<PAGE> 1
VANGUARD
CONVERTIBLE
SECURITIES FUND
Annual Report - November 30, 1997
[PHOTO]
[THE VANGUARD GROUP LOGO]
<PAGE> 2
OUR CREW MAKES THE DIFFERENCE
Throughout our history, The Vanguard Group has received considerable attention
as the low-cost provider of mutual funds. While such accolades are gratifying,
we are most proud, not of our low operating expenses or the billions of dollars
we manage, but of our sterling reputation created by the Vanguard crew.
We recognize that it is our crew members--more than 6,000 highly
motivated men and women--who form the cornerstone of our operations. As with
any cornerstone, we could not survive long--let alone prosper--without it.
That's why we chose this fiscal year's annual report to celebrate the spirit,
enthusiasm, and achievements of our crew. (We call those who work at Vanguard
crew members, not employees, because they operate as a team to accomplish our
mission of serving you, our clients.)
But while we prize the collective contributions of our crew, we also
take time to recognize the importance of the individual. Each calendar quarter,
we present our Award For Excellence to a handful of crew members who have
demonstrated particular excellence in the performance of their jobs and who
embody "The Vanguard Spirit." Our report cover shows only a few of the more
than 300 crew members who have received this distinction since 1984.
They, along with the rest of our valiant crew, look forward to serving
you in the years ahead.
[PHOTO] [PHOTO]
John C. Bogle John J. Brennan
Chairman President
CONTENTS
<TABLE>
<S> <C>
A MESSAGE TO OUR SHAREHOLDERS . . . . . . . . . . . . . . . . . . . . . 1
THE MARKETS IN PERSPECTIVE . . . . . . . . . . . . . . . . . . . . . . 4
REPORT FROM THE ADVISER . . . . . . . . . . . . . . . . . . . . . . . . 6
PERFORMANCE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . 7
PORTFOLIO PROFILE . . . . . . . . . . . . . . . . . . . . . . . . . . 8
FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . 11
REPORT OF INDEPENDENT ACCOUNTANTS . . . . . . . . . . . . . . . . . . 18
</TABLE>
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
<PAGE> 3
FELLOW SHAREHOLDER,
Vanguard Convertible Securities Fund earned a solid return of +14.8% during the
fiscal year ended November 30, 1997, benefiting from an economic environment
that was good for bonds and very good for stocks. Bond prices rose
modestly--reflecting slightly lower interest rates--while strong economic
growth, low unemployment, and tame inflation provided an ideal setting for the
continuation of the U.S. stock market's remarkable run.
The table at right presents the Fund's total return (capital change
plus reinvested dividends) compared with those of the average convertible
securities fund and our principal unmanaged benchmark, the Credit Suisse First
Boston Convertible Securities Index. We also present the returns of two indexes
as proxies for the broad market environment: for stocks, the Standard & Poor's
500 Composite Stock Price Index; for bonds, the Lehman Brothers Aggregate Bond
Index.
As shown in the table, our Fund's return trailed those of our two
competitive standards.
Our total return is based on a change in net asset value from $13.07
on November 30, 1996, to $13.01 on November 30, 1997, adjusted for dividends
totaling $0.47 per share from net investment income and distributions totaling
$1.29 per share from net realized capital gains. At fiscal year-end, the Fund's
dividend yield was 4.30%.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
TOTAL RETURNS
FISCAL YEAR ENDED
NOVEMBER 30, 1997
- ----------------------------------------------------------------------
<S> <C>
Vanguard Convertible Securities Fund +14.8%
- ----------------------------------------------------------------------
Average Convertible Securities Fund +16.4%
- ----------------------------------------------------------------------
CS First Boston Convertibles Index +15.4%
- ----------------------------------------------------------------------
S&P 500 Index +28.5%
Lehman Aggregate Bond Index + 7.6
- ----------------------------------------------------------------------
</TABLE>
FISCAL 1997 PERFORMANCE OVERVIEW
The United States experienced something close to economic nirvana in fiscal
1997. Growth in corporate profits was robust, and the U.S. unemployment rate at
fiscal year-end was 4.6%, a 24-year low. Yet inflation decelerated and
long-term interest rates declined slightly on balance during the year.
The stock market rose sharply for the third consecutive year, although
it suffered some setbacks. Curiously, while the declines early in the fiscal
year were attributed mainly to anxiety about higher inflation, a sharp drop in
October stemmed from concern that economic problems in Asia might result in
deflation. Anxiety receded, however, in the face of continued good news from
economic statistics and corporate profit reports.
Bond prices fell and long-term interest rates rose during the first
half of the fiscal year, then reversed course in the second half. On balance,
the yield on the bellwether 30-year U.S. Treasury bond declined 30 basis points
(0.3 percentage point), ending the fiscal year at 6.05%. Short-term interest
rates fluctuated within a fairly narrow band, and on balance the yield on
three-month U.S. Treasury bills rose 7 basis points to 5.20%.
Convertible bonds and preferred stocks--hybrid securities that exhibit
characteristics of both equities and bonds--fared well during the period,
earning a return between those of stocks and of intermediate-term bonds, albeit
considerably closer to the (lower) bond return.
Our Fund's return of +14.8% for the fiscal year, while quite solid on
an absolute basis, fell short of the returns of its average competitor (+16.4%)
and its benchmark
1
<PAGE> 4
index (+15.4%). The reasons for our shortfall versus our average peer are
fairly straightforward. First, our competitors owned a higher percentage of
convertible preferred stocks, which benefited from strong demand during the
twelve months. (The prices of convertible preferred stocks are more volatile
than prices of convertible bonds.) Second, the average convertible fund held a
7% position in common stocks, while Vanguard Convertible Securities Fund held
no stocks. Obviously, during such a robust period for the stock market, even a
relatively light commitment to stocks was beneficial for our competitors.
We lagged the CS First Boston Convertibles Index because some of our
individual holdings performed poorly, and because the Index, unlike actual
mutual funds, incurs no operating or transaction costs. Our objective,
nonetheless, is to outpace this unmanaged list of large convertibles over time.
LONG-TERM PERFORMANCE OVERVIEW
The table below presents the performance of our Fund over the past decade,
compared with that of its benchmarks. During this period, the return of our
Fund outpaced that of its average peer; however, both fell short of the return
of the Index.
<TABLE>
<CAPTION>
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TOTAL RETURNS
10 YEARS ENDED NOVEMBER 30, 1997
---------------------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- -----------------------------------------------------------------------------------------------------
<S> <C> <C>
Vanguard Convertible Securities Fund +13.1% $34,127
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Average Convertible Securities Fund +12.4% $32,314
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CS First Boston Convertibles Index +13.5% $35,478
- -----------------------------------------------------------------------------------------------------
</TABLE>
The difference in expenses accounted for virtually all of our
performance advantage versus our average peer and for our shortfall versus the
CS First Boston Index. Our expense ratio (annual expenses as a percentage of
net assets) in fiscal 1997 was 0.67%, less than half the 1.54% expense ratio of
the average convertible securities fund, giving us a head start of more than
0.8 percentage point each year. The Index, as noted earlier, is a theoretical
construct that incurs none of the real-world costs of fund management and
administration.
We emphasize that we do not expect our long-term performance to simply
reflect our built-in cost advantage over our competitors. Rather, we expect the
Fund's investment adviser, Oaktree Capital Management (which just completed its
first full fiscal year at the Fund's helm), to provide returns that top those
of our peers before taking expenses into account. We expect Oaktree to meet the
high standard we have set for the Fund.
In reviewing these longer-term returns, it's important to understand
that the past decade has been a truly remarkable period for both stocks and
bonds. Long-term interest rates are near their lowest level in more than a
decade, and returns from stocks over the past ten years have been more than
1 1/2 times the long-term historical average. Consequently, it is prudent to
expect that returns over the next decade will be lower than those of the recent
past.
IN SUMMARY
When the rewards of investing are so visible, there is a danger that investors
will overlook the risks inherent in financial markets. The recent market
volatility in the United States and abroad--punctuated by October's sudden
slide--should serve as a reminder that risk is ever present. Suffice it to say
that investing is not a one-way street, a fact that the markets will make clear
from time to time.
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<PAGE> 5
Nonetheless, the greatest risk is not investing in the first place. We
believe that risk is best managed through a balanced investment program of
stocks, bonds, and reserves--including, in particular circumstances,
convertible securities--tailored to fit your objectives, financial situation,
tolerance for risk, and time horizon. If you have such a program in place, you
are prepared to "stay the course" toward your investment goals.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Chairman of the Board President
December 23, 1997
3
<PAGE> 6
THE MARKETS IN PERSPECTIVE
Year Ended November 30, 1997
U.S. EQUITY MARKETS
The fiscal year ended November 30 tested investors' mettle on a number of
occasions, but most ended on a positive note. The increasingly global nature of
investing has rarely been more in evidence than it was over the period. Turmoil
in Southeast Asia raised serious questions about future growth in the region
and, significantly, called into question the earnings outlook for U.S.
companies with exposure there.
Over the 12 months, large-capitalization stocks continued their
advance, propelling the S&P 500 Index to a 28.5% gain. Small-cap stocks also
fared well, as illustrated by the 23.4% increase of the Russell 2000 Index.
These gains withstood a rocky October, when the sharp declines in Asian markets
led many investors to question their expectations regarding U.S. equities.
Although the domestic market dropped substantially--the Dow Jones Industrial
Average fell 554 points, or 7.2%, on October 27--it then rebounded smartly over
the next few days.
Among large-cap stocks, the financial services sector was again one of
the best performers, with an increase of 34.8% in fiscal 1997. Also noteworthy
was a November surge in utility stocks, which brought that sector's 12-month
return up to 34.5%. Utilities, those seemingly perennial cellar-dwellers, were
boosted by a drop in interest rates and by a general consensus that their
valuations at last adequately reflected the risks associated with the new
competitive landscape. In the final quarter of the fiscal year, utility stocks
jumped 23.6%, roughly three times the return generated by the S&P 500 Index
(6.7%). In sharp contrast were a number of market sectors that felt the brunt
of the disarray in Asian economies and--while showing positive gains for the
year--turned in negative fourth fiscal quarters. As the fiscal year ended,
there were growing indications from technology and manufacturing companies that
the economic distress in Southeast Asia would likely reduce their current and
future earnings.
<TABLE>
<CAPTION>
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AVERAGE ANNUALIZED RETURNS
PERIODS ENDED NOVEMBER 30, 1997
-----------------------------------------------
1 YEAR 3 YEARS 5 YEARS
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
EQUITY
S&P 500 Index 28.5% 31.1% 20.2%
Russell 2000 Index 23.4 22.7 16.8
MSCI EAFE Index -0.1 6.5 11.6
- ------------------------------------------------------------------------------------------------------
FIXED INCOME
Lehman Aggregate Bond Index 7.6% 10.3% 7.6%
Lehman 10-Year Municipal Bond Index 7.1 10.3 7.5
Salomon Brothers Three-Month
U.S. Treasury Bill Index 5.2 5.4 4.7
- ------------------------------------------------------------------------------------------------------
OTHER
Consumer Price Index 1.8% 2.6% 2.6%
- ------------------------------------------------------------------------------------------------------
</TABLE>
While small-company stocks failed to match the outsized advance of the
S&P 500 Index, their performance grew notably stronger in the second half of
the fiscal year. For the year, the Russell 2000 Index gained 23.4%. During the
second six months, the Russell 2000's 13.8% essentially matched the S&P 500's
13.6%. The improved performance of smaller companies cannot be attributed to
any single factor, but is, rather, due to a combination of attractive
valuations and good earnings.
4
<PAGE> 7
U.S. FIXED-INCOME MARKETS
Bonds were overshadowed by stocks for much of the year. Investors' returns from
bonds, however, were quite respectable. As the year progressed, investors grew
more confident that four seemingly strange bedfellows--strong economic growth,
reasonable inflation, low unemployment, and stable wage growth--would continue
to coexist peacefully. As a result, when interest rates dipped noticeably
toward the fiscal year's end, they fell furthest for issues with the longest
maturities. The yield on the 30-year U.S. Treasury bond closed the fiscal year
at 6.05%, compared to 6.35% on November 30, 1996. Falling rates flattened the
yield curve considerably: Only 0.85% separated the yield on Treasury bills from
the yield on the 30-year issue, down from a spread of 1.22% at the previous
fiscal year-end.
The positive effect of the yield drop on bond prices was apparent in
the 7.6% return of the Lehman Aggregate Bond Index, the broadest measure of
investment-grade issues. Investors in lower-quality securities fared even
better, as shown by the 12.6% gain of the Lehman High Yield Bond Index. The
strength of the economy, together with the lack of inflationary pressure,
produced an ideal environment for junk bonds.
INTERNATIONAL EQUITY MARKETS
Arguably, investors' greatest disappointments were in international
markets--and, of course, Asian markets in particular. During the fiscal year,
the Morgan Stanley Capital International (MSCI) Pacific Index declined by 26.3%
in U.S. dollar terms; the index fell 17.3% in the fourth quarter alone. Among
individual markets, the fiscal year saw sharp declines (in U.S. dollar terms)
in Japan, down 24.5%, including a 16.1% drop in the fourth quarter; Hong Kong,
down 25%; Malaysia, down 68%; and Singapore, down 23%. The general slump in
Asian markets began in midsummer with currency devaluations by a number of
countries. Because the values of many of these currencies had been linked to
the U.S. dollar, their fall caused it to appreciate greatly--so much so that
Asian businesses soon found it difficult to purchase American-made products and
to repay dollar-denominated loans. This situation raised questions about how
the region's economic growth would be affected. Related worries focused on
imprudent aspects of various countries' financial systems and the probability
of corporate bankruptcies. In short, there was no place to hide.
By contrast, the European markets continued to provide U.S. investors
with solid returns, although they, too, stumbled in late October and recovered
in November. The MSCI Europe Index posted a gain of 21.8% for the 12 months.
The robust character of the European markets reflects strong corporate earnings
and optimism that the European Monetary Union will provide a solid framework
for future fiscal responsibility and economic growth.
5
<PAGE> 8
REPORT FROM THE ADVISER
It is our pleasure to make this report to investors in Vanguard Convertible
Securities Fund for the fiscal year ended November 30, 1997. Since taking over
as portfolio managers of the Fund in late 1996, we have significantly
restructured its holdings with a focus exclusively on convertible securities.
For the 6- and 12-month periods ended November 30, we were reasonably
pleased with the Fund's performance both on an absolute basis and relative to
its comparative benchmarks. On balance, the period was a rewarding one for
investors in the Fund. Our return fell just shy of the return of the CS First
Boston Convertible Securities Index, a widely recognized indicator of the
convertible market's performance. Our relative performance was hurt by our
usual underweighting in convertible preferreds, since these riskier
securities--more volatile both in stock market upturns and
downturns--substantially outperformed convertible bonds in both the 6- and
12-month periods. In addition, a few individual bond holdings performed poorly
during the fiscal year because of negative developments for their issuers. On
the other hand, the Fund benefited from a number of convertible holdings that
we selected because they were cheap on a statistical basis. Many of these
holdings quickly proved their merit.
The second half of the fiscal year could best be described as both the
best of times and the worst of times, with the booming financial markets struck
by a sudden case of Asian flu late in the period. This change in psychology
sparked unusual volatility in the financial markets, including convertible
securities, both on a month-to-month basis and--especially--on an intraday
basis. This heightened volatility caused us to be fairly active in managing the
Fund. A very brisk new-issue calendar provided the opportunity to acquire
several attractively priced convertible securities. After the recent market
correction, several pending deals were repriced to reflect investor demand for
higher coupons and/or lower conversion premiums. In a few cases, the
underwriters became the owners of new convertible issues whose prices were
unappealing to buyers.
Overall, our strategy throughout this period has been to maintain a
discipline of taking profits on highly appreciated issues and investing the
proceeds in securities that we believe have the desired balance of potential
for equity appreciation and strong fixed-income properties, which provide some
protection from stock-market downturns.
The Fund today remains well diversified, with more than 90 issues
representing a wide variety of industrial groups. Convertible bonds with
intermediate-term maturities remain the dominant category. These will continue
to be our primary focus, and we will persist in restricting our holdings to
convertible securities that we believe offer a clear imbalance of upside
potential over downside risk.
Oaktree Capital Management LLC
December 9, 1997
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.
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: JUNE 17, 1986-NOVEMBER 30, 1997
- ---------------------------------------------------------------------------------
CONVERTIBLE SECURITIES FUND FIRST
BOSTON*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- ---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1986 -2.0% 1.8% -0.2% 1.6%
1987 -19.0 4.2 -14.8 -5.4
1988 11.4 7.4 18.8 16.5
1989 10.7 7.0 17.7 16.3
1990 -16.3 5.4 -10.9 -8.7
1991 21.7 7.5 29.2 24.6
1992 19.9 6.1 26.0 21.7
1993 9.5 4.4 13.9 19.2
1994 -8.5 4.1 -4.4 -3.9
1995 11.9 5.2 17.1 24.0
1996 9.9 5.0 14.9 15.3
1997 10.6 4.2 14.8 15.4
- ---------------------------------------------------------------------------------
</TABLE>
*CS First Boston Convertibles Index.
See Financial Highlights table on page 16 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: NOVEMBER 30, 1987-NOVEMBER 30, 1997
- --------------------------------------------------------------------------------
Convertible Average CS First Boston
Securities Convertible Convertibles
Fund Securities Fund Index
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
1987 11 10000 10000 10000
1988 02 11567 11032 11298
1988 05 11448 11196 11379
1988 08 11642 11360 11487
1988 11 11885 11547 11651
1989 02 12522 12101 12454
1989 05 13650 12821 13304
1989 08 14480 13478 13885
1989 11 13989 13166 13546
1990 02 13611 12843 13195
1990 05 14500 13404 13733
1990 08 13061 12547 12812
1990 11 12458 11935 12370
1991 02 14276 13398 13985
1991 05 15609 14442 14902
1991 08 16103 14967 15598
1991 11 16101 14940 15413
1992 02 18479 16387 17208
1992 05 18380 16630 17592
1992 08 18607 16837 17834
1992 11 20288 17703 18761
1993 02 20654 18289 19843
1993 05 21742 19476 20937
1993 08 22349 20413 21939
1993 11 23102 20560 22367
1994 02 23568 21016 23017
1994 05 22082 20290 21724
1994 08 22883 20954 22519
1994 11 22097 20101 21501
1995 02 22400 20459 22344
1995 05 23601 22006 24146
1995 08 25405 23378 26185
1995 11 25876 23963 26656
1996 02 26489 24976 28132
1996 05 28342 26344 29677
1996 08 28009 26032 28879
1996 11 29725 27768 30747
1997 02 30423 28396 31320
1997 05 31327 29800 32416
1997 08 33742 31988 35212
1997 11 34127 32314 35478
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</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED NOVEMBER 30, 1997
---------------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Convertible Securities Fund 14.81% 10.96% 13.06% $34,127
Average Convertible Securities Fund 16.37 12.79 12.44 32,314
CS First Boston Convertibles Index 15.39 13.59 13.50 35,478
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED SEPTEMBER 30, 1997*
- --------------------------------------------------------------------------------------------------------------------------
10 YEARS
INCEPTION ----------------------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Convertible Securities Fund 6/17/1986 18.89% 12.73% 5.31% 5.50% 10.81%
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
7
<PAGE> 10
PORTFOLIO PROFILE
Convertible Securities Fund
This Profile provides a snapshot of the Fund's characteristics as of November
30, 1997, 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 98
Yield 4.3%
Conversion Premium 31.3%
Average Weighted Maturity 5.6 years
Average Coupon 4.6%
Average Quality Ba
Average Duration 4.1 years
Foreign Holdings 5.5%
Turnover Rate 182%
Expense Ratio 0.67%
Cash Reserves 3.4%
</TABLE>
<TABLE>
<CAPTION>
DISTRIBUTION BY CREDIT QUALITY (% OF PORTFOLIO)
- --------------------------------------------
<S> <C>
Aaa/AAA 0.0%
Aa/AA 0.0
A/A 7.0
Baa/BBB 18.8
Ba/BB 11.8
B/B 39.1
Less than B/B 2.3
Not Rated 21.0
- --------------------------------------------
Total 100.0%
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- ------------------------------------------
CONVERTIBLE
SECURITIES S&P 500
- ------------------------------------------
<S> <C> <C>
R-Squared 0.43 1.00
Beta 0.50 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- ------------------------------------------
<S> <C>
Loews Corp. 2.5%
USA Waste Services Inc. 2.5
Rite Aid Corp. 2.3
Loral Space & Communications Ltd. 2.2
Thermo Electron Corp. 2.1
Kmart Financing 1.9
Evergreen Media Corp. 1.9
U.S. Filter Corp. 1.9
CUC International, Inc. 1.8
Ralston Purina Co. 1.8
- ------------------------------------------
Top Ten 20.9%
</TABLE>
<TABLE>
<CAPTION>
DISTRIBUTION BY MATURITY (% OF PORTFOLIO)
- ---------------------------------------
<S> <C>
Under 1 Year 4.9%
1-5 Years 40.7
5-10 Years 54.4
10-20 Years 0.0
20-30 Years 0.0
Over 30 Years 0.0
- ---------------------------------------
Total 100.0%
</TABLE>
8
<PAGE> 11
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF PORTFOLIO)
- ------------------------------------------------------------------------------------------
NOVEMBER 30, 1996 NOVEMBER 30, 1997
-----------------------------------------------
CONVERTIBLE SECURITIES CONVERTIBLE SECURITIES
-----------------------------------------------
<S> <C> <C>
Auto & Transportation . . . . . . . . . 5.0% 4.7%
Consumer Discretionary . . . . . . . . . 26.8 31.3
Consumer Staples . . . . . . . . . . . . 1.0 4.3
Financial Services . . . . . . . . . . . 14.6 4.6
Health Care . . . . . . . . . . . . . . 10.3 12.7
Integrated Oils . . . . . . . . . . . . 0.0 0.0
Other Energy . . . . . . . . . . . . . . 3.2 9.1
Materials & Processing . . . . . . . . . 5.0 0.4
Producer Durables . . . . . . . . . . . 17.7 12.5
Technology . . . . . . . . . . . . . . . 1.2 9.1
Utilities . . . . . . . . . . . . . . . 2.6 11.3
Other . . . . . . . . . . . . . . . . . 12.6 0.0
- ------------------------------------------------------------------------------------------
</TABLE>
AVERAGE COUPON. The average interest rate paid on the securities held by a
portfolio. It is expressed as a percentage of face value.
AVERAGE DURATION. An estimate of how much a bond portfolio's share price will
fluctuate in response to a change in interest rates. To see how the price
could shift, multiply the portfolio's 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 (or are called) 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
ratings assigned to a portfolio's securities holdings by credit-rating
agencies. The agencies make their judgment after appraising an issuer's ability
to meet its obligations. Quality is graded on a scale, with Aaa or AAA
indicating the most creditworthy bond issuers.
9
<PAGE> 12
BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned 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 securities.
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. This breakdown of a portfolio's securities by
credit rating can help in gauging the risk that returns could be affected by
defaults or other credit problems.
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.
FOREIGN HOLDINGS. The percentage of a portfolio's net assets 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 percentages of a portfolio's securities that come
from each of the major industry groups that compose the stock market.
TEN LARGEST HOLDINGS. The percentage of net assets that a portfolio has
invested in its ten largest holdings. As this percentage rises, a portfolio's
returns are likely to be more volatile, because they are more dependent on the
fortunes of a few companies.
TURNOVER RATE. An indication of trading activity during the past year.
Portfolios with high turnover rates incur higher transaction costs and are more
likely to distribute capital gains (which are taxable to investors).
YIELD. A snapshot of a portfolio's income from interest and dividends. The
yield, expressed as a percentage of the portfolio's net asset value, is based
on income earned over the past 30 days and is annualized, or projected forward
for the coming year.
10
<PAGE> 13
FINANCIAL STATEMENTS
November 30, 1997
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 (67.3%)
- --------------------------------------------------------------------------------------
<S> <C> <C>
AUTO & TRANSPORTATION (3.6%)
Magna International
5.00%, 10/15/2002 $1,835 $ 2,236
MascoTech Inc.
4.50%, 12/15/2003 3,045 2,664
(1) Tower Automotive Inc.
5.00%, 8/1/2004 1,945 1,926
----------
6,826
----------
CONSUMER DISCRETIONARY (21.9%)
CapStar Hotel Co.
4.75%, 10/15/2004 2,205 2,293
COREStaff Inc.
2.94%, 8/15/2004 3,505 2,944
CUC International, Inc.
3.00%, 2/15/2002 3,055 3,460
(1) Fine Host Corp.
5.00%, 11/1/2004 2,505 2,330
Hilton Hotels Corp.
5.00%, 5/15/2006 2,375 2,684
Home Depot, Inc.
3.25%, 10/1/2001 540 711
(1) HomeBase, Inc.
5.25%, 11/1/2004 2,615 2,707
IMAX Corp.
5.75%, 4/1/2003 1,065 1,390
(1) The Interpublic Group of Cos., Inc.
1.80%, 9/16/2004 3,045 2,485
Jacor Communications, Inc.
0.00%, 6/12/2011 3,430 2,109
Mail-Well, Inc.
5.00%, 11/1/2002 2,320 2,453
News America Holdings Inc.
0.00%, 3/11/2013 6,510 3,027
(1) Premiere Technologies, Inc.
5.75%, 7/1/2004 1,940 1,901
(1) Scandinavian Broadcasting
7.00%, 12/1/2004 1,185 1,191
Tele-Communications International
4.50%, 2/15/2006 950 786
Time Warner Inc.
0.00%, 6/22/2013 6,390 3,163
USA Waste Services Inc.
4.00%, 2/2/2002 4,575 4,712
WMX Technologies Inc.
2.00%, 1/24/2005 1,325 1,106
----------
41,452
----------
CONSUMER STAPLES (2.3%)
(1) Rite Aid Corp.
5.25%, 9/15/2002 3,870 4,373
----------
ENERGY (6.0%)
(1) Halter Marine Group, Inc.
4.50%, 9/15/2004 1,300 1,430
(1) Key Energy Group, Inc.
5.00%, 9/15/2004 955 866
Loews Corp. (Convertible into
Diamond Offshore)
3.125%, 9/15/2007 4,710 4,739
(1) Lomak Petroleum, Inc.
6.00%, 2/1/2007 630 715
Parker Drilling Corp.
5.50%, 8/1/2004 1,365 1,515
</TABLE>
11
<PAGE> 14
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
CONVERTIBLE SECURITIES FUND (000) (000)
- --------------------------------------------------------------------------------------
<S> <C> <C>
Pogo Producing Co.
5.50%, 6/15/2006 $1,045 $ 1,035
SEACOR Holdings, Inc.
5.375%, 11/15/2006 1,020 1,107
---------
11,407
---------
FINANCIAL SERVICES (0.4%)
Paliburg International Finance
3.50%, 2/6/2001 1,105 823
---------
HEALTH CARE (11.4%)
ALZA Corp.
0.00%, 7/14/2014 3,250 1,406
5.00%, 5/1/2006 1,705 1,671
Assisted Living Concepts, Inc.
6.00%, 11/1/2002 2,350 2,409
(1) Atria Communities, Inc.
5.00%, 10/15/2002 1,685 1,708
(1) CareMatrix Corp.
6.25%, 8/15/2004 1,640 1,739
(1) ESC Medical Systems Ltd.
6.00%, 9/1/2002 1,900 1,940
(1) Heartport, Inc.
7.25%, 5/1/2004 1,180 1,189
NCS HealthCare, Inc.
5.75%, 8/15/2004 1,830 1,857
PhyCor, Inc.
4.50%, 2/15/2003 2,595 2,433
Renal Treatment Centers, Inc.
5.625%, 7/15/2006 1,950 2,232
Sunrise Assisted Living, Inc.
5.50%, 6/15/2002 1,170 1,346
Tenet Healthcare Corp.
6.00%, 12/1/2005 1,735 1,631
---------
21,561
---------
PRODUCER DURABLES (10.4%)
(1) Orbital Sciences Corp.
5.00%, 10/1/2002 1,850 2,137
(1) SPACEHAB, Inc.
8.00%, 10/15/2007 985 980
Thermo Electron Corp.
4.25%, 1/1/2003 3,535 3,950
(1) Thermo Fibertek Inc.
4.50%, 7/15/2004 2,300 2,395
(1) Thermo Instruments Inc.
4.50%, 10/15/2003 380 417
(1) ThermoQuest Corp.
5.00%, 8/15/2000 1,550 1,608
U.S. Filter Corp.
4.50%, 12/15/2001 3,390 3,593
U.S. Office Products Co.
5.50%, 5/15/2003 2,740 2,552
Xerox Credit Corp.
2.875%, 7/1/2002 1,900 1,933
---------
19,565
---------
TECHNOLOGY (5.9%)
Comverse Technology Inc.
5.75%, 10/1/2006 1,820 1,838
EMC Corp.
3.25%, 3/15/2002 245 358
(1) Gilat Satellite Networks Ltd.
6.50%, 6/3/2004 1,790 1,777
HMT Technology Corp.
5.75%, 1/15/2004 1,060 938
Quantum Corp.
7.00%, 8/1/2004 1,300 1,287
(1) Safeguard Scientifics, Inc.
6.00%, 2/1/2006 1,055 1,205
System Software Associates, Inc.
7.00%, 9/15/2002 1,800 1,872
(1) Wind River Systems, Inc.
5.00%, 7/31/2002 1,755 1,874
---------
11,149
---------
UTILITIES (5.4%)
(1) SmarTalk TeleServices Inc.
5.75%, 9/15/2004 2,375 2,446
Telefonica Europe BV
2.00%, 7/15/2002 525 546
Tel-Save Holdings, Inc.
4.50%, 9/15/2002 2,970 3,156
U.S. Cellular Corp.
0.00%, 6/15/2015 5,755 2,133
Winstar Communications, Inc.
0.00%, 10/15/2005 1,795 1,849
---------
10,130
---------
- --------------------------------------------------------------------------------------
TOTAL CONVERTIBLE BONDS
(COST $124,353) 127,286
- --------------------------------------------------------------------------------------
SHARES
- --------------------------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS (29.3%)
- --------------------------------------------------------------------------------------
AUTO & TRANSPORTATION (1.0%)
- -(1)Federal-Mogul Finance Trust
7.00% Cvt. Pfd. 35,300 1,800
---------
CONSUMER DISCRETIONARY (8.3%)
- -(1)Big Flower Press Trust
6.00% Cvt. Pfd. 36,300 1,774
Evergreen Media Corp.
6.00% Cvt. Pfd. 55,300 3,629
Hollinger International, Inc.
9.75% Cvt. Pfd. 162,300 1,937
Houston Industries Inc.
(Convertible into
Time Warner Inc.)
7.00% Cvt. Pfd. 48,300 2,681
Kmart Financing 7.75% Cvt. Pfd. 66,300 3,667
Metromedia International Group,
Inc. 7.25% Cvt. Pfd. 43,100 1,983
---------
15,671
---------
CONSUMER STAPLES (1.8%)
Ralston Purina Co. 7.00% Cvt. Pfd. 52,100 3,439
---------
ENERGY (2.7%)
- -(1)EVI, Inc. 5.00% Cvt. Pfd. 75,200 3,356
- -(1)Lomak Petroleum , Inc.
5.75% Cvt. Pfd. 37,500 1,847
---------
5,203
---------
</TABLE>
12
<PAGE> 15
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------------
<S> <C> <C>
FINANCIAL SERVICES (4.0%)
American Heritage Life
Investors Corp. 8.50% Cvt. Pfd. 17,600 $ 994
Insignia Financial 6.50% Cvt. Pfd. 43,500 2,126
National Australia Bank Ltd.
7.875% Cvt. Pfd. 46,900 1,319
(1) PennCorp Financial Group Inc.
$3.50 Cvt. Pfd. 24,700 1,365
Salomon Inc. 6.25% Cvt. Pfd. 16,800 958
Westpac Banking Corp. Strypes
Trust 10.00% Cvt. Pfd. 23,300 760
--------
7,522
--------
HEALTH CARE (0.9%)
Laboratory Corp. 8.50% Cvt. Pfd. 32,239 1,660
--------
MATERIALS & PROCESSING (0.4%)
Freeport-McMoRan, Inc.
7.00% Cvt. Pfd. 32,900 753
--------
PRODUCER DURABLES (1.7%)
QUALCOMM, Inc. 5.75% Cvt. Pfd. 58,900 3,284
--------
TECHNOLOGY (2.9%)
Loral Space & Communications
Ltd. 6.00% Cvt. Pfd. Series C 65,600 4,141
Morgan Stanley/Advanced Micro
Devices $3.8625 PERQS
(Convertible into Advanced
Micro Devices) 45,900 1,331
--------
5,472
--------
UTILITIES (5.6%)
- -(1)AES Trust II 5.50% Cvt. Pfd. 37,700 1,748
CalEnergy Capital Trust II
6.25% Cvt. Pfd. 51,000 2,512
(1) ICG Communications Inc.
6.75% Cvt. Pfd. 49,300 2,841
- -(1)Intermedia Communication
7.00% Cvt. Pfd. 93,800 2,251
IXC Communications, Inc.
7.25% Cvt. Pfd. 7,499 1,200
--------
10,552
--------
- --------------------------------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(COST $53,263) 55,356
- --------------------------------------------------------------------------------------
FACE
AMOUNT
(000)
- --------------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (5.4%)
- --------------------------------------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.70%, 12/1/1997 $ 6,595 6,595
5.71%, 12/1/1997--Note F 3,588 3,588
- --------------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $10,183) 10,183
- --------------------------------------------------------------------------------------
TOTAL INVESTMENTS (102.0%)
(COST $187,799) 192,825
- --------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
MARKET
VALUE*
(000)
- --------------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-2.0%)
- --------------------------------------------------------------------------------------
<S> <C>
Other Assets--Note C $ 4,737
Liabilities--Note F (8,458)
----------
(3,721)
- --------------------------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------------------------
Applicable to 14,532,310 outstanding
$.001 par value shares
(authorized 1,000,000,000 shares) $189,104
======================================================================================
NET ASSET VALUE PER SHARE $13.01
======================================================================================
</TABLE>
*See Note A in Notes to Financial Statements.
-Non-Income-Producing Security. New issue that has not paid a dividend as
of November 30, 1997.
(1)Security exempt from registration under Rule 144A of the Securities Act of
1933. These securities may be sold in transactions exempt from registration,
normally to qualified institutional buyers. At November 30, 1997, the
aggregate value of these securities was $58,321,000, representing 30.8% of
net assets.
PERQS--Performance Equity-Linked Redemption Quarterly Pay Security.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------
AT NOVEMBER 30, 1997, NET ASSETS CONSISTED OF:
- -------------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- -------------------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $165,762 $11.40
Undistributed Net
Investment Income 2,102 .14
Accumulated Net Realized Gains 16,214 1.12
Unrealized Appreciation--Note E 5,026 .35
- -------------------------------------------------------------------------------------
NET ASSETS $189,104 $13.01
=====================================================================================
</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, 1997
(000)
- --------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 2,279
Interest 6,394
---------
Total Income 8,673
---------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 731
Performance Adjustment (91)
The Vanguard Group--Note C
Management and Administrative 434
Marketing and Distribution 34
Taxes (other than income taxes) 13
Custodian Fees 31
Auditing Fees 7
Shareholders' Reports 21
Annual Meeting and Proxy Costs 3
---------
Total Expenses 1,183
Expenses Paid Indirectly--Note G (30)
---------
Net Expenses 1,153
- --------------------------------------------------------------------------------------
NET INVESTMENT INCOME 7,520
- --------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 16,197
- --------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 169
- --------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $23,886
======================================================================================
</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,
-------------------------------------
1997 1996
(000) (000)
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 7,520 $ 5,593
Realized Net Gain 16,197 17,085
Change in Unrealized Appreciation (Depreciation) 169 (478)
-------------------------------------------
Net Increase in Net Assets Resulting from Operations 23,886 22,200
-------------------------------------------
DISTRIBUTIONS
Net Investment Income (6,451) (7,267)
Realized Capital Gain (16,736) (1,993)
-------------------------------------------
Total Distributions (23,187) (9,260)
-------------------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 43,991 32,298
Issued in Lieu of Cash Distributions 20,712 8,032
Redeemed (46,022) (55,628)
-------------------------------------------
Net Increase (Decrease) from Capital Share Transactions 18,681 (15,298)
- -----------------------------------------------------------------------------------------------------------------------
Total Increase (Decrease) 19,380 (2,358)
- -----------------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 169,724 172,082
-------------------------------------------
End of Year $189,104 $169,724
=======================================================================================================================
(1)Shares Issued (Redeemed)
Issued 3,549 2,601
Issued in Lieu of Cash Distributions 1,761 666
Redeemed (3,766) (4,586)
-------------------------------------------
Net Increase (Decrease) in Shares Outstanding 1,544 (1,319)
=======================================================================================================================
</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 1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $13.07 $12.03 $10.94 $12.89 $11.77
- --------------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .53 .43 .52 .53 .56
Net Realized and Unrealized Gain (Loss) on Investments 1.17 1.29 1.26 (1.04) 1.03
----------------------------------------------------------------
Total from Investment Operations 1.70 1.72 1.78 (.51) 1.59
----------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.47) (.54) (.51) (.53) (.47)
Distributions from Realized Capital Gains (1.29) (.14) (.18) (.91) --
----------------------------------------------------------------
Total Distributions (1.76) (.68) (.69) (1.44) (.47)
- --------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $13.01 $13.07 $12.03 $10.94 $12.89
================================================================================================================================
TOTAL RETURN 14.81% 14.88% 17.10% -4.35% 13.87%
================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $189 $170 $172 $175 $202
Ratio of Total Expenses to Average Net Assets 0.67% 0.69% 0.75% 0.73% 0.71%
Ratio of Net Investment Income to Average Net Assets 4.29% 3.43% 4.63% 4.68% 4.44%
Portfolio Turnover Rate 182% 97% 46% 52% 81%
Average Commission Rate Paid $.0593 $.0594 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: Securities are valued at the latest quoted bid
prices. Temporary cash investments are valued at cost, which approximates
market value.
2. FEDERAL INCOME TAXES: The Fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
3. REPURCHASE AGREEMENTS: The Fund, along with other members of The
Vanguard Group, 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.
4. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
5. 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. Discounts on
debt securities purchased are accreted to interest income over the lives of the
securities.
B. Oaktree Capital Management LLC provides investment advisory services
to the Fund for a fee calculated at an annual percentage rate of average net
assets. The basic fee is subject to quarterly adjustments based on performance
relative to the Credit Suisse First Boston Convertible Securities Index. For
the year ended November 30, 1997, the advisory fee represented an effective
annual rate of 0.42% of the Fund's average net assets before a decrease of
$91,000 (0.05%) based on performance.
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, 1997, the Fund had contributed capital of $13,000 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.
D. During the year ended November 30, 1997, the Fund purchased
$310,584,000 of investment securities and sold $307,971,000 of investment
securities, other than temporary cash investments.
E. At November 30, 1997, net unrealized appreciation of investment
securities for financial reporting and federal income tax purposes was
$5,026,000, consisting of unrealized gains of $8,902,000 on securities that had
risen in value since their purchase and $3,876,000 in unrealized losses on
securities that had fallen in value since their purchase.
F. The market value of securities on loan to broker/dealers at November
30, 1997, was $3,452,000, for which the Fund held cash collateral of
$3,588,000. Cash collateral received is invested in repurchase agreements.
G. The Fund's custodian bank has agreed to reduce its fees when the Fund
maintains cash on deposit in the non-interest-bearing custody account. For the
year ended November 30, 1997, custodian fee offset arrangements reduced
expenses by $30,000 (0.02%).
17
<PAGE> 20
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, 1997, the
results of its operations for the year then ended, the changes in its net
assets for each of the two years in the period then ended and the financial
highlights for each of the five years in the period then ended, 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, 1997 by
correspondence with the custodian and the application of alternative auditing
procedures where securities purchased had not been settled, provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
January 6, 1998
18
<PAGE> 21
SPECIAL 1997 TAX INFORMATION (UNAUDITED) FOR VANGUARD CONVERTIBLE SECURITIES
FUND
This information for the fiscal year ended November 30, 1997, is included
pursuant to provisions of the Internal Revenue Code.
The Fund designates $1,016,000 as capital gain dividends (from net
long-term capital gains), which will be distributed in December 1997. Of the
$1,016,000 capital gain dividends, the Fund designates $512,000 as a 20% rate
gain distribution.
For corporate shareholders, 8.51% of investment income (dividend
income plus short-term gains, if any) qualifies for the dividends-received
deduction.
19
<PAGE> 22
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.; Managing Director
of Global Health Care Partners/DLJ Merchant Banking Partners; Director of Sun
Company, Inc., and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER
Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions,
Inc., Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance
Co., and Ladies Professional Golf Association; Trustee Emerita of Wellesley
College.
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 Telecommunications 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. and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director 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
R. GREGORY BARTON
Managing Director, Legal Department.
ROBERT A. DISTEFANO
Managing Director, Information Technology.
JAMES H. GATELY
Managing Director, Individual Investor Group.
KATHLEEN C. GUBANICH
Managing Director, Human Resources.
IAN A. MACKINNON
Managing Director, Fixed Income Group.
F. WILLIAM MCNABB, III
Managing Director, Institutional Investor Group.
MICHAEL S. MILLER
Managing Director, Planning and Development.
RALPH K. PACKARD
Managing Director and Chief Financial Officer.
GEORGE U. SAUTER
Managing Director, Core Management Group.
"Standard & Poor's 500," "S&P 500(R)," "Standard & Poor's(R)," "S&P(R)," and
"500" are trademarks of The McGraw-Hill Companies, Inc. Frank Russell
Company is the owner of trademarks and copyrights relating to the
Russell Indexes. "Wilshire 4500" and "Wilshire 5000" are
trademarks of Wilshire Associates.
<PAGE> 23
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