<PAGE> 1
VANGUARD
CONVERTIBLE
SECURITIES FUND
Annual Report
November 30, 1996
THE VANGUARD GROUP:
LINKING TRADITION
AND INNOVATION
At Vanguard, we treasure our rich nautical heritage--even as we steer our
course toward the twenty-first century. Our Report cover reflects that blending
of tradition and innovation, of past, present, and future. The montage includes
a bronze medallion with a likeness of our namesake, HMS Vanguard (Lord Nelson's
flagship at The Battle of the Nile); a clock built circa 1816 in Scotland,
featuring a portrait of Nelson (who is also shown, accepting a surrender, in a
detail from a nineteenth-century engraving); and several views of our recently
completed campus, which is steeped in nautical imagery--from our buildings named
after Nelson's warships (Victory, Majestic, and Goliath are three shown), to our
artwork and ornamental compass rose.
<PAGE> 2
[PHOTO]
VANGUARD HAS ALWAYS STRIVED TO BE THE STANDARD-BEARER for mutual fund
disclosure, going well beyond the "letter of the law" in our shareholder
communications. During the past year, we raised the standard once again by
rewriting and reformatting our Fund prospectuses. They are designed to ensure
that prospective investors fully understand, before they make an investment,
each Fund's investment strategies, risks, and costs. In that spirit, we have
redesigned our Annual Reports to shareholders, which provide a comprehensive
discussion and analysis of the year's results in the context of each Fund's
investment objectives and policies. Since Vanguard has long been recognized for
the quality and content of these Fund Reports, our overriding objective was to
maintain the character of the previous Reports, while adding information to
assist shareholders in understanding the investment characteristics of their
Fund.
THE NEW FUND REPORTS INCLUDE A MESSAGE TO SHAREHOLDERS from Chairman John C.
Bogle and President John J. Brennan. This Message continues to provide a candid
assessment of the Fund's performance relative to an appropriate unmanaged market
benchmark and a peer group of mutual funds with similar investment policies. It
also reviews the principal factors contributing to--and detracting from--the
returns earned by the Fund. To help you evaluate your Fund's current-year
performance, the Message includes a discussion of the Fund's long-term
investment results, as well as a look ahead to the prospects for the coming
year. A recap of the financial markets, which had been included as part of the
Chairman's letter, now appears in The Markets In Perspective. This overview
covers the world's financial markets, putting the results of the Fund's strategy
in a global perspective.
THE PORTFOLIO PROFILE REPRESENTS AN ADDITION TO OUR FUND REPORTS. In this day
and age, many investors use detailed statistical information to evaluate their
mutual fund holdings, and our new Portfolio Profile furnishes shareholders with
comprehensive data on key characteristics--sector diversification, volatility,
top-ten holdings, among others--that ultimately define how a Fund is likely to
perform in various market environments. For this information to be used
effectively, we include a brief description of the profiled characteristics. The
Report From The Adviser (for our traditionally managed Funds) now covers
specific topics that we have defined as being the important ones for the adviser
to address--and we do our best to ensure that this Report is written in the same
simple and candid manner that characterizes all Vanguard communications.
Finally, each Adviser's Report will include an inset reminder of the adviser's
basic investment philosophy.
WE TRUST THAT THIS REDESIGNED FUND REPORT will continue to meet your need for a
fair, candid, and clear presentation of your Fund's investment results and a
thorough portfolio review. We welcome any comments that you might have at any
time regarding these Reports.
CONTENTS
A Message To
Our Shareholders
1
The Markets
In Perspective
3
Report From
The Adviser
5
Performance
Summary
7
Portfolio
Profile
8
Financial
Statements
11
Report Of
Independent
Accountants
19
Directors And
Officers
INSIDE BACK COVER
<PAGE> 3
[PHOTO]
John C. Bogle
[PHOTO]
John J. Brennan
FELLOW SHAREHOLDER,
Vanguard Convertible Securities Fund's fiscal year ended November 30,
1996--our tenth full year of operations--was a pretty good period for
convertible securities. Although interest rates edged higher, causing
interest-sensitive securities to decline in value, the stock market enjoyed a
second consecutive year of banner returns. Our Fund provided a solid return of
+14.9%, albeit one that trailed our two competitive standards.
This table presents the Fund's total return (capital change plus reinvested
dividends) for the year compared with those of the average convertible
securities fund and our principal unmanaged benchmark, the Goldman Sachs
Convertible 100 Index. We also show the returns of the two indexes that we have
traditionally used as a proxy for the broad market environment: for stocks, the
Standard & Poor's 500 Composite Stock Price Index; for bonds, the Lehman
Aggregate Bond Index.
<TABLE>
<CAPTION>
- --------------------------------------------------
TOTAL RETURN
FISCAL YEAR ENDED
NOVEMBER 30, 1996
- --------------------------------------------------
<S> <C>
Vanguard Convertible Securities Fund +14.9%
- --------------------------------------------------
Average Convertible Securities Fund +15.9%
- --------------------------------------------------
Goldman Sachs Convertible 100 Index +15.2%
- --------------------------------------------------
S&P 500 Index +27.9%
Lehman Aggregate Bond Index + 6.1
- --------------------------------------------------
</TABLE>
The Fund's return is based on an increase in net asset value from $12.03
per share on November 30, 1995, to $13.07 per share on November 30, 1996, with
the latter figure adjusted for the reinvestment of four quarterly dividends
totaling $0.54 per share paid from net investment income, plus a December 1995
distribution of $0.14 per share from net realized capital gains. (Net realized
capital gains totaling $1.29 per share were distributed in December 1996.)
FISCAL 1996 PERFORMANCE OVERVIEW
The bull market in stocks continued during fiscal 1996, as investor optimism was
fueled by moderate economic growth, subdued inflation, and rising corporate
profits. The S&P 500 Index provided positive returns in every month except July
on the way to a return of +27.9%. Interest rates fluctuated considerably during
the fiscal year but ended it just a shade higher than where they began, leaving
bond prices a bit lower.
In this environment, the returns on convertible bonds--which are hybrid
securities exhibiting some of the characteristics of bonds and some of
stocks--were about midway between the returns of stocks and the returns of
intermediate-term bonds. The +14.9% return of Vanguard Convertible Securities
Fund was satisfying on an absolute basis but paled a bit when compared to the
+15.2% return of the Goldman Sachs Index and the +15.9% return of the average
convertible securities fund.
Although we generally try not to make too much of this kind of marginal
difference in performance over a one-year period, we want to be clear that the
Fund's performance in fiscal 1996 was impaired by the portfolio restructuring
conducted by our new investment adviser, Oaktree Capital Management. (Oaktree
assumed its management responsibilities on November 1, 1996, as noted in our
announcement to shareholders on October 2.)
1
<PAGE> 4
While it is difficult to precisely quantify the impact on the Fund, we estimate
that transaction costs associated with the restructuring represented a "drag" on
our performance of roughly 50 basis points (0.50%). What's more, security sales
increased our net realized capital gains by approximately $1.00 per share, to a
total of $1.29 per share.
These costs, while substantial, were in line with our expectations. We
believe they will be fully justified by enhanced relative returns in the future.
Now that the process of change is complete, the portfolio today fully reflects
Oaktree's investment decisions, and we will carefully evaluate its performance
from this point forward.
LONG-TERM PERFORMANCE OVERVIEW
The table below presents the Fund's record over the past decade compared to
those of the average convertible securities fund and the Goldman Sachs Index.
During this extended period, our Fund matched the results of its typical
competitor; however, both our Fund and its peers fell short of the return of the
Index.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------
TOTAL RETURN
10 YEARS ENDED NOVEMBER 30, 1996
-----------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- -----------------------------------------------------------------------
<S> <C> <C>
Vanguard Convertible Securities Fund+ 9.7% $25,319
- -----------------------------------------------------------------------
Average Convertible Securities Fund+ 9.7% $25,224
- -----------------------------------------------------------------------
Goldman Sachs Convertible 100 Index +10.2% $26,474
- -----------------------------------------------------------------------
</TABLE>
Our shortfall relative to the Index is more than accounted for by our
annual expense ratio (expenses as a percentage of average net assets) of 0.69%.
The Index is a theoretical construct that incurs none of the real-world costs of
fund management and administration. That said, we enjoy an annual expense
advantage of 0.81% over the average convertible securities fund, which had an
expense ratio of 1.50%. In other words, although we matched the performance of
our peers on a net (after-expense) basis over the past decade, we lagged our
peers on a gross basis. As we noted in prior Reports, we expect the Fund's
investment adviser to enhance the natural expense advantage we enjoy relative to
our competition. So, we hope and expect that the change in adviser will help to
achieve this objective.
We should emphasize, of course, that future returns on convertible
securities may be lower than those of the past decade, which was an extremely
favorable period for financial assets. Indeed, with yields on long-term bonds
considerably lower now than they were ten years ago, and with stock prices
seemingly at elevated levels based on several valuation measures, investors may
do well to temper their expectations.
IN SUMMARY
While no one can accurately predict what will happen in the financial markets
over the next decade--or even the next year--it seems unlikely that financial
assets will enjoy a repeat of the exceptional returns of the past 15 years. In
fact, there are sure to be some rough seas ahead. Nonetheless, we believe that
investors who maintain a balanced investment portfolio will be rewarded. "Stay
the course" has proved wise counsel in the past, and we see no reason why it
should not prove so in the future.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
Chairman of the Board President
December 20, 1996
2
<PAGE> 5
THE MARKETS IN PERSPECTIVE: FISCAL YEAR ENDED NOVEMBER 30, 1996
[PHOTO]
U.S. EQUITY MARKETS
Few investors would have expected the stock market over the past 12 months to
come close to matching the 37.0% return of the prior 12. Yet when the past two
fiscal years are considered cumulatively, the Standard & Poor's 500 Composite
Stock Price Index has risen 75.1%. Not surprisingly, many of the factors that
drove the market higher in 1995 were also in place this year. Once again, steady
economic growth and low inflation were powerful motivators.
The equity markets were decidedly "un-equitable," however, when it came to
size and sectors. Companies with larger market values, such as those that
dominate the S&P 500 Index, prevailed. In fact, even within the Index, it was
the largest companies that turned in the best performance. The 50 biggest
companies in the S&P 500 Index (which account for roughly half its market value)
gained 31.8% in the fiscal year ended November 30, compared with an increase of
27.9% for the entire Index. Looking at the S&P 500 Index's performance by
sector, financial stocks were strongest, closing the year with a 41.9% gain.
Technology stocks were a close second, gaining 39.3%. Utilities, plagued early
in the year by higher interest rates and a rapidly changing competitive
landscape, eked out a 4.4% return, the lowest within the Index.
With the largest companies performing so well, it was difficult for smaller
issues to keep pace. This was evidenced in the considerable difference between
the 27.9% return of the S&P 500 Index and the 16.5% return of the Russell 2000
Small Stock Index. Even for the smaller companies, there was a significant range
of performance among sectors. Energy stocks led the Russell 2000 Index with a
77.0% gain for the year. Here, rising prices, limited exposure to the cyclical
refining business, and a reduced number of competitors created a favorable
environment for the stocks. At the other end of the spectrum were health-care
stocks, which showed a loss of -0.4%.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED NOVEMBER 30, 1996
-------------------------------
1 YEAR 3 YEARS 5 YEARS
- ------------------------------------------------------------------------
<S> <C> <C> <C>
Equity
S&P 500 Index 27.9% 21.0% 18.2%
Russell 2000 Index 16.5 14.0 16.8
MSCI-EAFE Index 12.1 11.7 9.9
- ------------------------------------------------------------------------
Fixed-Income
Lehman Aggregate Bond Index 6.1% 6.5% 7.9%
Lehman 10-Year Municipal
Bond Index 5.7 6.2 8.0
Salomon 90-Day U.S. Treasury Bills 5.3 5.0 4.4
- ------------------------------------------------------------------------
Other
Consumer Price Index 3.2% 2.8% 2.9%
- ------------------------------------------------------------------------
</TABLE>
U.S. FIXED-INCOME MARKETS
As the fiscal year ended, the 30-year U.S. Treasury yield of 6.4% was modestly
higher than its 6.1% level on November 30, 1995. The relatively small difference
in these figures belies the turmoil endured by the fixed-income markets over the
past 12 months.
When the fiscal year began, "Steady as she goes" was the common wisdom.
Modest economic growth and benign inflation were expected to continue, giving
the Federal Re-
3
<PAGE> 6
serve no reason to move interest rates higher. That complacency was shattered by
an exceptionally strong February jobs report, the first of what turned out to be
a succession of signs that in fact the economy was growing at a much faster--and
potentially inflation-inducing--pace. The bond market reacted swiftly to
compensate for the perceived risk: The 30-year Treasury yield jumped from just
below 6.0% in late December to 6.7% in late March. The next several months saw a
consistent pattern in which bond yields rose on the Friday of the jobs-report
release only to fall back by the middle of the month. In reality, there was
little bite to the bark. Inflation, as measured by the Consumer Price Index,
remained near an annualized rate of 3.2%. And, as the fiscal year entered its
final quarter, evidence once again pointed to more "acceptable" levels of
growth. That--plus the market's satisfaction with the national election results
and prospects for budget action--helped bonds finish the fiscal year with a
strong rally.
The rally enabled the longer-maturity sectors of the market to overcome
performance deficits and finish the year with positive returns. Although the
specter of the Federal Reserve Board loomed large during the year, in fact the
Board acted only twice, lowering the federal funds rate by a total of 0.5%.
Corporate bonds, mortgage-backed issues, and municipals were three
relatively bright spots over the past year. The strength in earnings that
benefited stock prices extended to the corporate bond sector as well. These
bonds, especially those of lower credit quality, performed well relative to
Treasuries as there appeared to be little risk of skipped interest payments or
bankruptcy against the good earnings backdrop. The stable-to-rising
interest-rate environment throughout most of the year benefited another large
segment of the bond market--mortgages--as the threat of refinancings receded.
Finally, municipal bonds outpaced their U.S. Treasury counterparts. The sector
was shielded to a certain extent from the inflation wars of the Treasury market,
and demand outstripped supply for much of the year.
INTERNATIONAL EQUITY MARKETS
Concern about U.S. Federal Reserve Board policy appeared to drive global markets
as much as it did those in the United States. In aggregate, the markets rose
17.0%, as measured by the Morgan Stanley Capital International-Europe,
Australasia, Far East Index. A stronger dollar reduced this return to 12.1% for
U.S.-based investors.
Regionally, Europe's 22.9% return overshadowed the 1.4% generated by the
Pacific Basin. Europe's major markets continued to work toward the economic
targets that must be attained by 1999 under the Maastricht Treaty. This ongoing,
albeit bumpy, effort kept the continent's economic growth modest and gave
investors confidence. The Pacific region, of course, was dominated by the
influence of the Japanese market. Despite evidence of a strengthening economy
early in the year, Japan's market was shadowed by lingering problems in the
banking and real estate sectors and by tepid interest on the part of Japanese
investors. The dollar's appreciation against the yen had a significant impact on
returns, turning the year's 7.1% gain in yen into a -4.5% loss in dollars. In
contrast, the returns for a number of other countries in the region were quite
strong: for example, Hong Kong, 38.2%, and Malaysia, 31.8% (in U.S. dollars).
4
<PAGE> 7
REPORT FROM THE ADVISER
[PHOTO]
Having taken on the management of Vanguard Convertible Securities Fund on
November 1, we are pleased to write our first adviser's report. In it, we will
introduce our investment approach and set out what you should expect of us and
the Fund in the years to come.
The people who work at Oaktree Capital Management LLC began to manage
convertible-securities portfolios more than 18 years ago. Since then, we have
stuck to and refined our approach to convertibles.
First, our approach stresses recognizing what convertibles can do. In our
view, they are unlikely to outperform the stock market in bullish times or fall
badly behind in harsher environments. Instead, we think they can do reasonably
well under a wide variety of scenarios: Although they are rarely the best
performers, they are highly unlikely to be the worst. Thus, we view convertibles
as balanced, versatile, and defensive. It is our goal to put together portfolios
that will reflect these attributes--capturing the vast majority of the stock
market's rise when things go well and providing substantial protection should
prices turn down.
For these reasons, we never buy convertibles that will perform just like
stocks (nor as a rule do we buy stocks themselves, for that matter). These would
give us full participation if the market did well, but they would give us no
protection if it didn't. Likewise, we don't buy convertibles that will behave
just like non-convertible bonds; these offer great protection but no upside
potential. Rather, we buy only balanced convertibles that we expect to provide
good participation in market gains (but less than 100%) and good protection from
declines.
Second, we realize that even our portfolios won't work all the time. They
may not share in the upside every year nor protect against every decline, but we
think in the long run they will do almost as well as stocks with less risk and
more income. That's what we have accomplished in the past, and that's our goal
for the future.
That said, 1996 presented some challenges for investors in convertibles.
The stock market's gains were concentrated in a short list of prominent,
high-quality stocks that were not well represented in the convertible universe.
And convertibles have a tough time keeping up when the market streaks ahead as
it did in November.
The performance of Oaktree's convertible portfolios this year was very good
in the absolute and well ahead of the convertible benchmarks, but it trailed the
stock market indexes, as often happens when stocks have an excellent year. When
this has occurred in the past, what generally followed were periods when stock
market performance cooled off and the gains spread out to include a broader list
of stocks. Convertibles catch up at these times, and we think they are likely to
do so again.
We will position the Fund in securities we think are likely to do well in a
wide variety of markets. We will hold very few, if any, common stocks or
non-convertible bonds. Because of the versatility and defensive nature of
INVESTMENT PHILOSOPHY
The adviser believes that a reasonable level of current income and
long-term growth in capital can be achieved by investing in a broadly
diversified group of convertible securities that provide attractive combinations
of current income and potential for price appreciation from their convertibility
into common stock.
5
<PAGE> 8
our convertibles, we won't make allowances for future market movements by
raising or lowering cash reserves; thus the portfolios will always be nearly
fully invested--and thoroughly diversified in a large number of both industries
and individual securities.
We spent November repositioning our portfolios to reflect these policies.
In that process, we sold 60% of the Fund's October 31 holdings, including
substantial investments in common stocks and in convertibles that we thought
would act like either common stocks (without defensive characteristics) or
non-convertible bonds (without upside potential). We also sold securities that
did not fully satisfy our fundamental requirements.
With the proceeds, we purchased almost $100 million of convertibles that we
feel provide a balance of upside potential and downside protection. After these
transactions, 91.4% of the Fund's total net assets was invested in convertible
bonds and convertible preferred stocks. The restructuring is largely completed;
among the areas we have highlighted are technology, communications, and energy.
An example of the securities we have purchased in this period is the
Staples Inc. 4.5% convertible bond due to be repaid in full in 2000. Each $1,000
bond is convertible into 45.45 shares of Staples common stock. The price we
paid--$1,040 per bond--is only 14% above the value of the stock into which it is
convertible, and at that price (only 16% above what we think this bond would be
worth if it weren't convertible), its current yield is 4.3%. We believe that if
Staples stock appreciates, this bond will capture about 80% of the rise, whereas
if there is a correction, we will suffer only about 20% of the decline. To us,
this is a very attractive investment.
While past performance proves little about the future, our portfolios made
up of securities like the Staples bond have historically done almost as well as
stocks on average, and they have accomplished this with much less risk. This
record has been built during an unusually good 18-year period during which the
stock market, on balance, rose strongly. We think we will be able to keep it up
if the market continues to rise, and if it doesn't, we think the defensive
nature of our convertibles will serve us particularly well.
We look forward in future letters to further describing our approach and
the performance it produces.
Oaktree Capital Management LLC
December 9, 1996
6
<PAGE> 9
PERFORMANCE SUMMARY: CONVERTIBLE SECURITIES FUND
All of the data on this page represent past performance, which cannot be used to
predict future returns that may be achieved by the Fund. Note, too, that both
share price and return can fluctuate widely so that an investment in the Fund
could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: 6/17/86-11/30/96
- --------------------------------------------
CONVERTIBLE SECURITIES FUND GOLDMAN
SACHS*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- --------------------------------------------
<S> <C> <C> <C> <C>
1986 -2.0% 1.8% -0.2% 0.5%
1987 -19.0 4.2 -14.8 -5.1
1988 11.4 7.4 18.8 16.4
1989 10.7 7.0 17.7 9.4
1990 -16.3 5.4 -10.9 -12.8
1991 21.7 7.5 29.2 24.9
1992 19.9% 6.1% 26.0% 21.8%
1993 9.5 4.4 13.9 17.0
1994 -8.5 4.1 -4.4 -2.7
1995 11.9 5.2 17.1 25.9
1996 9.9 5.0 14.9 15.2
- --------------------------------------------
</TABLE>
*Goldman Sachs Convertible 100 Index.
See Financial Highlights table on page 16 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: 11/30/86-11/30/96
- ------------------------------------------------------------------------------------------------------
Convertible Securities Lipper Convertible Securities Goldman Sachs Convertible
<S> <C> <C> <C> <C>
1986 11 10000 10000 10000
1987 02 11051 10820 11137
1987 05 10434 10681 11225
1987 08 11023 11305 12194
1987 11 8518 9084 9490
1988 02 9853 10045 10834
1988 05 9751 10191 10977
1988 08 9916 10383 10994
1988 11 10123 10489 11042
1989 02 10665 11019 11818
1989 05 11627 11671 12369
1989 08 12334 12319 12671
1989 11 11915 11960 12083
1990 02 11593 11694 11523
1990 05 12351 12201 11995
1990 08 11125 11468 11176
1990 11 10611 10842 10542
1991 02 12159 12199 12098
1991 05 13295 13146 12945
1991 08 13716 13680 13297
1991 11 13714 13572 13171
1992 02 15739 14921 14820
1992 05 15655 15138 14977
1992 08 15849 15389 15337
1992 11 17280 16081 16041
1993 02 17592 16653 16821
1993 05 18519 17728 17796
1993 08 19036 18657 18533
1993 11 19677 18676 18762
1994 02 20075 19136 19423
1994 05 18808 18469 18557
1994 08 19491 19152 19271
1994 11 18821 18260 18253
1995 02 19080 18629 19089
1995 05 20103 20032 20702
1995 08 21639 21368 22327
1995 11 22040 21768 22977
1996 02 22562 22743 24167
1996 05 24140 23980 25172
1996 08 23857 23793 24938
1996 11 25319 25224 26474
</TABLE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED NOVEMBER 30, 1996
---------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CONVERTIBLE SECURITIES FUND 14.88% 13.05% 9.73% $25,319
AVERAGE CONVERTIBLE
SECURITIES FUND 15.88 13.20 9.69 25,224
GOLDMAN SACHS CONVERTIBLE
100 INDEX 15.22 14.99 10.23 26,474
- -------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED 9/30/96*
- -------------------------------------------------------------------------------------------
10 YEARS
INCEPTION -------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Convertible Securities Fund 6/17/86 15.41% 12.72% 4.44% 5.60% 10.04%
- -------------------------------------------------------------------------------------------
</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar
quarter as well as for the Fund's fiscal year end.
7
<PAGE> 10
PORTFOLIO PROFILE: CONVERTIBLE SECURITIES FUND
NOVEMBER 30, 1996
This Profile provides a snapshot of the Fund's characteristics, compared where
appropriate to an unmanaged index. Key elements of this Profile are defined on
pages 9 and 10.
<TABLE>
<CAPTION>
FINANCIAL ATTRIBUTES
- -------------------------------------------
<S> <C>
Number of Securities 73
Yield 2.9%
Conversion Premium 22.7%
Average Weighted Maturity 5.8 years
Average Coupon 4.3%
Average Quality Ba
Average Duration 4.9 years
Foreign Holdings 5.1%
Turnover Rate 97%
Expense Ratio 0.69%
Cash Reserves 5.4%
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- -------------------------------------------
CONVERTIBLE
SECURITIES S&P 500
- -------------------------------------------
<S> <C> <C>
R-Squared 0.52 1.00
Beta 0.68 1.00
</TABLE>
<TABLE>
<CAPTION>
DISTRIBUTION BY MATURITY (% OF PORTFOLIO)
- -------------------------------------------
<S> <C>
Under 1 Year --
1-5 Years 40.3%
5-10 Years 58.9
10-20 Years 0.8
20-30 Years --
Over 30 Years --
- -------------------------------------------
Total 100.0%
</TABLE>
<TABLE>
<CAPTION>
DISTRIBUTION BY CREDIT QUALITY (% OF PORTFOLIO)
- -----------------------------------------------
<S> <C>
Aaa --
Aa --
A 7.5%
Baa 24.9
Ba 13.9
B 41.1
Not Rated 12.6
- ----------------------------------------------
Total 100.0%
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- -------------------------------------------
<S> <C>
Home Depot Inc. 4.1%
Office Depot, Inc. 3.3
Magna International Inc. 2.9
International Paper 2.7
Comcast Corp. 2.5
Integrated Health Services, Inc. 2.3
Mutual Risk Management Ltd. 2.3
Berkshire Hathaway 2.2
Saks Holdings Inc. 2.1
Aspect Telecommunications Corp. 2.0
- -------------------------------------------
Top Ten 26.4%
</TABLE>
8
<PAGE> 11
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF PORTFOLIO)
- -------------------------------------------------------------------------------------------
NOVEMBER 30, 1995 NOVEMBER 30, 1996
---------------------------------------------
CONVERTIBLE SECURITIES CONVERTIBLE SECURITIES
---------------------------------------------
<S> <C> <C>
Basic Materials ........................... 10.0% 5.6%
Capital Goods & Construction .............. 9.5 8.2
Consumer Cyclical ......................... 25.8 27.5
Consumer Staples .......................... 0.8 5.2
Energy .................................... 4.8 7.1
Financial ................................. 18.1 13.6
Health Care ............................... 3.4 8.0
Technology ................................ 24.9 17.5
Transport & Services ...................... 2.7 1.9
Utilities ................................. -- 4.3
Miscellaneous ............................. -- 1.1
- -------------------------------------------------------------------------------------------
</TABLE>
[PHOTO]
AVERAGE COUPON. The average interest rate, expressed as a percentage of face
value, paid on the securities held by a portfolio.
AVERAGE DURATION. An estimate of how much a portfolio's share price will
fluctuate in response to a change in interest rates. To estimate the price
sensitivity of a portfolio, multiply its duration by the change in rates. If
interest rates rise by one percentage point, the share price of a portfolio with
an average duration of five years would decline by about 5%. If rates decrease
by a percentage point, the portfolio's share price would rise by 5%.
AVERAGE WEIGHTED MATURITY. The average length of time until securities held by a
portfolio reach maturity and are repaid. In general, the longer the average
weighted maturity, the more a portfolio's share price will fluctuate in response
to changes in market interest rates.
AVERAGE QUALITY. An indicator of credit risk, this figure is the average of the
credit ratings assigned to a portfolio's securities holdings by credit-rating
agencies. Agencies assign credit ratings after appraising an issuer's ability to
meet its obligations. Quality is graded on a scale, with Aaa indicating the most
creditworthy issuers.
9
<PAGE> 12
BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the fluctuations in the overall market (or appropriate market
index). The market, or index, has a beta of 1.00, so a portfolio with a beta of
1.20 would have seen its share price rise or fall by 12% when the overall market
rose or fell by 10%.
CASH RESERVES. The percentage of a portfolio's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing investments.
CONVERSION PREMIUM. The average percentage by which the weighted average market
price of the convertible securities held by a portfolio exceeds the weighted
average market price of their underlying common stocks. For example, if a stock
is trading at $25 per share and a bond convertible into the stock is trading at
a price equivalent to $30 per share of stock, the conversion premium is 20%
($5 / $25 = 20%).
DISTRIBUTION BY CREDIT QUALITY. An indicator of the risk of default or other
credit problems on securities held by a portfolio.
DISTRIBUTION BY MATURITY. An indicator of interest-rate risk. In general, the
higher the concentration of longer-maturity issues, the more a portfolio's share
price will fluctuate in response to changes in interest rates.
EXPENSE RATIO. The percentage of a portfolio's average net assets used to pay
its annual administrative and advisory expenses. These expenses directly reduce
returns to investors. The average expense ratio for a convertible securities
fund was 1.50% in 1995.
FOREIGN HOLDINGS. The percentage of a portfolio's investments represented by
securities of companies based outside the United States.
NUMBER OF SECURITIES. An indicator of diversification. The more separate
securities a portfolio holds, the less susceptible it is to a price decline
stemming from the problems of a particular security.
R-SQUARED. A measure of how much of a portfolio's past returns can be explained
by the returns from the overall market (or its benchmark index). If a
portfolio's total return were precisely synchronized with the overall market's
return, its R-squared would be 1.00. If a portfolio's returns bore no
relationship to the market's returns, its R-squared would be 0.
SECTOR DIVERSIFICATION. The percentage of a portfolio's securities invested in
each of the major industry classifications that compose the stock market.
TEN LARGEST HOLDINGS. The percentage of a portfolio's total net assets
represented by its ten largest security holdings. As this percentage rises, a
portfolio's returns are likely to be more volatile since its return is more
dependent on the fortunes of a few companies.
TURNOVER RATE. Indicates trading activity during the past year. Portfolios with
high turnover rates incur higher transaction costs and are more likely to
realize and distribute capital gains (which are taxable to investors).
YIELD. A snapshot of a portfolio's income from interest or dividends. The yield,
expressed as a percentage of a portfolio's net asset value, is based on income
earned by the portfolio over the past 30 days and is annualized, or projected
forward for the coming year.
10
<PAGE> 13
[PHOTO]
FINANCIAL STATEMENTS
NOVEMBER 30, 1996
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, preferred stocks, bonds,
etc.) and by industry sector. Other assets are added to, and liabilities are
subtracted from, the value of Total Investments to calculate the Fund's Net
Assets. Finally, Net Assets are divided by the outstanding shares of the Fund to
arrive at its share price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table displaying
the composition of the Fund's net assets on both a dollar and per-share basis.
Because all income and any realized gains must be distributed to shareholders
each year, the bulk of net assets consists of Paid in Capital (money invested by
shareholders). The amounts shown for Undistributed Net Investment Income and
Accumulated Net Realized Gains usually approximate the sums the Fund had
available to distribute to shareholders as income dividends or capital gains as
of the statement date. Any Accumulated Net Realized Losses, and any cumulative
excess of distributions over net income or net realized gains, will appear as
negative balances. Unrealized Appreciation (Depreciation) is the difference
between the market value of the Fund's investments and their cost, and reflects
the gains (losses) that would be realized if the Fund were to sell all of its
investments at their statement- date values.
<TABLE>
<CAPTION>
- ---------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
CONVERTIBLE SECURITIES FUND (000) (000)
- ---------------------------------------------------------
CONVERTIBLE BONDS (66.0%)
- ---------------------------------------------------------
<S> <C> <C>
CAPITAL GOODS & CONSTRUCTION (6.5%)
Hexcel Corp.
7.00%, 8/1/03 $1,000 $ 1,332
Thermo Electron Corp. Euro
4.25%, 1/1/03 1,600 1,800
Thermo Electron Corp.
4.25%, 1/1/03 1,000 1,125
Thermo Instrument Systems Inc.
4.50%, 10/15/03 3,000 3,120
Varlen Corp.
6.50%, 6/1/03 2,000 2,000
WMX Technologies Inc.
2.00%, 1/24/05 1,600 1,576
---------
10,953
---------
CONSUMER CYCLICAL (19.5%)
Hilton Hotels Corp.
5.00%, 5/15/06 1,600 1,754
Home Depot Inc.
3.25%, 10/1/01 5,000 4,937
Magna International Inc.
5.00%, 10/15/02 4,255 4,915
Marriott International Inc.
0.00%, 3/25/11 4,500 2,542
Office Depot, Inc.
0.00%, 12/11/07 8,900 5,529
Pep Boys (Manny, Moe, & Jack)
0.00%, 9/20/11 3,000 1,703
Saks Holdings Inc.
5.50%, 9/15/06 3,500 3,544
Scholastic Corp.
5.00%, 8/15/05 1,400 1,585
Speedway Motorsports Inc.
5.75%, 9/30/03 2,000 1,965
The Sports Authority Inc.
5.25%, 9/15/01 1,720 1,716
Staples Inc.
4.50%, 10/1/00 2,685 2,900
---------
33,090
---------
CONSUMER STAPLES (4.7%)
Comcast Corp.
3.375%, 9/9/05 4,700 4,277
Imax Corp.
5.75%, 4/1/03 500 490
Jacor Communications Inc.
0.00%, 6/12/11 4,500 1,907
Time Warner Inc.
0.00%, 12/17/12 3,550 1,331
---------
8,005
---------
ENERGY (4.9%)
Nabors Industries Inc.
5.00%, 5/15/06 1,000 1,270
Pennzoil Co.
4.75%, 10/1/03 1,880 2,204
Pogo Producing Co.
5.50%, 6/15/06 910 1,094
Seacor Holdings Inc.
5.375%, 11/15/06 1,650 1,914
Swift Energy Co.
6.25%, 11/15/06 1,715 1,887
---------
8,369
---------
</TABLE>
11
<PAGE> 14
<TABLE>
<CAPTION>
- ---------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
CONVERTIBLE SECURITIES FUND (000) (000)
- ---------------------------------------------------------
<S> <C> <C>
FINANCIAL (8.0%)
Banco de Galicia, S.A.
7.00%, 8/1/12 $2,500 $ 2,725
Berkshire Hathaway
1.00%, 12/3/01 4,160 3,775
Meditrust
6.875%, 11/15/98 2,000 2,040
Mutual Risk Management Ltd.
0.00%, 10/30/15 9,820 3,854
Penn Treaty America Corp.
6.25%, 12/1/03 1,100 1,133
---------
13,527
---------
HEALTH CARE (7.3%)
Alza Corp.
0.00%, 7/14/14 3,900 1,687
Integrated Health Services, Inc.
5.75%, 1/1/01 4,150 3,901
PhyCor Inc.
4.50%, 2/15/03 1,500 1,575
Renal Treatment Centers, Inc.
5.625%, 7/15/06 1,390 1,397
Tenet Healthcare Corp.
6.00%, 12/1/05 2,700 2,835
Vivra Inc.
5.00%, 7/1/01 1,000 1,048
---------
12,443
---------
TECHNOLOGY (11.2%)
Data General Corp.
7.75%, 6/1/01 1,000 1,007
General Instrument Corp.
5.00%, 6/15/00 1,989 2,126
Motorola, Inc.
0.00%, 9/27/13 4,630 3,299
National Data Corp.
5.00%, 11/1/03 2,830 2,844
Platinum Technology Inc.
6.75%, 11/15/01 2,600 2,847
Quantum Corp.
5.00%, 3/1/03 1,855 2,479
SynOptics Communications, Inc.
(Convertible into Bay Networks)
5.25%, 5/15/03 2,750 2,616
Xilinx Inc.
5.25%, 11/2/02 1,640 1,785
---------
19,003
---------
TRANSPORT & SERVICES (1.7%)
Continental Airlines, Inc.
6.75%, 4/15/06 2,600 2,873
---------
UTILITIES (1.2%)
Midcom Communications Inc.
8.25%, 8/15/03 2,000 2,040
---------
MISCELLANEOUS (1.0%)
ADT Corp.
0.00%, 7/6/10 2,865 1,730
---------
- ---------------------------------------------------------
TOTAL CONVERTIBLE BONDS
(Cost $111,313) 112,033
- ---------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ---------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS (25.4%)
- ---------------------------------------------------------
<S> <C> <C>
BASIC MATERIALS (5.1%)
Freeport McMoRan, Inc. 7.00% 58,800 $ 1,632
International Paper $2.625 95,000 4,536
- - Titanium Metals Corp. $3.125 50,400 2,570
---------
8,738
---------
CAPITAL GOODS & CONSTRUCTION (1.0%)
Owens Corning 6.50% 30,000 1,710
---------
Consumer Cyclical (5.6%)
- - Designer Finance 6.00% 18,900 850
Golden Books Financial Trust
8.75% 35,000 2,030
Hollinger International 9.75% 176,200 1,894
Kmart Financing 7.75% 40,400 2,035
- - News Corp. Ltd. 6.00% 11,500 1,087
- - Wendy's International, Inc.
Series A 5.00% 30,200 1,597
---------
9,493
---------
ENERGY (1.6%)
Unocal Corp. 6.25% 46,000 2,662
---------
FINANCIAL (4.5%)
Catellus Development Corp. $3.625 38,000 2,024
- - Insignia Financial 6.50% 35,900 1,876
Merrill Lynch & Co., Inc. 6.25% 44,400 1,721
- - Penncorp Financial Group, Inc.
$3.50 33,300 1,931
---------
7,552
---------
TECHNOLOGY (4.8%)
Globalstar Telecommunications
6.50% 43,000 2,473
- - Loral Space & Communications
Ltd. 6.00% 49,900 2,807
SFX Broadcasting Inc. 6.50% 25,000 1,106
- - Vanstar Financial Trust 6.75% 32,000 1,828
---------
8,214
---------
UTILITIES (2.8%)
AirTouch Communications, Inc.
Series C 4.25% 44,200 2,033
- - Cincinnati Bell, Inc. 6.25% 44,100 2,657
---------
4,690
---------
- ---------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(COST $41,696) 43,059
- ---------------------------------------------------------
COMMON STOCKS (3.3%)
- ---------------------------------------------------------
+ Aspect Telecommunications Corp. 63,196 3,444
Home Depot, Inc. 40,000 2,085
- ---------------------------------------------------------
TOTAL COMMON STOCKS
(COST $2,755) 5,529
- ---------------------------------------------------------
</TABLE>
12
<PAGE> 15
<TABLE>
<CAPTION>
- ---------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- ---------------------------------------------------------
<S> <C> <C>
TEMPORARY CASH INVESTMENT (5.2%)
- ---------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.71%, 12/2/96
(COST $8,918) $8,918 8,918
- ---------------------------------------------------------
TOTAL INVESTMENTS (99.9%)
(COST $164,682) 169,539
- ---------------------------------------------------------
OTHER ASSETS AND LIABILITIES (0.1%)
- ---------------------------------------------------------
Other Assets--Note C 8,320
Liabilities (8,135)
---------
185
- ---------------------------------------------------------
NET ASSETS (100%)
- ---------------------------------------------------------
Applicable to 12,988,172 outstanding
$.001 par value shares
(authorized 1,000,000,000 shares) $169,724
=========================================================
NET ASSET VALUE PER SHARE $13.07
=========================================================
</TABLE>
* See Note A in Notes to Financial Statements.
o Non-Income Producing Security. New issue that has not paid a dividend as of
November 30, 1996.
+ Non-Income Producing Security.
<TABLE>
<CAPTION>
- ---------------------------------------------------------
AMOUNT PER
(000) SHARE
- ---------------------------------------------------------
AT NOVEMBER 30, 1996, NET ASSETS CONSISTED OF:
- ---------------------------------------------------------
<S> <C> <C>
Paid in Capital--Note A $147,081 $11.33
Undistributed Net
Investment Income--
Notes A and D 1,033 .08
Accumulated Net Realized
Gains--Note D 16,753 1.29
Unrealized Appreciation--
Note E 4,857 .37
- ---------------------------------------------------------
NET ASSETS $169,724 $13.07
=========================================================
</TABLE>
13
<PAGE> 16
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the Fund during the
reporting period, and details the operating expenses charged to the Fund. These
expenses directly reduce the amount of investment income available to pay to
shareholders as dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
CONVERTIBLE SECURITIES FUND
YEAR ENDED NOVEMBER 30, 1996
(000)
- ----------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 1,926
Interest 4,786
- ----------------------------------------------------------------------------------------
Total Income 6,712
- ----------------------------------------------------------------------------------------
EXPENSES
Investment Advisory Fees--Note B 578
The Vanguard Group--Note C
Management and Administrative 457
Marketing and Distribution 30
Taxes (other than income taxes) 6
Custodian Fees 6
Auditing Fees 7
Shareholders' Reports 30
Annual Meeting and Proxy Costs 4
Directors' Fees and Expenses 1
--------
Total Expenses 1,119
- ----------------------------------------------------------------------------------------
NET INVESTMENT INCOME 5,593
- ----------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 17,085
- ----------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES (478)
- ----------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $22,200
========================================================================================
</TABLE>
14
<PAGE> 17
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the Fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information that is
detailed in the Statement of Operations. The amounts shown as Distributions to
shareholders from the Fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined on
a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the amount shareholders invested in the
Fund, either by purchasing shares or by reinvesting distributions, as well as
the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed
are shown at the end of the Statement.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
CONVERTIBLE SECURITIES FUND
YEAR ENDED NOVEMBER 30,
---------------------------
1996 1995
(000) (000)
- -----------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 5,593 $ 7,924
Realized Net Gain 17,085 1,884
Change in Unrealized Appreciation (Depreciation) (478) 17,030
---------------------------
Net Increase in Net Assets Resulting from Operations 22,200 26,838
---------------------------
DISTRIBUTIONS
Net Investment Income (7,267) (7,826)
Realized Capital Gain (1,993) (2,865)
---------------------------
Total Distributions (9,260) (10,691)
---------------------------
NET EQUALIZATION CHARGES--Note A -- (324)
---------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 32,298 22,103
Issued in Lieu of Cash Distributions 8,032 9,297
Redeemed (55,628) (50,607)
---------------------------
Net Decrease from Capital Share Transactions (15,298) (19,207)
- -----------------------------------------------------------------------------------------
Total Decrease (2,358) (3,384)
- -----------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 172,082 175,466
---------------------------
End of Year $169,724 $172,082
=========================================================================================
(1)Shares Issued (Redeemed)
Issued 2,601 1,995
Issued in Lieu of Cash Distributions 666 866
Redeemed (4,586) (4,586)
---------------------------
Net Decrease in Shares Outstanding (1,319) (1,725)
=========================================================================================
</TABLE>
15
<PAGE> 18
FINANCIAL HIGHLIGHTS
This table summarizes the Fund's investment results and distributions to
shareholders on a per-share basis. It also presents the Fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the Fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the Fund's total return; how much it costs to operate the Fund;
and the extent to which the Fund tends to distribute capital gains.
The table also shows the Portfolio Turnover Rate, a measure of trading
activity. A turnover rate of 100% means that the average security is held in the
Fund for one year. Finally, the table lists the Fund's Average Commission Rate
Paid, a disclosure required by the SEC beginning in 1996. This rate is
calculated by dividing total commissions paid on portfolio securities by the
total number of shares purchased and sold on which commissions were charged.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
CONVERTIBLE SECURITIES FUND
YEAR ENDED NOVEMBER 30,
----------------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1996 1995 1994 1993 1992
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $12.03 $10.94 $12.89 $11.77 $ 9.82
- -------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .43 .52 .53 .56 .56
Net Realized and Unrealized Gain (Loss) on Investments 1.29 1.26 (1.04) 1.03 1.92
----------------------------------------------------------
Total from Investment Operations 1.72 1.78 (.51) 1.59 2.48
----------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.54) (.51) (.53) (.47) (.53)
Distributions from Realized Capital Gains (.14) (.18) (.91) -- --
----------------------------------------------------------
Total Distributions (.68) (.69) (1.44) (.47) (.53)
- -------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $13.07 $12.03 $10.94 $12.89 $11.77
=========================================================================================================================
TOTAL RETURN 14.88% 17.10% -4.35% 13.87% 26.01%
=========================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $170 $172 $175 $202 $120
Ratio of Total Expenses to Average Net Assets 0.69% 0.75% 0.73% 0.71% 0.85%
Ratio of Net Investment Income to Average Net Assets 3.43% 4.63% 4.68% 4.44% 4.80%
Portfolio Turnover Rate 97% 46% 52% 81% 55%
Average Commission Rate Paid $.0594 N/A N/A N/A N/A
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE> 19
NOTES TO FINANCIAL STATEMENTS
Vanguard Convertible Securities Fund is registered under the Investment Company
Act of 1940 as a diversified open-end investment company, or mutual fund.
A. The following significant accounting policies conform to generally accepted
accounting principles for mutual funds. The Fund consistently follows such
policies in preparing its financial statements.
1. SECURITY VALUATION: Convertible securities are valued at the latest
quoted bid prices. Common stocks listed on an exchange are valued at the latest
quoted sales prices as of the close of trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on the valuation date. 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. EQUALIZATION: Prior to December 1995, the Fund followed the accounting
practice known as "equalization," under which a portion of the price of capital
shares issued and redeemed, equivalent to undistributed net investment income
per share on the date of the transaction, was credited or charged to
undistributed income. As a result, undistributed income per share was unaffected
by capital share transactions. As of December 1, 1995, the Fund discontinued
equalization accounting and has reclassified accumulated net equalization
credits of $816,000 from undistributed net investment income to paid in capital.
This reclassification has no effect on the Fund's net assets, results of
operations, or net asset value per share.
4. REPURCHASE AGREEMENTS: The Fund, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other party
to the agreement, retention of the collateral may be subject to legal
proceedings.
5. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
6. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date the securities are bought or sold.
Costs used to determine realized gains (losses) on the sale of investment
securities are those of the specific securities sold. Premiums and discounts on
debt securities purchased are amortized and accreted, respectively, to interest
income over the lives of the securities.
B. Under a contract that expires October 31, 1998, the Fund pays Oaktree Capital
Management LLC an investment advisory fee calculated at an annual percentage
rate of average net assets. Prior to November 1, 1996, Desai Capital Management,
Inc. served as adviser to the Fund. For the year ended November 30, 1996, the
aggregate investment advisory fee represented an effective annual rate of 0.35%
of the Fund's average net assets after giving effect to a fee waiver of $13,000
(0.01%) during the period January 1, 1996, to February 29, 1996.
C. The Vanguard Group 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 November 30,
1996, the Fund had contributed capital of $16,000 to Vanguard (included in Other
Assets), representing 0.1% of Vanguard's capitalization. The Fund's directors
and officers are also directors and officers of Vanguard.
17
<PAGE> 20
D. During the year ended November 30, 1996, the Fund purchased $153,584,000 of
investment securities and sold $177,847,000 of investment securities, other than
temporary cash investments. Gains of $313,000 on securities held less than one
year are treated as ordinary income for tax purposes and will be included in
income dividends to shareholders; accordingly, such gains have been reclassified
from accumulated net realized gains to undistributed net investment income.
E. At November 30, 1996, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $4,857,000,
consisting of unrealized gains of $8,078,000 on securities that had risen in
value since their purchase and $3,221,000 in unrealized losses on securities
that had fallen in value since their purchase.
18
<PAGE> 21
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Directors of
Vanguard Convertible Securities Fund
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard Convertible Securities Fund (the "Fund") at November 30, 1996, and the
results of its operations, the changes in its net assets and the financial
highlights for each of the periods indicated, 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 at November 30, 1996 by
correspondence with the custodian and the application of alternative auditing
procedures, provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
December 31, 1996
19
<PAGE> 22
SPECIAL 1996 TAX INFORMATION (UNAUDITED)
VANGUARD CONVERTIBLE SECURITIES FUND
This information for the fiscal year ended November 30, 1996, is included
pursuant to provisions of the Internal Revenue Code.
The Fund designates $11,165,000 as capital gain dividends (from net
long-term capital gains), which will be distributed in December 1996.
For corporate shareholders, 15.8% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received deduction.
All comparative mutual fund data are from Lipper Analytical Services, Inc. or
Morningstar unless otherwise noted.
20
<PAGE> 23
DIRECTORS AND OFFICERS
JOHN C. BOGLE, Chairman of the Board and Director
of The Vanguard Group, Inc. and of
each of the investment companies in
The Vanguard Group.
JOHN J. BRENNAN, President, Chief Executive Officer,
and Director of The Vanguard Group,
Inc. and of each of the investment
companies in The Vanguard Group.
ROBERT E. CAWTHORN, Chairman Emeritus and
Director of Rhone-Poulenc Rorer
Inc.; Director of Sun Company, Inc.
and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER, Director of The Great
Atlantic and Pacific Tea Co., Alco
Standard Corp., Raytheon Co.,
Knight-Ridder, Inc., and Massa-
chusetts Mutual Life Insurance Co.
BRUCE K. MACLAURY, President Emeritus of The
Brookings Institution; Director of
American Express Bank Ltd., The St.
Paul Companies, Inc., and National
Steel Corp.
BURTON G. MALKIEL, Chemical Bank Chairman's
Professor of Economics, Princeton
University; Director of Prudential
Insurance Co. of America, Amdahl
Corp., Baker Fentress & Co., The
Jeffrey Co., and Southern New
England Communications Co.
ALFRED M. RANKIN, JR., Chairman, President, and
Chief Executive Officer of NACCO
Industries, Inc.; Director of NACCO
Industries, The BFGoodrich Co., and
The Standard Products Co.
JOHN C. SAWHILL, President and Chief Executive
Officer of The Nature Conservancy;
formerly, Director and Senior Partner of
McKinsey & Co. and President of New
York University; Director of Pacific Gas
and Electric Co., Procter & Gamble
Co., and NACCO Industries.
JAMES O. WELCH, JR., Retired Chairman of
Nabisco Brands, Inc.; retired Vice
Chairman and Director of RJR
Nabisco; Director of TECO Energy,
Inc. and Kmart Corp.
J. LAWRENCE WILSON, Chairman and Chief Executive
Officer of Rohm & Haas Co.;
Director of Cummins Engine Co.;
Trustee of Vanderbilt University.
OTHER FUND OFFICERS
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.
RICHARD F. HYLAND, Treasurer; Principal of The
Vanguard Group, Inc.; Treasurer of
each of the investment companies in
The Vanguard Group.
KAREN E. WEST, Controller; Principal of The
Vanguard Group, Inc.; Controller of
each of the investment companies in
The Vanguard Group.
OTHER VANGUARD OFFICERS
ROBERT A. DISTEFANO, Senior Vice President,
Information Technology.
JAMES H. GATELY, Senior Vice President,
Individual Investor Group.
IAN A. MACKINNON, Senior Vice President,
Fixed Income Group.
F. WILLIAM MCNABB III, Senior Vice President,
Institutional.
RALPH K. PACKARD, Senior Vice President and
Chief Financial Officer.
[THE VANGUARD GROUP LOGO]
Please send your comments to us at:
Post Office Box 2600, Valley Forge, Pennsylvania 19482
Fund Information: 1-800-662-7447
Individual Account Services: 1-800-662-2739
Institutional Investor Services: 1-800-523-1036
[email protected] http://www.vanguard.com
All Vanguard Funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other expenses
and should be read carefully before investing or sending money. Prospectuses may
be obtained directly from The Vanguard Group.
(c) 1996 Vanguard Marketing Corporation, Distributor
<PAGE> 24
THE VANGUARD FAMILY OF FUNDS
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard/Windsor Fund
Vanguard/Windsor II
Vanguard Equity Income Fund
Vanguard Quantitative Portfolios
Vanguard Selected Value Portfolio
Vanguard/Trustees' Equity-U.S. Portfolio
Vanguard Convertible Securities Fund
BALANCED FUNDS
Vanguard/Wellington Fund
Vanguard/Wellesley Income Fund
Vanguard STAR Portfolio
Vanguard Asset Allocation Fund
Vanguard LifeStrategy Portfolios
GROWTH FUNDS
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
AGGRESSIVE GROWTH FUNDS
Vanguard Explorer Fund
Vanguard Specialized Portfolios
Vanguard Horizon Fund
INTERNATIONAL FUNDS
Vanguard International Growth Portfolio
Vanguard/Trustees' Equity-International
Portfolio
INDEX FUNDS
Vanguard Index Trust
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
Vanguard Bond Index Fund
Vanguard International Equity Index Fund
Vanguard Total International Portfolio
FIXED-INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Money Market Reserves
Vanguard Admiral Funds
INCOME FUNDS
Vanguard Fixed Income Securities Fund
Vanguard Admiral Funds
Vanguard Preferred Stock Fund
TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, NJ, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
Q820-11/96
