $ 17.44
Realized Net Gain on Investments . . . . . . 1.73 2.69 1.17 1.7 7.38
Distributions from Realized Capital Gains . . -- -- (.08) (.22) (.11)
Provision for Taxes on Capital Gains Retained (.61) (.94) (.37) (.53) (.09)
Unrealized Appreciation (Depreciation) . . . (4.19) 1.64 1.71 3.75 (6.11)
- ---------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR . . . . . . . . . . $ 19.03 $ 22.10 $ 18.71 $ 16.28 $ 11.51
=====================================================================================================================
</TABLE>
SUMMARY OF QUARTERLY RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Amounts in Thousands and Per Share (Unaudited)
------------------------------------------------------------------------------------
Three Months Ended
- ---------------------------------------------------------------------------------------------------------------------
March 31, 1994 June 30, 1994 September 30, 1994 December 31, 1994
------------------ --------------- ------------------- --------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net Investment Income $ 4,504 $ .41 $4,542 $.42 $5,123 $ .47 $ 4,806 $ .44
Net Realized Gain (Loss)
and Change in Unrealized
Appreciation (Depreciation) $(13,003) $(1.19) $9,433 $.86 $(2,140) $ (.19) $(21,217) $(1.94)
- ---------------------------------------------------------------------------------------------------------------------
March 31, 1993 June 30, 1993 September 30, 1993 December 31, 1993
------------------ --------------- ------------------- --------------------
Net Investment Income $ 4,332 $ .40 $4,311 $.39 $4,621 $ .42 $ 4,900 $ .45
Net Realized Gain (Loss)
and Change in Unrealized
Appreciation (Depreciation) $ 23,032 $ 2.11 $5,742 $.53 $21,301 $1.95 $ (2,795) $ (.26)
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
12
<PAGE> 15
NOTE TO FINANCIAL STATEMENTS
Gemini II is registered under the Investment Company Act of 1940 as a
diversified closed-end investment company. Certain of the Fund's investments
are in corporate debt instruments; the issuers' abilities to meet these
obligations may be affected by economic developments in their respective
industries.
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 amortized 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.
Realized net long-term gains, if any, on security transactions are retained
and applicable taxes thereon are accrued at the end of the Fund's fiscal
year (see Note B).
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, 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. Discounts and premiums on debt securities purchased are
amortized to interest income over the lives of the respective securities.
B. Income Shareholders are entitled to receive as distributions the higher of
$.80 per share (annually) or all of the net investment income available for
distribution. Income distributions to Capital Shareholders are prohibited as
long as any Income Shares remain outstanding. Capital Shareholders are entitled
to any net realized short-term gains on investment securities annually.
C. Under the terms of a contract expiring January 31, 1996, the Fund pays
Wellington Management Company a basic investment advisory fee calculated at an
annual percentage rate of average net assets of the Fund. The basic fee thus
computed is subject to quarterly adjustments based on performance relative to
the Standard & Poor's 500 Stock Index. For the year ended December 31, 1994,
the investment advisory fee represents an effective annual base rate of .34 of
1% of average net assets before an increase of $319,000 (.09 of 1%) based on
performance.
D. The Vanguard Group, Inc. furnishes at cost corporate management and
administrative, transfer agency, 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
$50,000 to Vanguard (included in Other Assets), representing .2% of Vanguard's
capitalization. The Fund's directors and officers are also directors and
officers of Vanguard.
13
<PAGE> 16
NOTE TO FINANCIAL STATEMENTS (continued)
Vanguard has requested the Fund's investment adviser to direct certain
portfolio trades, subject to obtaining the best price and execution, to brokers
who have agreed to rebate or credit to the Fund a portion of the commissions
generated. Such rebates or credits are used solely to reduce the Fund's
administrative expenses. For the year ended December 31, 1994, directed
brokerage arrangements reduced the Fund's expenses by $18,000 (.01 of 1% of
average net assets).
E. During the year ended December 31, 1994, the Fund made purchases of
$122,355,000 and sales of $117,069,000 of investment securities other than U.S.
Government securities and temporary cash investments. Purchases and sales of
U.S. Government securities were $7,343,000 and $15,431,000, respectively. At
December 31, 1994, unrealized depreciation for financial reporting and Federal
income tax purposes aggregated $4,435,000, of which $18,349,000 related to
appreciated securities and $22,784,000 related to depreciated securities.
F. The market value of securities on loan to broker/dealers at December 31,
1994, was $6,714,000, for which the Fund had received cash collateral of
$6,940,000.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors
Gemini II
In our opinion, the accompanying statements of net assets and shareholders'
equity and the related statements of operations and of changes in shareholders'
equity and the financial highlights present fairly, in all material respects,
the financial position of Gemini II (the "Fund") at December 31, 1994, the
results of its operations, the changes in its shareholders' equity 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
Philadelphia, Pennsylvania 19103
February 13, 1995
14
<PAGE> 17
SPECIAL TAX INFORMATION
CAPITAL SHAREHOLDERS:
Gemini II Capital Shares, of course, receive all capital appreciation (or
depreciation) from the Fund's investments, including any net capital gains that
are realized from the sale of portfolio securities. The net realized long-term
capital gains are retained in the value of the Capital Shares rather than being
distributed to shareholders. According to provisions of the Internal Revenue
Code, the Fund pays Federal income tax on these net realized long-term capital
gains at the corporate capital gains tax rate, and the amount of this tax is
deducted from the net asset value of the Capital Shares at year end.
As a result of this procedure, there are three important tax steps which
you, as a Capital Shareholder, should take:
1) You should report on your 1994 personal income tax return the net
long-term capital gains realized by your Fund during the year.
2) You should take credit for the Federal taxes paid by the Fund on these
realized gains. Since the effective personal capital gains tax rate
cannot exceed 28%, no inequity is created since you receive full credit
for the tax paid by the Fund.
3) You should increase the tax cost basis of your Capital Shares by the
amount of the after-tax gains. This is the difference between the amount
of net capital gains realized and the tax paid on these gains by the
Fund (see the table below).
Federal tax Form 2439, which you should receive by March 1, 1995,
provides for your account the specific amounts of realized capital gains and
corresponding taxes paid as discussed in 1) and 2) above. Enclosed with this
Form are specific instructions on how to record this information for tax
purposes, but please feel free to contact us if you have any questions regarding
taxes and your Gemini II Capital Shares. IF YOUR SHARES ARE HELD FOR YOU IN A
NOMINEE REGISTRATION AND YOU HAVE NOT AS YET RECEIVED TAX FORM 2439, YOU SHOULD
CONTACT YOUR BANK OR BROKER TO OBTAIN THE FORM. A copy must be filed with your
Federal income tax return.
The table below shows: the amount of net realized capital gains per
Capital Share; the Federal taxes paid on your behalf; the Fund's capital gains
tax rate; and the amount by which your cost per share should be increased for
fiscal years 1985 through 1994.
INCOME SHAREHOLDERS:
Additional Tax Information--For possible use in the preparation of your state
income tax return: 0.98% of your 1994 income was derived from direct U.S.
Government obligations.
Corporate shareholders should note that 81.6% of the 1994 income
qualifies for the intercorporate dividends received deduction.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Realized Long-Term Capital Gains
Per Capital Share
-------------------------------------------------------------------------------------------
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
REALIZED LONG-TERM
CAPITAL GAINS $.21 $2.66 $3.14 $.86 $.97 $.27 $1.56 $1.08 $2.69 $1.73
FEDERAL CAPITAL GAINS
TAXES PAID .06 .74 1.07 .29 .33 .09 .53 .37 .94 .61
(TAX RATE IN EFFECT) (28%) (28%) (34%) (34%) (34%) (34%) (34%) (34%) (35%) (35%)
NET AMOUNT BY
WHICH YOUR COST
SHOULD BE INCREASED .15 1.92 2.07 .57 .64 .18 1.03 .71 1.75 1.12
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
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.
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
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Vanguard Financial Center Valley Forge, Pennsylvania 19482
New Account Information: 1-(800) 662-7447 Shareholder Account Services: 1-(800) 662-2739
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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.
Q340-12/94
<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 Cumulative Performance Growth Stocks versus Value
Stocks, Standard & Poor's Growth Index and Standard & Poor's Value Index for
the period 1990-1994 at the top left of page two.
A bar chart depicting Gemini II Performance of Income Shares (Income
Per Share) and Capital Shares (Adjusted Net Asset Value) for the period
February 15, 1985 to December 31, 1994, including Average Annual Total Returns,
appears at the bottom of page five.
A running head featuring a map and a telescope appear on page seven.
A running head featuring a log book and pen appears on page eight
through fifteen.
A running head featuring a compass appears on page sixteen.
At the bottom of the inside back cover 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. A running head featuring a lantern appears on page nine.
