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VANGUARD[R] CONVERTIBLE SECURITIES FUND
[PHOTO]
SEMIANNUAL REPORT
May 31, 2000
[THE VANGUARD GROUP LOGO]
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HAVE THE PRINCIPLES OF INVESTING CHANGED?
In a world of frenetic change in business, technology, and the financial
markets, it is natural to wonder whether the basic principles of investing have
changed.
We don't think so.
The most successful investors over the coming decade will be those who
began the new century with a fundamental understanding of risk and who had the
discipline to stick with long-term investment programs.
Certainly, investors today confront a challenging, even unprecedented,
environment. Valuations of market indexes are at or near historic highs. The
strength and duration of the bull market in U.S. stocks have inflated people's
expectations and diminished their recognition of the market's considerable
risks. And the incredible divergence in stock returns--many technology-related
stocks gained 100% or more in 1999, yet prices fell for more than half of all
stocks--has made some investors question the idea of diversification.
And then there is the Internet. Undeniably, it is a powerful medium for
communications and transacting business. For investors, the Internet is a vast
source of information about investments, and online trading has made it
inexpensive and convenient to trade stocks and invest in mutual funds.
However, new tools do not guarantee good workmanship. Information is not
the same as wisdom. Indeed, much of the information, opinion, and rumor that
swirl about financial markets each day amounts to "noise" of no lasting
significance. And the fact that rapid-fire trading is easy does not make it
beneficial. Frequent trading is almost always counterpro-ductive because
costs--even at low commission rates--and taxes detract from the returns that the
markets provide. Sadly, many investors jump into a "hot" mutual fund just in
time to see it cool off. Meanwhile, long-term fund investors are hurt by
speculative trading activity because they bear part of the costs involved in
accommodating purchases and redemptions.
Vanguard believes that intelligent investors should resist short-term
thinking and focus instead on a few time-tested principles:
o Invest for the long term. Pursuing your long-term investment goals is more
like a marathon than a sprint.
o Diversify your investments with holdings in stocks, bonds, and cash
investments.
Remember that, at any moment, some part of adiversified portfolio will lag other
parts, and be wary of taking on more risk by "piling onto" the best-performing
part of your holdings. Today's leader could well be tomorrow's laggard.
o Step back from the daily frenzy of the markets; focus on your overall asset
allocation.
o Capture as much of the market's return as possible by minimizing costs and
taxes. Costs and taxes diminish long-term returns while doing nothing to
reduce the risks you incur as an investor.
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CONTENTS
REPORT FROM THE CHAIRMAN 1 FUND PROFILE 8
THE MARKETS IN PERSPECTIVE 4 PERFORMANCE SUMMARY 11
REPORT FROM THE ADVISER 6 FINANCIAL STATEMENTS 12
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All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc.,
unless otherwise noted.
"Standard & Poor's (R)," "S&P(R)," "S&P 500(R)," "Standard & Poor's 500,"
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 5000(R)" and "Wilshire 4500" are trademarks of Wilshire Associates
Incorporated.
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REPORT FROM THE CHAIRMAN
[PHOTO]
JOHN J. BRENNAN
Vanguard Convertible Securities Fund earned a strong return of 12.0% during the
first half of its fiscal year, surpassing the results of its average peer and
its benchmark index. During a very volatile period for financial markets, the
fund's gains well surpassed the returns of the broad stock and bond markets.
The table at right presents the fund's total return (capital change plus
reinvested dividends) for the six months ended May 31, along with those of the
average competing fund and our unmanaged benchmark, the Credit Suisse First
Boston Convertible Securities Index. We also present the returns of the Wilshire
5000 Total Market Index, which is a proxy for the overall U.S. stock market, and
the Lehman Brothers Aggregate Bond Index, a benchmark for the overall taxable
bond market.
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TOTAL RETURNS
SIX MONTHS ENDED
MAY 31, 2000
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Vanguard Convertible Securities Fund 12.0%
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Average Convertible Securities Fund* 10.7%
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CS First Boston Convertibles Index 10.4%
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Wilshire 5000 Total Market Index 2.4%
Lehman Aggregate Bond Index 1.4
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*Derived from data provided by Lipper Inc.
Our total return is based on an increase in net asset value from $13.18 per
share on November 30, 1999, to $13.77 per share on May 31, 2000, and is adjusted
for dividends totaling $0.25 per share paid from net investment income and a
distribution of $0.70 per share paid from net realized capital gains. The fund's
annualized dividend yield was 3.99% on May 31, up from 3.16% when the period
began.
THE PERIOD IN REVIEW
The U.S. economy continued a remarkably strong advance during the first half of
our fiscal year. The economy's total output during the first quarter of calendar
2000 was 5.0% higher--after adjusting for inflation--than in the first quarter
of 1999. And May marked the 110th month of uninterrupted expansion for the U.S.
economy--the longest period ever without a recession.
A growing economy generally means good news for corporate profits and for
stocks. However, during the past six months, many investors were concerned that
the economy might be too robust and that its rapid growth, combined with a very
low unemployment rate (around 4% of the workforce), could light a fire under
inflation. To siphon some steam from the economy, the Federal Reserve Board
raised its target for short-term interest rates three times for a total of 1
percentage point from February 2 through May 16.
The overall stock market, as measured by the Wilshire 5000 Index, rose 2.4%
during the six months. However, there were frequent and wide swings in stock
prices, especially among small-capitalization stocks and for technology issues,
whose valuations had reached very high levels. The small-cap Russell 2000 Growth
Index, which is heavily weighted in technology stocks, saw a 43.6% gain from
November 30 through February 29, followed by a -26.6% decline from February 29
through May 31, resulting in a 5.4% return for the half-year.
1
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When the dust cleared, nearly all the major stock indexes registered gains.
However, in contrast to recent years, value stocks showed some strength. They
slightly outpaced growth stocks in both the S&P 500 and Russell 2000 Indexes
over the six months ended May 31.
For fixed income investors, the Fed's efforts to boost interest rates had
mixed results. In response to the Fed's 1-percentage-point increase in its
target federal funds rate, the yield on 3-month U.S. Treasury bills climbed as
much as 91 basis points (0.91 percentage point), to 6.21% as of May 16. However,
in the final two weeks of the period, rates fell. Apparently, many market
participants thought that the Fed's half-point increase in rates on May 16 might
suffice to slow the economy enough to preempt inflation. By May 31, the 3-month
T-bill yield was 5.62%, representing an increase of 32 basis points during the
half-year.
Prices of longer-term Treasury securities benefited from a shrinking
supply, as the growing federal budget surplus resulted in reduced issuance of
new bonds and the repurchase of some outstanding bonds. The yield of the 30-year
Treasury bond fell 28 basis points, on balance, ending the half-year at 6.01%.
The yield of the 10-year Treasury note rose 8 basis points, to 6.27%. Prices of
most corporate bonds declined during the half-year. The 1.4% return for the
Lehman Aggregate Bond Index consisted of an average price decline of about 2%,
offset by a six-month income return of 3.4%.
PERFORMANCE OVERVIEW
Vanguard Convertible Securities Fund's 12.0% return for the half-year was very
satisfactory, exceeding the returns of all of our benchmarks. This performance,
however, did not mean that the fund, or convertible securities in general,
escaped the price gyrations seen in many market sectors.
Our fund gained 23.2% during the first three months of the half-year, then
fell -9.1% from March through May. Our average peer saw similar fluctuations to
a somewhat lesser degree with returns of 20.5% and -7.6% for the respective
periods. CS First Boston Convertibles Index diverged more (+25.4% and -11.9%).
Our holdings in the technology, telecommunications, and health care sectors
helped our performance during the first half of the reporting period. Because
our fund typically sells securities that have risen to extreme valuations, we
escaped some of the impact of sharp declines experienced by certain
technology-related convertibles during the March-May quarter. Some of these
securities had significant weightings within the index, so their declines
disproportionately hurt this benchmark during the second fiscal quarter.
For more details on the convertible securities market, see the Report From
The Adviser on page 6.
IN SUMMARY
The volatility of the stock and bond markets during the past six months
certainly illustrated the beneficial role convertible securities can play in
some portfolios. As stock-bond hybrids, convertibles typically provide higher
income than common stocks and higher potential for capital appreciation than
bonds. They also can provide a degree of protection against steep drops in
common stocks.
Because there are no guarantees that any asset class will perform well in
any given period, we advocate a diversified portfolio of stock funds, bond
funds, and money market funds. The mix of such funds should fit your goals, time
horizon, and risk tolerance.
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Sticking with such a plan for the long haul can help investors ride out market
turbulence on course to their long-term goals.
/S/
John J. Brennan
Chairman and Chief Executive Officer
June 29, 2000
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NOTICE TO SHAREHOLDERS
In the past, the quarterly income dividend that Vanguard Convertible Securities
Fund distributed to shareholders was paid at a set rate of $0.12 per share. Any
income the fund earned in excess of the set rate was distributed in the December
income dividend. Beginning with the dividend of $0.11 per share that was paid in
March 2000, the fund is distributing income on a "pay as you go" basis, rather
than according to a set rate. This policy change provides for a more even
distribution of income throughout the year.
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IN MEMORY
It is with great sadness that I report the death of John C. Sawhill, an
independent trustee of the fund and a member of The Vanguard Group's board of
directors since 1991. John, an economist who was president and chief executive
officer of The Nature Conservancy, died on May 18 at age 63. He was a senior
lecturer at the Harvard Business School and had formerly served as president of
New York University and as deputy secretary of the U.S. Department of Energy
under President Jimmy Carter. John was a remarkable man who was full of energy,
vigor, and life. His experience and wisdom added a great deal to Vanguard, and
his death is a blow to everyone who knew and loved him. Though John's work on
behalf of our funds was often carried on behind the scenes, he was a dedicated
advocate for the best interests of our shareholders. He will be missed.
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3
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THE MARKETS IN PERSPECTIVE
SIX MONTHS ENDED MAY 31, 2000
Strong crosscurrents pushed and tugged at financial markets during the six
months ended May 31, 2000. Positive influences included very strong economic
growth and rising corporate profits. Negative factors included tighter monetary
policy, higher inflation, and concerns about stock valuations.
Interest rates rose in most segments of the bond market, and bond prices
slipped. Stock prices rose slightly, on balance, although wide day-to-day price
swings were frequent.
Uncertainty in both the bond and stock markets centered on the surprising
performance of the U.S. economy, which grew at a torrid 7.3% pace in the final
three months of 1999 and at a still-robust 5.4% during the first quarter of
2000. With U.S. unemployment at around 4.0% of the workforce, the Federal
Reserve Board continued to be concerned that inflation would worsen unless the
economic expansion slowed. The Fed raised short-term interest rates by 0.25
percentage point in February and again in March, before boosting rates by 0.50
percentage point in mid-May. These boosts, following three
quarter-percentage-point increases in 1999, took the Fed's target for short-term
rates to 6.5%. By the end of May, some signs of slowing had emerged in the
economy, although it was not certain that the Fed had finished applying the
brakes.
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TOTAL RETURNS
PERIODS ENDED MAY 31, 2000
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6 MONTHS 1 YEAR 5 YEARS*
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STOCKS
S&P 500 Index 2.9% 10.5% 23.8%
Russell 2000 Index 5.5 9.9 13.5
Wilshire 5000 Index 2.4 10.7 22.3
MSCI EAFE Index 0.7 17.4 10.4
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BONDS
Lehman Aggregate Bond Index 1.4% 2.1% 6.0%
Lehman 10 Year Municipal Bond Index 0.7 -0.2 5.3
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 2.7 5.2 5.2
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OTHER
Consumer Price Index 1.8% 3.1% 2.4%
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*Annualized.
Evidence on inflation was ambiguous. The Consumer Price Index increased
1.8% and 3.1%, respectively, for the six- and twelve-month periods ended May 31,
but much of the increase was due to higher energy and food prices. Core
inflation, which excludes those sectors, was up a less-scary 2.4% during the
twelve months ended May 31.
U.S. STOCK MARKETS
Optimism about long-term prospects for technology, media, and telecommunications
companies dominated the equity markets through the first three months of the
period. But sentiment shifted suddenly in mid-March, sending the tech and
telecom groups sharply lower. The tech-heavy Nasdaq Composite Index, for
example, registered a 41.1% return from November 30 through February 29, only to
give back most of the gains over the next three months. End result: a 2.4%
return for the six months ended May 31.
The overall stock market, as measured by the Wilshire 5000 Index, also
returned 2.4%. Value stocks, those characterized by above-average dividend
yields and below-average price/earnings and price/book value ratios, enjoyed a
resurgence beginning in mid-March.
4
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For the full six months, the value components of both the large-capitalization
S&P 500 Index and the small-cap Russell 2000 Index outperformed the indexes'
growth components.
Within the S&P 500, the half-year's best return was the 48% gain recorded
by "other energy" stocks, including oil-drilling and services companies that
benefited from a continuing rise in oil prices. The producer-durables sector
gained 18%, largely because of big gains for a number of manufacturers of
telecommunications gear and semiconductor testing and fabrication equipment.
Technology stocks, which now account for about one-quarter of the total stock
market's value, gained about 12% for the six months.
Poor performers included the utilities sector (-14% return), which was hurt
by downturns in several large telephone stocks, and many consumer staples (-9%)
and consumer-discretionary (-6%) companies. Prices fell steeply for a number of
high-profile retailers, beverage and food makers, tobacco companies, and
entertainment enterprises.
U.S. BOND MARKETS
The Federal Reserve's influence on interest rates is strongest for short-term
securities. Over the six months, the Fed pushed up the rate charged on overnight
loans between banks by 1 percentage point to 6.5%. Yields of 3-month U.S.
Treasury bills rose only one-third as far (0.32 percentage point, or 32 basis
points), to 5.62%. And long-term Treasury yields moved even less. The 10-year
Treasury note rose just 8 basis points to 6.27% as of May 31, and yields fell
for very long-term Treasury bonds due to a cutback in issuance of new bonds. As
a result of the shrinking supply of long-term bonds, the yield of the 30-year
Treasury bond declined 28 basis points--from 6.29% to 6.01%--during the
half-year.
Because short-term rates moved higher while long-term rates declined, there
was an unusual "inversion" in the yield curve. Instead of sloping upward--with
yields increasing along with the maturity of Treasury securities--the curve
sloped down. The 6.01% yield of 30-year Treasuries on May 31 was 70 basis points
below the 6.71% yield on 3-year Treasury notes.
Corporate and municipal bonds did not perform as well as Treasury
securities, and the yield curve for these sectors remained positive--yields of
long-term bonds remained higher than those of short-term securities. The Lehman
Aggregate Bond Index, a proxy for the overall taxable bond market, returned
1.4%, as a price decline of 2% offset most of the 3.4% income provided by bonds
during the half-year.
INTERNATIONAL STOCK MARKETS
A stronger U.S. dollar and weak Asian markets made the half-year a lackluster
one for U.S. investors in foreign stocks. Improving economic growth in most of
the world helped a number of markets in Europe, Asia, and Latin America to
produce good gains in their local currencies. However, the U.S. dollar increased
in value versus most currencies, significantly reducing the returns received by
dollar-based investors. (Conversely, when the dollar falls in value, returns
from abroad are enhanced for U.S. investors.)
The overall return in dollars from developed foreign markets was a scant
0.7%, as measured by the Morgan Stanley Capital International Europe,
Australasia, Far East (EAFE) Index. However, in local currencies, the EAFE Index
return for the six months was a very respectable 7.8%.
In Europe, where stocks benefited from a continuance of corporate
acquisitions, an average 12.8% gain in local-currency terms was reduced to 4.7%
for U.S. investors because of the dollar's strength. Stocks in the Pacific
region, which is dominated by Japan, returned -7.0% in dollars, as a -2.0%
return in local-currency terms was further diminished by the dollar's gains. The
Select Emerging Markets Free Index returned -2.8% in U.S. dollars.
5
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REPORT FROM THE ADVISER
Vanguard Convertible Securities Fund's performance during the first half of its
2000 fiscal year was reasonably rewarding, given the extremely volatile
investing environment. During the six months ended May 31, the fund had an
attractive absolute return of 12.0%, which was moderately ahead of the returns
for both of our primary benchmarks: the average convertible-securities mutual
fund (+10.7%) and the CS First Boston Convertibles Index (+10.4%).
The half-year was certainly a period of extremes--sharp gains for
growth-stock indexes early in the period followed by steep losses in the latter
months. Of course, the markets were extremely volatile during this time, with
significant changes intraweek and even intraday. In this extreme environment,
the fund performed relatively well. The downside protection of convertibles
held, as expected, protecting our shareholders from the full decline in the
equity markets.
Your fund's performance during the past six months was affected by a
variety of positive factors. The first was the fund's significant exposure to
the technology and telecommunication sectors, where many individual holdings
were above-average performers. Second, the fund's exposure to the health care
sector was beneficial because the stocks of biotech and genomic companies
generally performed very well. Lastly, the fund benefited from a generally busy
calendar of new issues, as a wide variety of companies used the convertibles
market as a source of financing. Many of these issues appeared cheap by various
statistical measures and experienced immediate appreciation.
Despite the recent sharp decline in many telecommunications securities, we
continue to feel positive about this sector and to emphasize wireless
communications (including not only the service providers themselves, but also
companies providing infrastructure for wireless communications). Our positions
in this area include Nextel Communications, EchoStar Communications, American
Tower, and Pinnacle Holdings. During the latter half of the six months, our
winners came from the defensive sectors, including energy, health care, and
financial services issues. Not surprisingly, investment-grade convertibles
outperformed those of lower credit quality when the market fell and investors
flocked to high-rated issues.
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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.
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We recently increased our exposure to oil and gas companies, adding
Kerr-McGee, Anadarko Petroleum, and Pride International convertibles. The first
two are investment-grade issues.
During the six-month period, the CS First Boston Convertibles Index was
buffeted by the same forces that affected your fund. However, the index declined
further during the market sell-off. This is because many of the index's largest
components are convertibles that behave as pure equity substitutes and that
accordingly felt the full force of the declines in the underlying stocks. In the
past, when these securities were soaring, we noted that they totally lacked
downside protection; now we report that they performed poorly, as expected, when
downside protection was needed.
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As usual, we are fully invested in convertible securities; we hold no
common stocks or other nonconvertible investments. The fund remains well
diversified, with approximately 23% of assets in convertible preferreds and the
balance in convertible bonds. Given the market's recent weakness, our average
conversion premium has expanded. Over time, we will follow our usual practice of
rotating out of issues with extremely high conversion premiums and reinvesting
in convertibles with a favorable balance of upside potential to downside risk.
One effect of the recent sharp stock market decline has been a dramatic
slowdown in new convertibles coming to market. Only a few deals were priced in
April and May, in contrast to the first-quarter deluge. We expect issuance to be
moderate over the summer months. Despite this lull, year-to-date new issuance is
quite strong, with $30.9 billion in convertibles priced through May 2000, versus
$9.2 billion for the first five months of 1999.
We feel that current convertible valuations are attractive. Given the
moderating pace of new issuance, the relative lack of supply will keep upward
pressure on the prices of issues with significant call protection. In addition,
forced conversions and redemptions will continue to occur, which should increase
demand for the remaining issues. Overall, liquidity has been quite reasonable
given the extreme market environment.
Our principal strategy has been to take profits on highly appreciated
issues and reinvest the proceeds in securities that offer a good balance between
the potential for appreciation due to the underlying stocks and the downside
protection of strong fixed income properties. Given the market's recent
volatility, we continue to place a heavy emphasis on securities with downside
protection. We believe this is particularly important today, when there is
considerable potential for interest rates to move higher.
In summary, we note that this has been a very volatile market for all
financial assets, but that balanced convertibles have provided favorable
absolute and relative returns as well as good downside protection when needed.
Finally, we reiterate that balanced convertibles are attractively priced today
and should continue to provide the reasonable return/risk trade-off we desire.
Oaktree Capital Management, LLC
June 9, 2000
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FUND PROFILE
CONVERTIBLE SECURITIES FUND
This Profile provides a snapshot of the fund's characteristics as of May 31,
2000, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on pages 9 and 10.
FINANCIAL ATTRIBUTES
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Number of Securities 80
Yield 4.0%
Conversion Premium 29.8%
Average Weighted Maturity 6.1 years
Average Coupon 4.3%
Average Quality B
Average Duration 4.7 years
Foreign Holdings 8.6%
Turnover Rate 200%*
Expense Ratio 0.60%*
Cash Reserves 4.2%
*Annualized.
DISTRIBUTION BY CREDIT QUALITY
(% OF BONDS)
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Aaa/AAA 1.1%
Aa/AA 0.0
A/A 3.0
Baa/BBB 12.9
Ba/BB 10.4
B/B 30.7
Less than B/B 10.7
Not Rated 31.2
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Total 100.0%
VOLATILITY MEASURES
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CONVERTIBLE S&P 500
SECURITIES
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R-Squared 0.45 1.00
Beta 0.59 1.00
TEN LARGEST HOLDINGS
(% OF TOTAL NET ASSETS)
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American Tower Corp. 3.5%
Titan Capital Trust 3.4
Nextel Communications, Inc. 3.3
SCI Systems Inc. 3.2
EchoStar Communications Corp. 2.8
Sepracor Inc. 2.8
Rational Software Corp. 2.7
Semtech Corp. 2.6
Solectron Corp. 2.4
SEACOR Holdings, Inc. 2.3
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Top Ten 29.0%
DISTRIBUTION BY MATURITY
(% OF BONDS)
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Under 1 Year 0.0%
1-5 Years 34.7
5-10 Years 65.3
10-20 Years 0.0
20-30 Years 0.0
Over 30 Years 0.0
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Total 100.0%
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SECTOR DIVERSIFICATION (% OF PORTFOLIO)
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MAY 31, 1999 MAY 31, 2000
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CONVERTIBLE CONVERTIBLE
SECURITIES SECURITIES
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Auto & Transportation ................. 8.4% 2.4%
Consumer Discretionary ................ 20.7 6.1
Consumer Staples ...................... 1.5 0.0
Financial Services .................... 5.1 3.1
Health Care ........................... 16.6 15.5
Integrated Oils ....................... 2.1 2.7
Other Energy .......................... 6.6 13.0
Materials & Processing ................ 1.8 2.4
Producer Durables ..................... 4.2 7.0
Technology ............................ 22.2 32.3
Utilities ............................. 10.8 15.5
Other ................................. 0.0 0.0
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AVERAGE COUPON. The average interest rate paid on the securities held by a fund.
It is expressed as a percentage of face value.
AVERAGE DURATION. An estimate of how much a bond fund's share price will
fluctuate in response to a change in interest rates. To see how the price could
shift, multiply the fund's duration by the change in rates. If interest rates
rise by one percentage point, the share price of a fund with an average duration
of five years would decline by about 5%. If rates decrease by a percentage
point, the fund's share price would rise by 5%.
AVERAGE QUALITY. An indicator of credit risk, this figure is the average of the
ratings assigned to a fund'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.
AVERAGE WEIGHTED MATURITY. The average length of time until securities held by a
fund reach maturity (or are called) and are repaid. In general, the longer the
average weighted maturity, the more a fund's share price will fluctuate in
response to changes in market interest rates.
BETA. A measure of the magnitude of a fund'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 fund 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 fund'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 fund 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%).
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DISTRIBUTION BY CREDIT QUALITY. This breakdown of a fund'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 fund's share
price will fluctuate in response to changes in interest rates.
EXPENSE RATIO. The percentage of a fund'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 fund's net assets represented by
securities of companies based outside the United States.
NUMBER OF SECURITIES. An indicator of diversification. The more separate issues
a fund 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 fund's past returns can be explained by
the returns from the overall market (or its benchmark index). If a fund's total
return were precisely synchronized with the overall market's return, its
R-squared would be 1.00. If a fund's returns bore no relationship to the
market's returns, its R-squared would be 0.
SECTOR DIVERSIFICATION. The percentages of a fund'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 fund has invested in
its ten largest holdings. As this percentage rises, a fund'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 period. Funds 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 fund's income from interest and dividends. The yield,
expressed as a percentage of the fund's net asset value, is based on income
earned over the past 30 days and is annualized, or projected forward for the
coming year.
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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. An investor's shares, when
redeemed, could be worth more or less than their original cost.
TOTAL INVESTMENT RETURNS: JUNE 17, 1986-MAY 31, 2000
--------------------------------------------------------
CONVERTIBLE SECURITIES FUND FIRST BOSTON*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
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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
--------------------------------------------------------
TOTAL INVESTMENT RETURNS: JUNE 17, 1986-MAY 31, 2000
--------------------------------------------------------
CONVERTIBLE SECURITIES FUND FIRST BOSTON*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
--------------------------------------------------------
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
1998 -6.4 4.2 -2.2 1.4
1999 18.7 6.1 24.8 30.6
2000** 10.1 1.9 12.0 10.4
--------------------------------------------------------
*CS First Boston Convertibles Index.
**Six months ended May 31, 2000.
See Financial Highlights table on page 17 for dividend and capital gains
information for the past five years.
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED MARCH 31, 2000*
--------------------------------------------------------------------------------
10 YEARS
INCEPTION ------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
--------------------------------------------------------------------------------
Convertible Securities
Fund 6/17/1986 51.11% 17.60% 8.78% 5.17% 13.95%
--------------------------------------------------------------------------------
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
11
<PAGE>
FINANCIAL STATEMENTS
MAY 31, 2000 (UNAUDITED)
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, 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, but may differ because certain investments or
transactions may be treated differently for financial statement and tax
purposes. 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.
--------------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
CONVERTIBLE SECURITIES FUND (000) (000)
--------------------------------------------------------------------------------
CONVERTIBLE BONDS (72.7%)
--------------------------------------------------------------------------------
AUTO & TRANSPORTATION (1.5%)
Tower Automotive Inc.
5.00%, 8/1/2004 $ 5,730 $ 4,613
----------
CONSUMER DISCRETIONARY (5.2%)
EchoStar Communications Corp.
(1)4.875%, 1/1/2007 8,110 8,597
Getty Images, Inc.
(1)5.00%, 3/15/2007 4,595 3,515
IMAX Corp.
5.75%, 4/1/2003 415 460
Jacor Communications, Inc.
0.00%, 2/9/2018 1,125 667
Lamar Advertising Co.
5.25%, 9/15/2006 2,605 2,761
----------
16,000
----------
FINANCIAL SERVICES (1.1%)
American International Group Inc.
0.50%, 5/15/2007 3,295 3,208
----------
HEALTH CARE (13.3%)
Affymetrix, Inc.
(1)4.75%, 2/15/2007 705 465
5.00%, 10/1/2006 2,065 2,323
Alpharma, Inc.
3.00%, 6/1/2006 1,145 1,810
--------------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
--------------------------------------------------------------------------------
ALZA Corp.
0.00%, 7/14/2014 $ 2,540 $ 1,635
Athena Neurosciences Inc.
4.75%, 11/15/2004 2,460 3,035
COR Therapeutics, Inc.
(1)5.00%, 3/1/2007 3,320 3,554
Human Genome Sciences, Inc.
3.75%, 3/15/2007 1,960 1,235
Imclone Systems, Inc.
(1)5.50%, 3/1/2005 4,920 4,114
Incyte Pharmaceuticals, Inc.
(1)5.50%, 2/1/2007 3,495 2,250
Ivax Corp.
(1)5.50%, 5/15/2007 3,650 4,398
Millennium Pharmaceuticals, Inc.
5.50%, 1/15/2007 4,405 5,110
Roche Holdings, Inc.
0.00%, 4/20/2010 4,055 2,278
Sepracor Inc.
(1)5.00%, 2/15/2007 6,730 8,076
7.00%, 12/15/2005 285 472
----------
40,755
----------
INTEGRATED OILS (2.6%)
Devon Energy Corp.
4.95%, 8/15/2008 6,095 6,125
Kerr-McGee Corp.
5.25%, 2/15/2010 1,535 1,798
----------
7,923
----------
12
<PAGE>
--------------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
--------------------------------------------------------------------------------
OTHER ENERGY (6.7%)
Anadarko Petroleum Corp.
0.00%, 3/7/2020 $ 8,915 $ 6,051
Pride International, Inc.
0.00%, 4/24/2018 10,435 4,409
SEACOR Holdings, Inc.
5.375%, 11/15/2006 6,730 7,193
Transocean Sedco Forex Inc.
0.00%, 5/24/2020 4,845 2,846
----------
20,499
----------
PRODUCER DURABLES (6.7%)
American Tower Corp.
5.00%, 2/15/2010 11,595 10,726
Efficient Networks, Inc.
(1)5.00%, 3/15/2005 3,865 2,474
Kulicke & Soffa Industries, Inc.
4.75%, 12/15/2006 1,550 1,974
Mark IV Industries, Inc.
4.75%, 11/1/2004 1,555 1,434
Pinnacle Holdings, Inc.
(1)5.50%, 9/15/2007 4,870 3,993
----------
20,601
----------
TECHNOLOGY (27.5%)
COMMUNICATIONS TECHNOLOGY (5.0%)
Aether Systems, Inc.
6.00%, 3/22/2005 4,325 3,741
Gilat Satellite Networks Ltd.
(1)4.25%, 3/15/2005 10,005 7,179
Juniper Networks, Inc.
4.75%, 3/15/2007 5,510 4,436
COMPUTER SERVICES SOFTWARE & SYSTEMS (2.9%)
Mail.com, Inc.
(1)7.00%, 2/1/2005 1,590 700
Rational Software Corp.
(1)5.00%, 2/1/2007 6,745 8,254
ELECTRONICS--SEMICONDUCTORS/COMPONENTS (12.7%)
ASM Lithography Holding NV
(1)4.25%, 11/30/2004 2,175 2,523
Amkor Technologies, Inc.
(1)5.00%, 3/15/2007 6,095 6,110
Burr-Brown Corp.
(1)4.25%, 2/15/2007 1,440 1,732
Cymer, Inc.
3.50%, 8/6/2004 4,645 4,506
Cypress Semiconductor Corp.
4.00%, 2/1/2005 4,610 5,336
LSI Logic Corp.
4.00%, 2/15/2005 4,780 4,918
S3 Inc.
5.75%, 10/1/2003 450 458
Semtech Corp.
(1) 4.50%, 2/1/2007 9,340 8,079
TriQuint Semiconductor, Inc.
(1)4.00%, 3/1/2007 2,895 2,654
Vitesse Semiconductor Corp.
(1)4.00%, 3/15/2005 3,355 2,629
--------------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
--------------------------------------------------------------------------------
ELECTRONICS--TECHNOLOGY (6.9%)
SCI Systems Inc.
3.00%, 3/15/2007 $ 9,375 $ 9,750
Sanmina Corp.
4.25%, 5/1/2004 2,600 4,046
Solectron Corp.
0.00%, 5/8/2020 12,915 7,362
----------
84,413
----------
UTILITIES (8.1%)
Level 3 Communications, Inc.
6.00%, 3/15/2010 7,160 5,925
NTL Inc.
(1)5.75%, 12/15/2009 5,895 4,569
Nextel Communications, Inc.
(1)5.25%, 1/15/2010 11,545 10,145
Primus Telecommunications Group, Inc.
(1)5.75%, 2/15/2007 5,855 4,216
----------
24,855
----------
--------------------------------------------------------------------------------
TOTAL CONVERTIBLE BONDS
(COST $232,167) 222,867
--------------------------------------------------------------------------------
Shares
--------------------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS (23.1%)
--------------------------------------------------------------------------------
AUTO & TRANSPORTATION (0.8%)
Tower Automotive Capital Trust
6.75% Cvt. Pfd. 71,800 2,369
----------
CONSUMER DISCRETIONARY (0.6%)
Emmis Communications Corp.
6.25% Cvt. Pfd. 36,800 1,877
----------
ENERGY (5.7%)
o(1)AES Trust VII
6.00% Cvt. Pfd. 86,700 4,964
Apache Corp.
6.50% Cvt. Pfd. 83,000 4,363
EVI, Inc.
5.00% Cvt. Pfd. 125,700 6,049
Pogo Trust I
6.50% Cvt. Pfd. 37,300 2,156
----------
17,532
----------
FINANCIAL SERVICES (2.0%)
Ace, Ltd. 8.25% Cvt. Pfd. 100,800 5,998
----------
HEALTH CARE (1.6%)
o Biovail Corp. 6.75% Cvt. Pfd. 102,800 4,754
----------
MATERIALS & PROCESSING (2.3%)
Georgia Pacific Group 7.50%
Cvt. Pfd. 13,700 498
Sealed Air Corp. $2.00 Cvt. Pfd. 119,800 6,499
----------
6,997
----------
TECHNOLOGY (3.4%)
(1)Titan Capital Trust 5.75% Cvt. Pfd. 226,000 10,509
----------
UTILITIES (6.7%)
Broadwing Inc. 6.75% Cvt. Pfd 51,100 2,223
Decs Trust VI 6.25% Cvt. Pfd. 30,200 1,683
Global Crossing Holding Ltd.
7.00% Cvt. Pfd. 14,550 2,521
13
<PAGE>
--------------------------------------------------------------------------------
MARKET
VALUE*
CONVERTIBLE SECURITIES FUND SHARES (000)
--------------------------------------------------------------------------------
MediaOne Group, Inc. 7.00%
Cvt. Pfd. 20,600 932
MGC Communications, Inc.
7.25% Cvt. Pfd. 41,000 1,640
(1)PSINet Inc. 7.00% Cvt. Pfd. 183,700 6,246
UnitedGlobalCom Inc. 7.00%
Cvt. Pfd. 89,600 4,077
Winstar Communications, Inc.
7.25% Cvt. Pfd. 1,400 1,204
----------
20,526
----------
--------------------------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(COST $73,364) 70,562
--------------------------------------------------------------------------------
Face
Amount
(000)
--------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (6.4%)
--------------------------------------------------------------------------------
REPURCHASE AGREEMENTS
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
6.38%, 6/1/2000 $12,837 12,837
6.43%, 6/1/2000--Note F 6,730 6,730
--------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $19,567) 19,567
--------------------------------------------------------------------------------
TOTAL INVESTMENTS (102.2%)
(COST $325,098) 312,996
--------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-2.2%)
--------------------------------------------------------------------------------
Other Assets--Note C 4,879
Liabilities--Note F (11,549)
----------
(6,670)
--------------------------------------------------------------------------------
NET ASSETS (100%)
--------------------------------------------------------------------------------
Applicable to 22,251,650 outstanding
$.001 par value shares of beneficial interest.
(unlimited authorization) $306,326
================================================================================
NET ASSET VALUE PER SHARE $13.77
================================================================================
*See Note A in Notes to Financial Statements.
oNon-income producing security. New issue that has not
paid a dividend as of May 31, 2000.
(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 May 31, 2000, the aggregate value
of these securities was $121,945,000, representing 39.8% of net assets.
--------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
--------------------------------------------------------------------------------
AT MAY 31, 2000, NET ASSETS CONSISTED OF:
--------------------------------------------------------------------------------
Paid in Capital $283,242 $12.73
Undistributed Net
Investment Income 2,422 .11
Accumulated Net Realized Gains 32,764 1.47
Unrealized Depreciation--Note E (12,102) (.54)
--------------------------------------------------------------------------------
NET ASSETS $306,326 $13.77
================================================================================
14
<PAGE>
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.
--------------------------------------------------------------------------------
CONVERTIBLE SECURITIES FUND
SIX MONTHS ENDED MAY 31, 2000
(000)
--------------------------------------------------------------------------------
INVESTMENT INCOME
Income
Dividends $ 1,474
Interest 4,743
Security Lending 34
---------
Total Income 6,251
---------
Expenses
Investment Advisory Fees--Note B
Basic Fee 544
Performance Adjustment (194)
The Vanguard Group--Note C
Management and Administrative 394
Marketing and Distribution 13
Custodian Fees 9
Auditing Fees 4
Shareholders' Reports 7
---------
Total Expenses 777
--------------------------------------------------------------------------------
NET INVESTMENT INCOME 5,474
--------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 32,850
--------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION
(DEPRECIATION) OF INVESTMENT SECURITIES (25,387)
--------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $12,937
================================================================================
15
<PAGE>
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 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
---------------------------------
SIX MONTHS YEAR
ENDED ENDED
MAY 31, 2000 NOV. 30, 1999
(000) (000)
-----------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 5,474 $ 7,219
Realized Net Gain 32,850 10,911
Change in Unrealized Appreciation (Depreciation) (25,387) 19,254
--------------------------------
Net Increase in Net Assets Resulting from Operations 12,937 37,384
--------------------------------
DISTRIBUTIONS
Net Investment Income (4,219) (8,161)
Realized Capital Gain (9,590) --
--------------------------------
Total Distributions (13,809) (8,161)
--------------------------------
CAPITAL SHARE TRANSACTIONS1
Issued 151,496 28,408
Issued in Lieu of Cash Distributions 12,342 6,782
Redeemed (36,272) (56,911)
--------------------------------
Net Increase (Decrease) from Capital Share Transactions 127,566 (21,721)
-----------------------------------------------------------------------------------------------------------
Total Increase 126,694 7,502
-----------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 179,632 172,130
--------------------------------
End of Period $306,326 $179,632
===========================================================================================================
1Shares Issued (Redeemed)
Issued 10,220 2,386
Issued in Lieu of Cash Distributions 925 603
Redeemed (2,523) (4,869)
--------------------------------
Net Increase (Decrease) in Shares Outstanding 8,622 (1,880)
===========================================================================================================
</TABLE>
16
<PAGE>
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.
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
CONVERTIBLE SECURITIES FUND
YEAR ENDED NOVEMBER 30,
FOR A SHARE OUTSTANDING SIX MONTHS ENDED -----------------------------------------------------
THROUGHOUT EACH PERIOD MAY 31, 2000 1999 1998 1997 1996 1995
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $13.18 $11.10 $13.01 $13.07 $12.03 $10.94
---------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .27 .52 .52 .53 .43 .52
Net Realized and Unrealized Gain (Loss)
on Investments 1.27 2.13 (.77) 1.17 1.29 1.26
-----------------------------------------------------------------
Total from Investment Operations 1.54 2.65 (.25) 1.70 1.72 1.78
-----------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.25) (.57) (.54) (.47) (.54) (.51)
Distributions from Realized Capital Gains (.70) -- (1.12) (1.29) (.14) (.18)
-----------------------------------------------------------------
Total Distributions (.95) (.57) (1.66) (1.76) (.68) (.69)
---------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $13.77 $13.18 $11.10 $13.01 $13.07 $12.03
===============================================================================================================
TOTAL RETURN 12.03% 24.85% -2.16% 14.81% 14.88% 17.10%
===============================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions $306 $180 $172 $189 $170 $172
Ratio of Total Expenses to
Average Net Asset 0.60%* 0.55% 0.73% 0.67% 0.69% 0.75%
Ratio of Net Investment Income to
Average Net Assets 4.20%* 4.30% 4.36% 4.29% 3.43% 4.63%
Portfolio Turnover Rate 200%* 162% 186% 182% 97% 46%
===============================================================================================================
*Annualized.
</TABLE>
17
<PAGE>
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: Equity securities 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; such securities not
traded on the valuation date are valued at the mean of the latest quoted bid and
asked prices. Prices are taken from the primary market in which each security
trades. Bonds are valued using the latest bid prices or using valuations based
on a matrix system (which considers such factors as security prices, yields,
maturities, and ratings), both as furnished by independent pricing services.
Temporary cash investments are valued at cost, which approximates market value.
Securities for which market quotations are not readily available are valued by
methods deemed by the board of trustees to represent fair 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. Distributions are determined on a tax basis and may differ
from net investment income and realized capital gains for financial reporting
purposes.
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
respective 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 six
months ended May 31, 2000, the advisory fee represented an effective annual rate
of 0.42% of the fund's average net assets before a decrease of $194,000 (0.15%)
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 trustees. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At May 31, 2000, the fund had contributed capital of $62,000 to
Vanguard (included in Other Assets), representing 0.02% of the fund's net assets
and 0.06% of Vanguard's capitalization. The fund's trustees and officers are
also directors and officers of Vanguard.
18
<PAGE>
D. During the six months ended May 31, 2000, the fund purchased $373,157,000 of
investment securities and sold $242,466,000 of investment securities, other than
temporary cash investments.
E. At May 31, 2000, net unrealized depreciation of investment securities for
financialreporting and federal income tax purposes was $12,102,000, consisting
of unrealized gains of $16,768,000 on securities that had risen in value since
their purchase and $28,870,000 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 May 31, 2000, was
$6,581,000, for which the fund held cash collateral of $6,730,000. Cash
collateral received is invested in repurchase agreements.
19
<PAGE>
THE VANGUARD(R) FAMILY OF FUNDS
STOCK FUNDS
----------------------------------------
500 Index Fund
Aggressive Growth Fund
Capital Opportunity Fund
Convertible Securities Fund
Emerging Markets Stock
Index Fund
Energy Fund
Equity Income Fund
European Stock Index Fund
Explorer(TM) Fund
Extended Market Index Fund*
Global Equity Fund
Gold and Precious Metals Fund
Growth and Income Fund
Growth Index Fund*
Health Care Fund
Institutional Index Fund*
International Growth Fund
International Value Fund
Mid-Cap Index Fund*
Morgan(TM) Growth Fund
Pacific Stock Index Fund
PRIMECAP Fund
REIT Index Fund
Selected Value Fund
Small-Cap Growth Index Fund*
Small-Cap Index Fund*
Small-Cap Value Index Fund*
Tax-Managed Capital
Appreciation Fund*
Tax-Managed Growth and
Income Fund*
Tax-Managed International Fund*
Tax-Managed Small-Cap Fund*
Total International Stock
Index Fund
Total Stock Market Index Fund*
U.S. Growth Fund
Utilities Income Fund
Value Index Fund*
Windsor(TM) Fund
Windsor(TM) II Fund
BALANCED FUNDS
----------------------------------------
Asset Allocation Fund
Balanced Index Fund
Global Asset Allocation Fund
LifeStrategy(R) Conservative
Growth Fund
LifeStrategy(R) Growth Fund
LifeStrategy(R) Income Fund
LifeStrategy(R) Moderate
Growth Fund
STAR(TM) Fund
Tax-Managed Balanced Fund
Wellesley(R) Income Fund
Wellington(TM) Fund
BOND FUNDS
----------------------------------------
Admiral(TM) Intermediate-Term
Treasury Fund
Admiral(TM) Long-Term Treasury
Fund
Admiral(TM) Short-Term Treasury
Fund
GNMA Fund
High-Yield Corporate Fund
High-Yield Tax-Exempt Fund
Insured Long-Term Tax-Exempt
Fund
Intermediate-Term Bond
Index Fund
Intermediate-Term Corporate Fund
Intermediate-Term Tax-Exempt
Fund
Intermediate-Term Treasury Fund
Limited-Term Tax-Exempt Fund
Long-Term Bond Index Fund
Long-Term Corporate Fund
Long-Term Tax-Exempt Fund
Long-Term Treasury Fund
Preferred Stock Fund
Short-Term Bond Index Fund
Short-Term Corporate Fund*
Short-Term Federal Fund
Short-Term Tax-Exempt Fund
Short-Term Treasury Fund
State Tax-Exempt Bond Funds
(California, Florida,
Massachusetts, New Jersey,
New York, Ohio, Pennsylvania)
Total Bond Market Index Fund*
MONEY MARKET FUNDS
----------------------------------------
Admiral(TM) Treasury Money
Market Fund
Federal Money Market Fund
Prime Money Market Fund*
State Tax-Exempt Money Market
Funds (California, New Jersey,
New York, Ohio, Pennsylvania)
Tax-Exempt Money Market Fund
Treasury Money Market Fund
VARIABLE ANNUITY PLAN
----------------------------------------
Balanced Portfolio
Diversified Value Portfolio
Equity Income Portfolio
Equity Index Portfolio
Growth Portfolio
High-Grade Bond Portfolio
High Yield Bond Portfolio
International Portfolio
Mid-Cap Index Portfolio
Money Market Portfolio
REIT Index Portfolio
Short-Term Corporate Portfolio
Small Company Growth Portfolio
*Offers Institutional Shares.
For information about Vanguard funds and our variable annuity plan, including
charges and expenses,
obtain a prospectus from The Vanguard Group, P.O. Box 2600, Valley Forge,
PA 19482-2600.
Read it carefully before you invest or send money.
20
<PAGE>
--------------------------------------------------------------------------------
THE PEOPLE WHO GOVERN YOUR FUND
The trustees of your mutual fund are there to see that the fund is operated and
managed in your best interests since, as a shareholder, you are part owner of
the fund. Your fund trustees also serve on the board of directors of The
Vanguard Group, which is owned by the funds and exists solely to provide
services to them on an at-cost basis.
Six of Vanguard's seven board members are independent, meaning that they have
no affiliation with Vanguard or the funds they oversee, apart from the sizable
personal investments they have made as private individuals. They bring
distinguished backgrounds in business, academia, and public service to their
task of working with Vanguard officers to establish the policies and oversee the
activities of the funds.
Among board members' responsibilities are selecting investment advisers for
the funds; monitoring fund operations, performance, and costs; reviewing
contracts; nominating and selecting new trustees/directors; and electing
Vanguard officers.
The list below provides a brief description of each trustee's
professional affiliations. Noted in parentheses is the year in which the trustee
joined the Vanguard board.
TRUSTEES
JOHN J. BRENNAN (1987) Chairman of the Board, Chief Executive Officer, and
Director/Trustee of The Vanguard Group, Inc., and each of the investment
companies in The Vanguard Group.
JOANN HEFFERNAN HEISEN (1998) Vice President, Chief Information Officer, and a
member of the Executive Committee of Johnson & Johnson; Director of Johnson &
JohnsonoMerck Consumer Pharmaceuticals Co., The Medical Center at Princeton, and
Women's Research and Education Institute.
BRUCE K. MACLAURY (1990) President Emeritus of The Brookings Institution;
Director of American Express Bank Ltd., The St. Paul Companies, Inc., and
National Steel Corp.
BURTON G. MALKIEL (1977) Chemical Bank Chairman's Professor of Economics,
Princeton University; Director of Prudential Insurance Co. of America, Banco
Bilbao Gestinova, Baker Fentress & Co., The Jeffrey Co., and Select Sector SPDR
Trust.
ALFRED M. RANKIN, JR. (1993) Chairman, President, Chief Executive Officer, and
Director of NACCO Industries, Inc.; Director of The BFGoodrich Co.
JAMES O. WELCH, JR. (1971) 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 (1985) Retired Chairman of Rohm & Haas Co.; Director of
AmeriSource Health Corporation, 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.
THOMAS J. HIGGINS Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of
each of the investment companies in The Vanguard Group.
VANGUARD MANAGING DIRECTORS
R. GREGORY BARTON Legal Department.
ROBERT A. DISTEFANO Information Technology.
JAMES H. GATELY Individual Investor Group.
KATHLEEN C. GUBANICH Human Resources.
IAN A. MACKINNON Fixed Income Group.
F. WILLIAM MCNABB, III Institutional Investor Group.
MICHAEL S. MILLER Planning and Development.
RALPH K. PACKARD Chief Financial Officer.
GEORGE U. SAUTER Quantitative Equity Group.
<PAGE>
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