<PAGE> 1
GEMINI II
THIRD QUARTER REPORT
SEPTEMBER 30, 1996
<PAGE> 2
FELLOW SHAREHOLDER,
After a pullback in July, the stock market resumed its remarkable rise during
the three months ended September 30, the third quarter of Gemini II's 1996
fiscal year. The Fund's returns failed to keep pace with the exuberant rise in
the broad stock market during the past nine months.
During the quarter, Gemini II earned a total return (capital change plus
reinvested dividends) of +2.6%, bringing our total return for the first nine
months to +9.3%. While quite respectable on an absolute basis, our year-to-date
return trailed the returns of our two principal performance benchmarks, the
average value (growth and income) mutual fund and the unmanaged Standard &
Poor's 500 Composite Stock Price Index. The following table shows the total
return for the Fund and our evaluation standards.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
TOTAL RETURN
------------------------------
PERIODS ENDED
SEPTEMBER 30, 1996
------------------------------
THREE MONTHS NINE MONTHS
- -------------------------------------------------------------------------------
<S> <C> <C>
GEMINI II +2.6% + 9.3%
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AVERAGE VALUE MUTUAL FUND +2.9% +12.5%
STANDARD & POOR'S 500 INDEX +3.1 +13.5
- -------------------------------------------------------------------------------
</TABLE>
The Fund's total return is allocated so that 100% of the portfolio's capital
appreciation (or depreciation) is received by the Capital Shares, which
provided 50% of the Fund's initial capital. By the same token, 100% of the net
investment income is received by the Income Shares, which provided the
remaining 50% of the Fund's initial capital.
THE CAPITAL SHARE RESULTS
The net asset value of each Capital Share rose to $28.18 on September 30, 1996.
This represented an increase of +1.7% from the value of $27.71 on June 30,
1996, and an increase of +6.9% for the nine months since December 31, 1995,
when the net asset value was $26.35 per share. The price increase of +6.9% for
the nine months was well behind the price increase of +11.6% for the Standard &
Poor's 500 Index (excluding income). Our leverage factor--which helps our
performance in rising markets but hampers our performance in falling
markets--was 1.3 times on September 30, compared with 2.0 times at our
inception in February 1985. Our shortfall in capital return for the nine months
is largely
<PAGE> 3
explained by the significant contribution of income return to our total return,
as well as by our relatively defensive position in convertible securities and
cash.
THE INCOME SHARE RESULTS
During the quarter, we paid our regular quarterly dividend of $.35 per share,
bringing our total for the year to date to $1.05 per share. As in the past, we
expect to maintain this rate in the fourth quarter, and to pay an extra
year-end dividend that represents undistributed net income over and above the
four-quarter total of $1.40. Although we can offer no guarantee, we expect net
income for 1996 to be slightly higher than last year's total of $1.80 per
share.
PORTFOLIO STATISTICS
The following table shows the composition of our portfolio on September 30,
1996.
<TABLE>
<CAPTION>
- -------------------------------------------------------
PERCENTAGE OF NET ASSETS
- -------------------------------------------------------
<S> <C>
EQUITY EQUIVALENTS
COMMON STOCKS 44%
CONVERTIBLE SECURITIES 36
LOWER-GRADE BONDS 2
- -------------------------------------------------------
TOTAL EQUITY EQUIVALENTS 82%
- -------------------------------------------------------
TEMPORARY CASH INVESTMENTS 18%
- -------------------------------------------------------
TOTAL PORTFOLIO 100%
- -------------------------------------------------------
</TABLE>
This structure is quite similar, in general, to what it was at the end of our
second quarter.
PREMIUMS AND DISCOUNTS
The table below presents the current market discount for the Capital Shares and
the premium for the Income Shares, based on each class's net asset values and
the market price at which each class was trading on the New York Stock Exchange
on September 30. Since the end of 1995, the premium on the Income Shares has
narrowed almost to zero, while the discount on the Capital Shares has widened.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------
SEPTEMBER 30, 1996
------------------------------------------
NET ASSET MARKET
VALUE PRICE DIFFERENCE
- ------------------------------------------------------------------------
<S> <C> <C> <C>
CAPITAL SHARES $28.18 $26.50 -6.0%
INCOME SHARES 9.73* 9.75 +0.2
- ------------------------------------------------------------------------
TOTAL $37.91 $36.25 -4.4%
- ------------------------------------------------------------------------
</TABLE>
*Includes $.43 of undistributed income.
<PAGE> 4
GEMINI II TO MATURE
As planned in Gemini II's original operating structure, our Income Shares will
be redeemed on January 31, 1997, for $9.30 per share. We will send a separate
check representing accumulated and unpaid dividends for the period January 1
through January 31, 1997. Details, including instructions on how to redeem
shares, are contained in the letter that accompanies this Report.
On January 31, our Capital Shares will be the sole remaining class of
shares of Gemini II. As planned from the Fund's inception on February 15, 1985,
the Fund will be converted to an open-end investment company as soon as
practical after January 31. Details of this proposal will be provided to
holders of Capital Shares in the proxy materials we will send to you by
December 1996.
Sincerely,
/s/ JOHN C. BOGLE
John C. Bogle
Chairman of the Board
/s/ JOHN J. BRENNAN
John J. Brennan
President
October 10, 1996
Note: Mutual fund data from Lipper Analytical Services, Inc.
<PAGE> 5
INVESTMENTS
September 30, 1996
<TABLE>
<CAPTION>
Market
Value
Shares (000)
- --------------------------------------------------------------------------------
<S> <C> <C>
COMMON STOCKS (44.5%)
- --------------------------------------------------------------------------------
BASIC MATERIALS (2.0%)
- --------------------------------------------------------------------------------
British Steel PLC ADR 277,000 $ 8,449
- --------------------------------------------------------------------------------
CONSUMER CYCLICAL (10.1%)
- --------------------------------------------------------------------------------
Chrysler Corp. 830,622 23,777
Ford Motor Co. 571,653 17,864
--------------
SECTOR TOTAL 41,641
--------------
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ENERGY (3.6%)
- --------------------------------------------------------------------------------
Atlantic Richfield Co. 61,500 7,841
Pennzoil Co. 5,900 312
USX-Marathon Group 307,100 6,641
--------------
SECTOR TOTAL 14,794
--------------
- --------------------------------------------------------------------------------
FINANCIAL (26.7%)
- --------------------------------------------------------------------------------
BANKS (6.5%)
Chase Manhattan Corp. 50,600 4,054
First Union Corp. 166,300 11,101
KeyCorp 141,889 6,243
NationsBank Corp. 65,300 5,673
INSURANCE (5.4%)
CIGNA Corp. 67,600 8,104
GCR Holdings, Ltd. 435,000 10,494
IPC Holdings Ltd. 200,000 3,925
REAL ESTATE INVESTMENT
TRUSTS (7.1%)
Camden Property Trust REIT 125,000 3,203
Colonial Properties Trust REIT 74,600 1,958
Equity Residential
Properties Trust REIT 385,000 13,764
Evans Withycombe
Residential, Inc. REIT 195,000 4,266
Oasis Residential, Inc. REIT 180,000 3,937
Urban Shopping Centers REIT 82,800 2,018
SAVINGS & LOAN (7.7%)
H.F. Ahmanson & Co. 549,600 15,389
Great Western Financial Corp. 610,740 16,185
--------------
SECTOR TOTAL 110,314
--------------
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TRANSPORT & SERVICES (1.6%)
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Delta Air Lines, Inc. 93,161 6,708
--------------
- --------------------------------------------------------------------------------
UTILITIES (.5%)
- --------------------------------------------------------------------------------
Unicom Corp. 87,937 2,209
--------------
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost $136,084) 184,115
- --------------------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS (33.8%)
- --------------------------------------------------------------------------------
BASIC MATERIALS (26.2%)
- --------------------------------------------------------------------------------
CHEMICALS (4.5%)
Atlantic Richfield Co. 9.00% 785,500 18,459
METALS & MINING (7.1%)
Kaiser Aluminum 8.255% 979,400 10,896
Reynolds Metals 7.00% 401,400 18,464
PAPER (7.0%)
Boise Cascade Corp. $1.58 35,800 984
Bowater, Inc. 7.00% 534,000 16,888
International Paper Co. 5.25% 238,000 11,305
</TABLE>
<PAGE> 6
<TABLE>
<CAPTION>
Market
Value
Shares (000)
<S> <C> <C>
- --------------------------------------------------------------------------------
STEEL (7.6%)
AK Steel Holding 7.00% 574,500 $ 21,400
Bethlehem Steel Corp. $3.50 258,400 10,142
--------------
SECTOR TOTAL 108,538
--------------
- --------------------------------------------------------------------------------
CAPITAL GOODS & CONSTRUCTION (4.7%)
- --------------------------------------------------------------------------------
Beazer Homes 8.00% 370,000 9,204
Owens Corning Capital LLC
6.50% 200,000 10,400
--------------
SECTOR TOTAL 19,604
--------------
- --------------------------------------------------------------------------------
ENERGY (.2%)
- --------------------------------------------------------------------------------
Valero Energy $3.125 15,000 759
--------------
- --------------------------------------------------------------------------------
OTHER (2.7%) 11,100
--------------
- --------------------------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(Cost $139,540) 140,001
- --------------------------------------------------------------------------------
CONVERTIBLE BONDS (1.9%)
- --------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Face
Amount
(000)
--------
<S> <C> <C>
Quantum Corp.
6.375%, 4/1/02 $ 5,700 6,270
Toll Corp.
4.75%, 1/15/04 58 55
U.S. Home
4.875%, 11/1/05 1,750 1,426
- --------------------------------------------------------------------------------
TOTAL CONVERTIBLE BONDS
(Cost $7,084) 7,751
- --------------------------------------------------------------------------------
BONDS (2.3%)
- --------------------------------------------------------------------------------
Geneva Steel
11.125%, 3/15/01 7,000 5,950
Ryland Group
9.625%, 6/1/04 2,500 2,475
Weirton Steel Corp.
10.875%, 10/15/99 1,180 1,209
- --------------------------------------------------------------------------------
TOTAL BONDS
(Cost $10,655) 9,634
- --------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (16.6%)
- --------------------------------------------------------------------------------
U.S. GOVERNMENT & AGENCY OBLIGATIONS
Federal Home Loan Mortgage Corp.
5.28%, 10/18/96 20,000 19,950
COMMERCIAL PAPER
Abbott Laboratories
5.32%, 10/7/96 5,000 4,996
The Coca-Cola Co.
5.40%, 10/17/96 5,000 4,988
E.I. du Pont de Nemours & Co.
5.375%, 10/7/96 5,000 4,996
Harvard Univ.
5.30%, 10/1/96 5,000 5,000
Hewlett-Packard Co.
5.30%, 10/30/96 5,000 4,978
Kellogg Co.
5.28%, 10/8/96 5,000 4,994
Merck & Co., Inc.
5.42%, 10/15/96 5,000 4,990
MetLife Funding, Inc.
5.28%, 10/7/96 5,000 4,995
</TABLE>
<PAGE> 7
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)
- --------------------------------------------------------------------------------
<S> <C> <C>
Motorola Credit Co.
5.30%, 10/3/96 $ 5,000 $ 4,999
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.74%, 10/1/96 3,998 3,998
- --------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(Cost $68,886) 68,884
- --------------------------------------------------------------------------------
TOTAL INVESTMENTS (99.1%)
(Cost $362,249) 410,385
- --------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES--
NET (.9%) 3,642
- --------------------------------------------------------------------------------
NET ASSETS (100%) $414,027
================================================================================
</TABLE>
ADR--American Depository Receipt.
<PAGE> 8
THE VANGUARD FAMILY OF FUNDS
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Market Portfolio
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(CA, NJ, OH, PA)
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(CA, FL, NJ, NY, OH, PA)
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Securities Fund
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Shareholder Account Services: 1 (800) 420-8574
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.
Q343-9/96
