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VANGUARD
EQUITY INCOME
FUND
ANNUAL REPORT
SEPTEMBER 30, 1999
[PHOTO OF SHIP]
[A MEMBER OF THE VANGUARD GROUP LOGO]
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[PHOTO OF JOHN C. BOGLE]
JOHN C. BOGLE
FELLOW SHAREHOLDERS:
TWO ROADS DIVERGED IN A WOOD, AND I--I TOOK THE ONE LESS TRAVELED BY, AND
THAT HAS MADE ALL THE DIFFERENCE.
I can think of no better words than those of Robert Frost to begin this special
letter to our shareholders, who have placed such extraordinary trust in me and
in Vanguard over the past quarter century. When the firm was founded 25 years
ago, we deliberately took a new road to managing a mutual fund enterprise.
Instead of having the funds controlled by an outside management company with its
own financial interests, the Vanguard funds--there were only 11 of them
then--would be controlled by their own shareholders and operate solely in their
financial interests. The outcome of our unprecedented decision was by no means
certain. We described it then as "The Vanguard Experiment."
Well, I guess it's fair to say it's an experiment no more. During the past
25 years, the assets we hold in stewardship for investors have grown from $1
billion to more than $500 billion, and I believe that our reputation for
integrity, fair-dealing, and sound investment principles is second to none in
this industry. Our staggering growth--which I never sought--has come in
important part as a result of the simple investment ideas and basic human values
that are the foundation of my personal philosophy. I have every confidence that
they will long endure at Vanguard, for they are the right ideas and right
values, unshakable and eternal.
While Emerson believed that "an institution is the lengthened shadow of one
man," Vanguard today is far greater than any individual. The Vanguard crew has
splendidly implemented and enthusiastically supported our founding ideas and
values, and deserve the credit for their vital role in forging our success over
the years. It is a dedicated crew of fine human beings, working together in an
organization that is well prepared to press on regardless long after I am gone.
Creating and leading this enterprise has been an exhilarating run. Through it
all, I've taken the kudos and the blows alike, enjoying every moment to the
fullest, and even getting a second chance at life with a heart transplant three
years ago. What more could a man ask?
While I shall no longer be serving on the Vanguard Board, I want to assure
you that I will remain vigorous and active in a newly created Vanguard unit,
researching the financial markets, writing, and speaking. I'll continue to focus
whatever intellectual power and ethical strength I possess on my mission to
assure that mutual fund investors everywhere receive a fair shake. In the spirit
of Robert Frost:
BUT I HAVE PROMISES TO KEEP, AND MILES TO GO BEFORE I SLEEP, AND MILES TO
GO BEFORE I SLEEP.
You have given me your loyalty and friendship over these long years, and I
deeply appreciate your thousands of letters of support. For my part, I will
continue to keep an eagle eye on your interests, for you deserve no less. May
God bless you all, always.
/S/
JCB
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CONTENTS
REPORT FROM THE CHAIRMAN..............1 PERFORMANCE SUMMARY....................9
AFTER-TAX RETURN REPORT...............4 FUND PROFILE..........................10
THE MARKETS IN PERSPECTIVE............5 FINANCIAL STATEMENTS..................12
REPORT FROM THE ADVISERS..............7 REPORT OF INDEPENDENT ACCOUNTANTS.....20
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[PHOTO OF JOHN J. BRENNAN]
JOHN J. BRENNAN
REPORT FROM THE CHAIRMAN
Vanguard Equity Income Fund got off to a strong start during its 1999 fiscal
year but faltered somewhat during the second half of the period, when the U.S.
stock market struggled. The fund earned a total return of 12.6% for the 12
months ended September 30, 1999, surpassing the return of its average peer but
falling far short of the remarkable 27.8% gain of the Standard & Poor's 500
Index.
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TOTAL RETURNS
FISCAL YEAR ENDED
SEPTEMBER 30, 1999
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Vanguard Equity Income Fund 12.6%
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Average Equity Income Fund* 12.3%
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S&P 500 Index 27.8%
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*Based on data from Lipper Inc.
The adjacent table presents the fund's 12-month total return, as well as
the returns of the average equity income fund and the S&P 500 Index, which is
dominated by large-capitalization stocks. The fund's total return (capital
change plus reinvested dividends) is based on an increase in net asset value
from $22.80 per share on September 30, 1998, to $24.14 per share on September
30, 1999, and is adjusted for dividends totaling $0.67 per share paid from net
investment income and a distribution of $0.83 per share paid from net realized
capital gains. We anticipate making a capital gains distribution of roughly
$0.75 per share in December 1999.
FINANCIAL MARKETS IN REVIEW
At first blush, the performance of U.S. stocks during the 12 months ended
September 30 appeared to be the latest chapter in the story of an ongoing bull
market. The Wilshire 5000 Total Market Index, a measure of the entire U.S. stock
market, returned a marvelous 27.0% against a backdrop of strong economic growth
and low inflation. But that impressive return masked weakness during the second
half of the period. Nearly all of the Wilshire 5000's gain came from October
1998 through March 1999, when the index advanced 26.1%. From April through
September, the index returned just 0.7%.
When the fiscal year began, stocks were in the early stages of a swift,
impressive recovery from the swoon of late-summer 1998, and bonds were basking
in an environment that featured declining interest rates and nary a hint of
inflation. The U.S. economy was growing and international markets were getting
back on their feet. But around the period's halfway point, investors seemed to
focus on the possibility that the U.S. economy's expansion would engender higher
inflation. The nation's record trade deficits, due in part to the economy's
strength, became worrisome as the U.S. dollar weakened versus the Japanese yen.
Rising interest rates also were a burden on both stocks and bonds.
The shift in sentiment was felt everywhere, even in the large-cap stocks
that for several years have led the market. The S&P 500 Index, which had gained
27.3% from October through March, returned just 0.4% during the past six months.
Within the S&P 500, technology stocks were the clear leaders during the 12
months, gaining 77%.
Gains made by growth stocks outstripped those of value stocks by a wide
margin. The growth component of the S&P 500 Index returned 33.4% during the 12
months, while the index's value share--those issues characterized by
below-average prices in relation to such measures as earnings and book
value--returned 21.5%.
Bond prices slid during the 12 months amid inflation fears. The yield of
the 30- year U.S. Treasury bond, which moves in the opposite direction from its
price, rose
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more than 1 percentage point on balance. The 30-year Treasury's yield stood at
6.05% on September 30, 107 basis points (1.07 percentage points) higher than its
level a year earlier. The Lehman Brothers Aggregate Bond Index, a measure of the
entire U.S. bond market, provided a total return of -0.4% for the year.
FISCAL 1999 PERFORMANCE OVERVIEW
Vanguard Equity Income Fund's total return of 12.6% was a bit higher than the
12.3% return of the average equity income fund but less than half the 27.8%
return of the S&P 500 Index. The fund advanced 11.9% from September 1998 through
March 1999, but gained just 0.6% during the six months ended September 30, 1999.
Our significant shortfall versus the S&P 500 Index can be traced to several
factors. Most important was the sizzling performance of technology stocks, many
of which pay little or no dividend income and therefore are not candidates for
your fund. As you know, the Equity Income Fund's mandate is to provide long-term
growth, current income, and below-average price volatility--an investment
approach that necessarily steers the fund's selections toward traditional value
stocks. As a result, the high-flying--but low-yielding--tech issues that powered
the S&P 500 were nearly absent from our fund. The fund's emphasis on income is
based on our belief that dividends are an important component of total return in
rising markets and can provide a cushion in down markets. As of September 30,
Vanguard Equity Income Fund's yield was 2.6%, twice the 1.3% yield of the S&P
500.
We held our customary heavy weighting in the utilities group--also in
keeping with the fund's income mandate--with about one-quarter of assets
committed to the sector, about twice the index weighting. While utilities had a
solid year, our selections were concentrated in electric and local telephone
companies, which lagged the exceptional gains posted by long-distance and
wireless telecommunications companies.
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TOTAL ASSETS MANAGED
AS OF SEPTEMBER 30, 1999
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$ MILLION PERCENT
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Newell Associates $1,834 61%
John A. Levin & Company, Inc. 547 18
Spare, Kaplan, Bischel & Associates 481 16
Cash Reserves* 147 5
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Total $3,009 100%
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*This cash reserve is invested in equity index futures to
simulate investment in stocks; each adviser also maintains
a modest cash reserve.
Our relatively light commitment to consumer-discretionary issues-- a sector
dominated by retailers, which, as a group, pay skimpy dividends--also hampered
our performance relative to the index.
As noted, our return was slightly higher than that of the average equity
income fund, which has tended to stray somewhat from a strict value standard and
therefore has a larger share of the growth-oriented companies that your fund
must eschew.
The fund's stocks are selected by three investment advisers, each of which
uses its own methodology. The table above shows the current allocation of assets
to each adviser.
LONG-TERM PERFORMANCE OVERVIEW
An annual review of a mutual fund's performance should also include a look at
the longer-term record. The table on the next page presents the average annual
returns of the Equity Income Fund and its comparative benchmarks for the past
ten years. It also presents the results of hypothetical $10,000 investments made
a decade ago in the fund, its average competitor, and the S&P 500 Index.
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Over the decade, a $10,000 investment in the Equity Income Fund would have
grown to $33,816, nearly $1,800 more than would have accumulated in the average
equity income fund over the same period. In comparison, the same initial
investment in the S&P 500 Index, which has been boosted by a relatively small
group of large growth stocks, would have grown to $47,334.
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TOTAL RETURNS
10 YEARS ENDED SEPTEMBER 30, 1999
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AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
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Vanguard Equity Income Fund 13.0% $33,816
Average Equity Income Fund 12.4% $32,056
S&P 500 Index 16.8% $47,334
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Our margin over our average peer is mainly due to our much lower expenses.
The fund's expense ratio (expenses as a percentage of average net assets) is
0.41%, a fraction of the 1.38% charged by our average competitor. This
difference--we call it the "Vanguard advantage"--gives our fund a head start
year after year.
As you can see, the S&P 500 Index posted an annual average total return of
nearly 17% over the past decade. While investors can certainly be thankful for
such a soaring market, it would be unwise to consider such performance the norm.
The future is unpredictable, but I believe that investors should count on no
more from common stocks than the long-term historical average of about 11%
annually and should be prepared for periods--maybe extended periods--of returns
that are far lower.
IN SUMMARY
The past 12 months demonstrated a fact of investing life: Markets fluctuate. The
first six months of the period gave ample evidence of the rewards that the
financial markets can provide, while the final six months reminded us of the
risks that are ever present. We have long suggested that combining stock funds,
bond funds, and short-term reserves is the best way to participate in the
long-term rewards of the financial markets while tempering the risk. Creating
such a balanced plan and sticking with it is a time-tested approach to long-term
investment success.
/S/
John J. Brennan
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
October 13, 1999
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A NOTE OF THANKS TO OUR FOUNDER
================================================================================
As you may have read on the inside cover of our report, our founder, John C.
Bogle, is retiring December 31, 1999, as Senior Chairman of our Board after
nearly 25 years of devoted service to Vanguard and our shareholders. Vanguard
investors have Jack to thank for creating a truly MUTUAL mutual fund company
that operates solely in the interest of its fund shareholders. And mutual fund
investors everywhere have benefited from his energetic efforts to improve this
industry. Finally, on a personal note, I am forever grateful to Jack for giving
me the opportunity to join this great company in 1982.
3
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A REPORT ON YOUR FUND'S AFTER-TAX RETURN
Beginning with this annual report, Vanguard is pleased to provide a review of
the Equity Income Fund's after-tax performance. The figures on this page
demonstrate the considerable impact that federal income taxes can have on a
fund's return--an important consideration for investors who own mutual funds in
taxable accounts. While the pretax return is most often used to tally a fund's
performance, the fund's after-tax return, which accounts for taxes on
distributions of capital gains and income dividends, is a better representation
of the return that many investors actually received. IF YOU OWN THE EQUITY
INCOME FUND IN A TAX-DEFERRED ACCOUNT SUCH AS AN INDIVIDUAL RETIREMENT ACCOUNT
OR A 401(K), THIS INFORMATION DOES NOT APPLY TO YOU. SUCH ACCOUNTS ARE NOT
SUBJECT TO CURRENT TAXES.
The table below presents the pretax and after-tax returns for your fund and
an appropriate peer group of mutual funds. Two things to keep in mind:
o The after-tax return calculations use the top federal income tax rates in
effect at the time of each distribution. The tax burden, therefore, would be
somewhat less, and the after-tax return somewhat more, for those in lower tax
brackets.
o The peer funds' returns are provided by Morningstar, Inc. (Elsewhere in
this report, returns for comparable mutual funds are based on data from Lipper
Inc. and may differ somewhat.)
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AVERAGE ANNUAL RETURNS: PRETAX AND AFTER-TAX
PERIODS ENDED SEPTEMBER 30, 1999
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1 YEAR 5 YEARS 10 YEARS
----------------- ----------------- -----------------
PRETAX AFTER-TAX PRETAX AFTER-TAX PRETAX AFTER-TAX
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Equity Income Fund 12.6% 10.4% 19.5% 17.2% 13.0% 10.7%
Average Large Value Fund* 15.9 13.9 17.5 14.6 13.2 10.5
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*Based on data from Morningstar, Inc.
As you can see, the Equity Income Fund's pretax total return of 12.6% for
the 12 months ended September 30, 1999, was reduced by taxes to 10.4%. In other
words, for investors in the highest tax bracket, the fund's pretax return was
cut by 2.2 percentage points. In comparison, the average large-cap value fund
earned a pretax return of 15.9% and an after-tax return of 13.9%, a difference
of 2 percentage points.
Over longer periods, the Equity Income Fund's after-tax performance
compares favorably with that of its average peer. Over the ten years ended
September 30, 1999, your fund lost less to taxes (2.3 percentage points) than
the peer-group average (2.7 percentage points) though it generated a slightly
lower pretax return.
We must stress that because many interrelated factors affect how
tax-friendly a fund may be, it's very difficult to predict tax efficiency. A
fund's tax efficiency can be influenced by its turnover rate, the types of
securities it holds, the accounting practices it uses when selling shares, and
the net cash flow it receives.
Finally, it's important to understand that our calculation does not reflect
the tax effect of your own investment activities. Specifically, you may incur
additional capital gains taxes--thereby lowering your after-tax return--if you
decide to sell all or some of your shares.
A NOTE ABOUT OUR CALCULATIONS: Pretax total returns assume that all
distributions received (income dividends, short-term capital gains, and
long-term capital gains) are reinvested in new shares, while our after-tax
returns assume that distributions are reduced by any taxes owed on them before
reinvestment. When calculating the taxes due, we used the highest individual
federal income tax rates at the time of the distributions. Those rates are
currently 39.6% for dividends and short-term capital gains and 20% for long-term
capital gains. State and local income taxes were not considered. The competitive
group returns provided by Morningstar are calculated in a manner consistent with
that used for Vanguard funds.
4
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THE MARKETS IN PERSPECTIVE
YEAR ENDED SEPTEMBER 30, 1999
The fiscal year ended September 30, 1999, was, in a sense, two distinctly
different periods. During the first half of the year, stock markets rebounded
sharply from the crisis of confidence that had shaken investors during the
summer of 1998. Then, during the second half, fears of a global economic slump
gave way to optimism about improving business activity. Indeed, a new
concern--that economic growth might be getting out of hand--came to the fore,
causing interest rates to rise and bond prices to fall, depressing the total
returns on bonds and cooling off the hot U.S. stock market.
U.S. STOCK MARKETS
A robust U.S. economy and rising expectations for corporate earnings buoyed the
U.S. stock market, especially during the first half of the fiscal year.
Consumers, whose spending accounts for roughly two-thirds of economic activity,
spent like never before, encouraged by rising wealth from a long bull market, a
bright employment picture (unemployment was at a slim 4.2% of the workforce in
September), and rising incomes (after-tax personal income in August was up 5.2%
from a year earlier). Indeed, on average, U.S. households in August spent just
above $1.01 for every $1.00 of after-tax income, dipping into savings or
borrowing to finance some of their purchases.
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AVERAGE ANNUAL RETURNS
PERIODS ENDED SEPTEMBER 30, 1999
---------------------------------
1 YEAR 3 YEARS 5 YEARS
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STOCKS
S&P 500 Index 27.8% 25.1% 25.0%
Russell 2000 Index 19.1 8.7 12.4
Wilshire 5000 Index 27.0 21.9 22.7
MSCI EAFE Index 31.3 10.7 9.4
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BONDS
Lehman Aggregate Bond Index -0.4% 6.8% 7.8%
Lehman 10 Year Municipal Bond Index -0.5 5.9 6.8
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 4.6 5.0 5.2
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OTHER
Consumer Price Index 2.6% 2.1% 2.4%
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During the first half of the period, the stock market rose 26.1%, as
measured by the Wilshire 5000 Total Market Index. Investor confidence, already
high due to the booming economy, was bolstered by easier monetary policy--the
Federal Reserve's Open Market Committee cut short-term interest rates a total of
0.75 percentage point during autumn 1998. However, stock returns were muted
during the second half of the fiscal year, when the Fed acted to boost
short-term rates to slow the economy and reduce inflationary pressures. Higher
rates tend to hurt stock prices because many investors use current interest
rates to discount the value of a stock's projected earnings and dividends. And
the higher the rate, the more future earnings are discounted, and the less
investors are willing to pay for the stock now. After a second-half gain of just
0.7%, the Wilshire 5000 Index recorded a 27.0% return for the full fiscal year.
A rise in corporate profits helped stock investors overcome their worries about
higher interest rates.
Big stocks outperformed small stocks during the fiscal year, and growth
stocks outpaced value stocks. The S&P 500 Index, which is made up largely of
large-capitalization
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stocks, gained 27.8%, while the small-cap Russell 2000 Index posted a 19.1%
return. Large and small growth stocks--whose high prices in relation to
earnings, book value, and dividends indicate high expectations for future
growth--outdistanced value stocks, posting gains of roughly 33%. Value stocks
within the S&P 500 Index gained 21.5%, while the value stocks in the Russell
2000 recorded a meager 5.8% return.
The market's leaders were large-cap technology stocks, which as a group
posted a gain of 77% during the year. Big gains also were posted by retailers
and other members of the consumer-discretionary sector (up 34%) and by the
producer-durables sector (up 45%), which includes engine, machinery, and
aircraft makers. The weakest sectors were consumer staples (a -1% return), where
food and beverage company stocks were hurt by disappointing earnings, and health
care (up 1%), where stocks suffered from weaker-than-expected earnings and
concerns about government efforts to limit health-care spending.
U.S. BOND MARKETS
The powerful economic growth that helped stocks was seen as a negative for
bonds. Investors and Federal Reserve policymakers alike worried that growth was
so strong it was bound to push up inflation. However, the Consumer Price Index
rose a relatively modest 2.6% during the 12-month period.
The Fed, having lowered interest rates late in 1998 to help fuel the
economy, reversed its stance and tapped on the monetary brakes with
quarter-point rate increases on June 30 and again on August 24. The Fed said it
sought to "diminish the risk of rising inflation." Yields of long-term U.S.
Treasury bonds rose by 1 to 1.5 percentage points during the fiscal year.
The yield of the 30-year Treasury bond increased 1.07 percentage points (107
basis points), from 4.98% on September 30, 1998, to 6.05% a year later. The
yield of the 10-year Treasury, a key benchmark for mortgage loans, rose 146
basis points, from 4.42% to 5.88%. Three-month Treasury bills rose on balance by
49 basis points, from 4.36% to 4.85%.
The Lehman Brothers Aggregate Bond Index, a benchmark for the entire
taxable bond market, posted a negative -0.4% return, as interest income of 6.1%
from bonds was more than offset by an average price decline of -6.5%. Returns
were somewhat higher for high-yield (junk) bonds and mortgage-backed securities
such as GNMAs.
INTERNATIONAL STOCK MARKETS
International markets recorded big gains during the 12 months ended September
30. The Morgan Stanley Capital International Europe, Australasia, Far East
(EAFE) Index provided a 31.3% return for U.S. investors. Gains were especially
large in the Pacific region, where the MSCI Pacific Free Index posted a 70.2%
return for the fiscal year. Currency fluctuations, principally the U.S. dollar's
slide versus the Japanese yen, accounted for more than 30 percentage points of
the gain in the Pacific region. Emerging markets, as measured by the Select
Emerging Markets Free Index, gained 47.9% for U.S. investors. Returns from
Europe were 17.4%, as measured by the MSCI Europe Index. European currencies
generally declined versus the U.S. dollar, which for U.S. investors reduced the
26.2% gains made in local currencies.
Stocks benefited from a general brightening of the world economic outlook.
When the fiscal year began, markets were still reacting to economic weakness in
Japan and upheavals elsewhere in Asia, Russia, and Latin America. But business
rebounded in many nations around the world, aided by the efforts of central
banks to spur economic growth with lower interest rates.
6
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REPORT FROM THE ADVISERS
During the fiscal year ended September 30, 1999, Vanguard Equity Income Fund
earned 12.6%. This return was slightly ahead of that recorded by the average
equity income fund, based on data from Lipper, but was far below the 27.0%
earned by the Wilshire 5000 Index and the 27.8% gain of the S&P 500 Index.
The market's performance was lopsided--nearly all the progress came during
the first six months, during which central banks around the world, including the
U.S. Federal Reserve, were cutting interest rates to boost economic growth and
restore calm to financial markets ruffled during the summer of 1998. Once the
Fed perceived that the "insurance policy" of lower rates was no longer needed,
it began raising rates during the second half of the fiscal year. Major market
indexes fluctuated considerably in this period, but on balance were little
changed.
Stock performance during the year also was asymmetrical in terms of growth
and value stocks. In a pattern that has grown familiar, growth stocks led by
glamorous technology names handily outpaced value stocks. Within the S&P 500
Index, growth stocks returned 33.4%, while value stocks gained 21.5%. Indeed, a
relative handful of large-capitalization growth stocks--including Microsoft,
America Online, MCI Worldcom, and Cisco Systems--were the main drivers of the
market's advance.
Indeed, these "mega-cap" technology stocks on their own accounted for much
of the disparity in performance between growth and value stocks and for much of
your fund's shortfall compared with the S&P 500 Index. Tech stocks--the largest
group within the S&P 500, representing more than 17% of the index--gained an
astounding 77% during the 12 months. Your fund's small stake in tech stocks
gained about 85%. However, technology was one of our smallest sector weightings
(averaging 1% of assets) because many of these stocks pay no dividends; they are
thus off-limits for the fund, whose charter is to invest in income-producing
stocks. Another reason for our shortfall versus the index was our emphasis
within the utility sector on electric-company stocks, which were market
laggards, and our relatively light weighting in long-distance and wireless
telecommunications companies, which were among the group's leaders.
On balance, our commitments to various industry sectors changed slightly
during the past year. The biggest change was a decline of about 4 percentage
points in our largest sector weighting, the utilities sector (22.3% of common
stocks on September 30, 1999, versus 26.4% a year earlier). There were increases
of about 1 percentage point each in the consumer-discretionary, "other energy,"
and producer-durables groups.
The six largest holdings in the fund as of September 30 were on our top-ten
list a year ago as well. The four other stocks in our current top ten also were
sizable holdings a year earlier. In short, we continue to like many of the
stocks that we liked a year ago.
Such stability in our holdings is not unusual. Although our stock-selection
methods differ, each of your three advisers seeks out companies that have low
valuations relative to the overall market. Because these stocks typically sport
above-average dividend yields, we
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INVESTMENT PHILOSOPHY
The advisers believe that a fund made up of undervalued stocks, most of which
offer high dividend yields compared to their past levels and to the overall
market, can provide a high level of current income, the potential for capital
appreciation, and below-average price volatility for a stock mutual fund.
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7
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are often content to hold them while we wait for the rest of the market to
discover the value we see in them. During the past year, a number of merger and
acquisition proposals showed that corporate America recognized some of the
values we had long believed were "hidden" among your fund's excellent holdings.
Equity Income Fund holdings that were acquired or are being acquired include
AMP, Amoco, Atlantic Richfield, Bankers Trust, BetzDearborn, Browning-Ferris,
Chrysler, MediaOne Group, Rubbermaid, Sundstrand, and Union Camp.
However, the fund is certainly not static. Buying opportunities have been
increased by virtue of the market's emphasis--one might say overemphasis--on a
narrow group of large-cap stocks and its disappointment with slowing earnings
growth at other blue-chip companies. Among the high-quality companies we've been
able to add as their dividend yields have become relatively attractive are
Procter & Gamble, Gillette, and PepsiCo.
Overall, the fund should continue to offer relatively high dividend yields
and below-average price volatility. If at some point we experience a bear
market, we believe the fund's low volatility and high-yield characteristics will
help cushion the blow. If the market continues to rise, the fund will be in a
position to participate. This is, after all, the whole idea behind a
conservative equity fund.
The direction of the stock market's movements is, of course, beyond our
control. So all of us continue to focus on selecting portfolios of good stocks
that should hold up well in weak markets and be competitive in rising ones.
NEWELL ASSOCIATES
JOHN A. LEVIN & COMPANY, INC.
SPARE, KAPLAN, BISCHEL & ASSOCIATES
October 11, 1999
8
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PERFORMANCE SUMMARY
EQUITY INCOME 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: MARCH 21, 1988-SEPTEMBER 30, 1999
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EQUITY INCOME FUND S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
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1988 5.8% 2.5% 8.3% 3.2%
1989 23.8 5.0 28.8 33.0
1990 -20.5 4.3 -16.2 -9.2
1991 18.0 8.5 26.5 31.2
1992 6.4 5.9 12.3 11.1
1993 14.1 5.1 19.2 13.0
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EQUITY INCOME FUND S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
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1994 -6.5% 4.3% -2.2% 3.7%
1995 19.8 5.0 24.8 29.7
1996 14.2 4.0 18.2 20.3
1997 30.0 4.2 34.2 40.4
1998 6.5 3.0 9.5 9.0
1999 9.6 3.0 12.6 27.8
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See FINANCIAL HIGHLIGHTS table on page 17 for dividend and capital gains
information for the past five years.
CUMULATIVE PERFORMANCE: SEPTEMBER 30, 1989-SEPTEMBER 30, 1999
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EQUITY INCOME FUND AVERAGE EQUITY INCOME FUND S&P 500 INDEX
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[10 YEAR GRAPH]
198909 10000 10000 10000
198912 10078 10030 10206
199003 9693 9697 9899
199006 9868 9928 10522
199009 8375 8722 9076
199012 8877 9259 9890
199103 10064 10425 11326
199106 10004 10492 11300
199109 10591 11199 11904
199112 11130 11769 12902
199203 11003 11822 12577
199206 11530 12131 12816
199209 11889 12533 13220
199212 12151 13018 13886
199303 13064 13873 14492
199306 13399 14043 14562
199309 14168 14749 14939
199312 13932 14864 15285
199403 13018 14326 14705
199406 13273 14466 14767
199409 13858 15138 15489
199412 13710 14652 15487
199503 15021 15765 16995
199506 15932 16874 18617
199509 17291 18199 20097
199512 18829 19136 21306
199603 19391 19944 22450
199606 20063 20595 23458
199609 20442 21316 24183
199612 22102 22761 26198
199703 22748 23057 26901
199706 25530 26050 31597
199709 27427 28477 33964
199712 28991 28918 34939
199803 32152 31794 39813
199806 31748 31471 41128
199809 30043 28548 37037
199812 34018 32035 44924
199903 33605 31778 47163
199906 36905 34782 50487
199909 33816 32056 47334
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED SEPTEMBER 30, 1999
---------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- --------------------------------------------------------------------------------
Equity Income Fund 12.56% 19.53% 12.96% $33,816
Average Equity Income Fund* 12.29 16.19 12.35 32,056
S&P 500 Index 27.80 25.03 16.82 47,334
- --------------------------------------------------------------------------------
*Based on data from Lipper Inc.
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED SEPTEMBER 30, 1999
- --------------------------------------------------------------------------------
10 YEARS
INCEPTION --------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------
Equity Income Fund 3/21/1988 12.56% 19.53% 8.23% 4.73% 12.96%
- --------------------------------------------------------------------------------
9
<PAGE>
FUND PROFILE
EQUITY INCOME FUND
This Profile provides a snapshot of the fund's characteristics as of September
30, 1999, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on page 11.
PORTFOLIO CHARACTERISTICS
- -----------------------------------------------------
EQUITY INCOME S&P 500
- -----------------------------------------------------
Number of Stocks 185 500
Median Market Cap $27.8B $65.4B
Price/Earnings Ratio 21.3x 27.1x
Price/Book Ratio 3.2x 4.9x
Yield 2.6% 1.3%
Return on Equity 20.5% 23.0%
Earnings Growth Rate 7.2% 14.8%
Foreign Holdings 4.5% 1.6%
Turnover Rate 18% --
Expense Ratio 0.41% --
Cash Reserves 1.9% --
INVESTMENT FOCUS
- -------------------------------------
[GRID]
STYLE VALUE
MARKET CAP LARGE
VOLATILITY MEASURES
- -------------------------------------
EQUITY INCOME S&P 500
- -------------------------------------
R-Squared 0.83 1.00
Beta 0.71 1.00
TEN LARGEST HOLDINGS
(% OF TOTAL NET ASSETS)
- -------------------------------------
Bell Atlantic Corp. 3.6%
Bristol-Myers Squibb Co. 2.4
GTE Corp. 2.1
BP Amoco PLC ADR 2.0
Chevron Corp. 2.0
Texaco Inc. 1.9
Atlantic Richfield Co. 1.8
Mobil Corp. 1.8
U S WEST, Inc. 1.7
Ameritech Corp. 1.7
- -------------------------------------
Top Ten 21.0%
SECTOR DIVERSIFICATION (% OF COMMON STOCKS)
- --------------------------------------------------------------------------------
SEPTEMBER 30, 1998 SEPTEMBER 30, 1999
---------------------------------------------------
EQUITY INCOME EQUITY INCOME S&P 500
---------------------------------------------------
Auto & Transportation ...... 3.5% 3.2% 2.2%
Consumer Discretionary ..... 6.1 7.1 12.2
Consumer Staples ........... 8.8 8.8 7.2
Financial Services ......... 16.3 16.5 14.7
Health Care ................ 11.5 10.7 10.5
Integrated Oils ............ 15.2 15.2 5.5
Other Energy ............... 0.1 1.5 1.5
Materials & Processing ..... 6.5 6.2 3.4
Producer Durables .......... 2.2 3.2 3.5
Technology ................. 1.0 1.1 21.8
Utilities .................. 26.4 22.3 11.2
Other ...................... 2.4 4.2 6.3
- --------------------------------------------------------------------------------
10
<PAGE>
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. This
figure does not include cash invested in futures contracts to
simulate stock investment.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a fund.
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 equity assets represented by stocks
or American Depositary Receipts of companies based outside the United States.
INVESTMENT FOCUS. This grid indicates the focus of a fund in terms of two
attributes: market capitalization (large, medium, or small) and relative
valuation (growth, value, or a blend).
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the proportion of the fund's assets
invested in each stock. Stocks representing half of the fund's assets have
market capitalizations above the median, and the rest are below it.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund holds,
the more diversified it is and the more likely to perform in line with the
overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a fund, the weighted average price/book ratio of the
stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a fund, the weighted average P/E of the stocks
it holds. P/E is an indicator of market expectations about corporate prospects;
the higher the P/E, the greater the expectations for a company's future growth.
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.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a fund, the weighted average return on
equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a fund's common stocks 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. (The average for stock mutual funds is about 35%.) 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 past year. 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. The index yield is based on the current annualized rate of
dividends paid on stocks in the index.
11
<PAGE>
FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
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. 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.
- -----------------------------------------------------
MARKET
VALUE*
EQUITY INCOME FUND SHARES (000)
- -----------------------------------------------------
COMMON STOCKS (91.4%)(1)
- -----------------------------------------------------
AUTO & TRANSPORTATION (2.9%)
Ford Motor Co. 654,191 $ 32,832
Genuine Parts Co. 524,646 13,936
Union Pacific Corp. 261,800 12,583
Dana Corp. 237,600 8,821
Norfolk Southern Corp. 291,958 7,153
CSX Corp. 146,300 6,199
General Motors Corp. 80,100 5,041
The Goodyear Tire & Rubber Co. 1,900 91
---------
86,656
---------
CONSUMER DISCRETIONARY (6.4%)
J.C. Penney Co., Inc. 885,680 30,445
May Department Stores Co. 713,504 25,998
Tribune Co. 514,000 25,572
Whirlpool Corp. 230,900 15,081
Eastman Kodak Co. 189,124 14,267
International Flavors &
Fragrances, Inc. 385,700 13,307
Kimberly-Clark Corp. 202,875 10,651
The McGraw-Hill Cos., Inc. 199,600 9,656
Gillette Co. 248,100 8,420
Black & Decker Corp. 174,800 7,986
The Stanley Works 264,400 6,660
o Fox Entertainment Group, Inc.
Class A 247,500 5,228
Newell Rubbermaid, Inc. 159,100 4,544
American Greetings Corp.
Class A 175,000 4,506
Avon Products, Inc. 174,100 4,320
Sears, Roebuck & Co. 126,429 3,967
Wal-Mart Stores, Inc. 60,000 2,854
The Ackerley Group, Inc. 35,000 431
---------
193,893
---------
CONSUMER STAPLES (8.1%)
Philip Morris Cos., Inc. 1,279,450 43,741
Anheuser-Busch Cos., Inc. 358,200 25,096
General Mills, Inc. 264,700 21,474
UST, Inc. 610,500 18,429
Ralston-Ralston Purina Group 532,700 14,816
H.J. Heinz Co. 341,540 14,686
PepsiCo, Inc. 415,300 12,563
The Quaker Oats Co. 195,800 12,115
Kellogg Co. 288,200 10,789
Nabisco Holdings Corp.Class A 292,500 10,110
Sara Lee Corp. 387,300 9,077
Procter & Gamble Co. 93,000 8,719
The Clorox Co. 205,000 7,841
Gallaher Group PLC ADR 263,600 7,167
Campbell Soup Co. 172,800 6,761
Albertson's, Inc. 117,100 4,633
Hershey Foods Corp. 94,700 4,611
Bestfoods 90,001 4,365
Rite Aid Corp. 247,529 3,419
ConAgra, Inc. 103,400 2,333
---------
242,745
---------
FINANCIAL SERVICES (15.1%)
Bank of America Corp. 653,623 36,399
Bank One Corp. 867,422 30,197
First Union Corp. 824,830 29,333
Mellon Bank Corp. 838,100 28,286
Marsh & McLennan Cos., Inc 383,100 26,242
12
<PAGE>
- -----------------------------------------------------
MARKET
VALUE*
SHARES (000)
- -----------------------------------------------------
J.P. Morgan & Co., Inc. 200,700 22,930
PNC Bank Corp. 434,494 22,892
American General Corp. 323,100 20,416
First Data Corp. 383,450 16,824
Dun & Bradstreet Corp. 547,900 16,369
Lincoln National Corp. 391,000 14,687
Washington Mutual, Inc. 476,210 13,929
SAFECO Corp. 484,200 13,558
Fleet Financial Group, Inc. 362,599 13,280
Wachovia Corp. 162,835 12,803
XL Capital Ltd. Class A 262,300 11,803
U.S. Bancorp 342,549 10,341
The Chase Manhattan Corp. 130,957 9,871
Equity Residential Properties
Trust REIT 227,300 9,632
The Bank of New York Co., Inc. 273,400 9,142
Mercury General Corp. 322,300 8,883
KeyCorp 338,170 8,729
St. Paul Cos., Inc. 316,133 8,694
Northern Trust Corp. 86,800 7,248
Merrill Lynch & Co., Inc. 106,816 7,177
Equity Office Properties
Trust REIT 277,500 6,452
The Chubb Corp. 121,001 6,027
PartnerRe Ltd. 152,300 5,292
National City Corp. 164,400 4,387
H & R Block, Inc. 100,300 4,357
Ace, Ltd. 251,000 4,251
Wells Fargo Co. 102,965 4,080
Prison Realty Trust, Inc. 367,800 3,954
Fannie Mae 59,100 3,705
Crescent Real Estate, Inc. REIT 107,300 1,931
---------
454,101
---------
HEALTH CARE (9.8%)
Bristol-Myers Squibb Co. 1,066,600 71,995
American Home Products Corp. 1,056,304 3,836
Pharmacia & Upjohn, Inc. 875,974 43,470
Merck & Co., Inc. 514,500 33,346
Glaxo Wellcome PLC ADR 478,100 24,861
Warner-Lambert Co. 224,000 14,868
Johnson & Johnson 154,600 14,204
Baxter International, Inc. 205,759 12,397
Eli Lilly & Co. 183,500 11,744
Aetna Inc. 151,600 7,466
McKesson HBOC, Inc. 215,900 6,261
SmithKline Beecham PLC ADR 73,500 4,235
Pfizer, Inc. 97,500 3,504
Abbott Laboratories 76,700 2,819
---------
295,006
---------
INTEGRATED OILS (13.9%)
BP Amoco PLC ADR 555,609 61,568
Chevron Corp. 688,246 61,082
Texaco Inc. 910,600 57,482
Atlantic Richfield Co. 627,100 55,577
Mobil Corp. 530,040 53,402
Exxon Corp. 662,564 50,313
Royal Dutch Petroleum Co. ADR 484,400 28,610
Phillips Petroleum Co. 416,500 20,304
Unocal Corp. 310,500 11,508
USX-Marathon Group 303,900 8,889
Conoco Inc. Class A 301,500 8,367
Conoco Inc. Class B 45,067 1,234
---------
418,336
---------
OTHER ENERGY (1.4%)
Schlumberger Ltd. 242,000 15,080
Williams Cos., Inc. 311,000 11,643
Equitable Resources, Inc. 210,000 7,941
Baker Hughes, Inc. 225,700 6,545
---------
41,209
---------
MATERIALS & PROCESSING (5.6%)
Dow Chemical Co. 390,729 44,396
International Paper Co. 519,010 24,945
Weyerhaeuser Co. 408,600 23,546
E.I. du Pont de Nemours & Co. 266,927 16,249
Eastman Chemical Co. 314,500 12,580
Nalco Chemical Co. 230,300 11,630
Lubrizol Corp. 271,500 6,974
Potlatch Corp. 152,400 6,277
Phelps Dodge Corp. 85,000 4,680
o Owens-Illinois, Inc. 215,000 4,260
Armstrong World Industries Inc. 90,600 4,071
Temple-Inland Inc. 60,400 3,654
USX-U.S. Steel Group 140,600 3,620
Placer Dome, Inc. 188,405 2,803
---------
169,685
---------
PRODUCER DURABLES (3.0%)
Emerson Electric Co. 204,259 12,907
Pitney Bowes, Inc. 211,400 12,882
United Technologies Corp. 192,116 11,395
Thomas & Betts Corp. 220,566 11,249
Xerox Corp. 257,500 10,799
The BFGoodrich Co. 285,200 8,271
Honeywell, Inc. 50,700 5,644
Caterpillar, Inc. 85,264 4,674
Lockheed Martin Corp. 133,400 4,361
Deere & Co. 95,946 3,712
The Boeing Co. 69,700 2,971
---------
88,865
---------
TECHNOLOGY (1.0%)
o Seagate Technology Inc. 408,400 12,584
International Business
Machines Corp. 91,900 11,154
Compaq Computer Corp. 286,500 6,571
---------
30,309
---------
UTILITIES (20.4%)
Bell Atlantic Corp. 1,602,240 107,851
GTE Corp. 812,073 62,428
U S WEST, Inc. 904,286 51,601
Ameritech Corp. 750,727 50,439
AT&T Corp. 1,012,052 44,024
BellSouth Corp. 854,704 38,462
SBC Communications Inc. 505,317 25,803
Consolidated Natural Gas Co. 405,400 25,287
Duke Energy Corp. 363,152 20,019
Southern Co. 656,710 16,910
Allegheny Energy, Inc. 450,400 14,328
Texas Utilities Co. 365,896 13,652
Edison International 551,640 13,412
KeySpan Corp. 466,236 13,346
PacifiCorp 609,441 12,265
13
<PAGE>
- -----------------------------------------------------
MARKET
VALUE*
EQUITY INCOME FUND SHARES (000)
- -----------------------------------------------------
NICOR, Inc. 307,292 11,427
Constellation Energy Group 404,850 11,386
Ameren Corp. 248,800 9,408
Wisconsin Energy Corp. 373,300 8,749
Dominion Resources, Inc. 179,600 8,104
Consolidated Edison Inc. 173,270 7,191
Northern States Power Co. 331,400 7,146
FPL Group, Inc. 133,135 6,707
Florida Progress Corp. 130,200 6,022
Central & South West Corp. 284,200 6,004
Eastern Utilities Associates 177,600 5,306
TECO Energy, Inc. 214,000 4,521
Potomac Electric Power Co. 140,000 3,561
Sempra Energy 153,838 3,202
OGE Energy Corp. 130,200 2,897
Entergy Corp. 82,600 2,390
SCANA Corp. 7,900 191
---------
614,039
---------
OTHER (3.8%)
General Electric Co. 296,800 35,189
Minnesota Mining &
Manufacturing Co. 344,807 33,123
Fortune Brands, Inc. 427,431 13,785
Monsanto Co. 355,000 12,669
Federal Signal Corp. 297,200 5,907
Textron, Inc. 72,100 5,579
Tenneco, Inc. 286,500 4,870
Cooper Industries, Inc. 85,000 3,974
---------
115,096
---------
- -----------------------------------------------------
TOTAL COMMON STOCKS
(COST $1,941,777) 2,749,940
- -----------------------------------------------------
CONVERTIBLE PREFERRED STOCKS (1.0%)
- -----------------------------------------------------
Loral Space & Communications
Ltd. 6.00% Cvt. Pfd. 222,600 10,740
Owens-Illinois Inc. 4.75% Cvt.
Pfd. 294,400 9,642
Crown Cork & Seal Co., Inc.
4.50% Cvt. Pfd. 236,800 5,284
Globalstar Telecommunications
Ltd. 8.00% Cvt. Pfd. 60,100 3,407
- -----------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(COST $33,694) 29,073
- -----------------------------------------------------
FACE
AMOUNT
(000)
- -----------------------------------------------------
CONVERTIBLE BONDS (0.8%)
Hewlett-Packard Co.
0.00%, 10/14/2017 22,600 13,687
National Semiconductor
6.50%, 10/1/2002 2,590 2,567
Security Capital U.S. Realty
2.50%, 5/22/2003 8,300 6,101
Waste Management Inc.
4.00%, 2/1/2002 4,000 3,565
- -----------------------------------------------------
TOTAL CONVERTIBLE BONDS
(COST $26,335) 25,920
- -----------------------------------------------------
TEMPORARY CASH INVESTMENTS (6.9%)(1)
- -----------------------------------------------------
Federal Home Loan Mortgage Corp.
(2)5.13%, 10/22/1999 2,000 1,994
Federal National Mortgage Assn.
(2)5.07%, 10/19/1999 7,000 6,981
U.S. Treasury Bill
(2)4.74%, 10/28/1999 2,000 1,993
Repurchase Agreements
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.30%, 10/1/1999 190,355 190,355
5.25%, 10/1/1999--Note G 5,973 5,973
- -----------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $207,298) 207,296
- -----------------------------------------------------
TOTAL INVESTMENTS (100.1%)
(COST $2,209,104) 3,012,229
- -----------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.1%)
- -----------------------------------------------------
Other Assets--Note C 21,596
Liabilities--Note G (25,082)
---------
(3,486)
- -----------------------------------------------------
NET ASSETS (100%)
- -----------------------------------------------------
Applicable to 124,625,301 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $3,008,743
=====================================================
NET ASSET VALUE PER SHARE $24.14
=====================================================
* See Note A in NOTES TO FINANCIAL STATEMENTS.
o Non-Income-Producing Security.
(1)The fund invests a portion of its cash reserves in
equity markets through the use of index futures
contracts. After giving effect to futures invest-
ments, the fund's effective common stock and
temporary cash investment positions represent
96.3% and 2.0%, respectively, of net assets.
See Note F in NOTES TO FINANCIAL STATEMENTS.
(2)Security segregated as initial margin for open
futures contracts.
ADR--American Depositary Receipt.
REIT--Real Estate Investment Trust.
- -----------------------------------------------------
AT SEPTEMBER 30, 1999, NET ASSETS CONSISTED OF:
- -----------------------------------------------------
AMOUNT PER
(000) SHARE
- -----------------------------------------------------
Paid in Capital $2,111,521 $16.94
Undistributed Net
Investment Income 2,915 .02
Accumulated Net
Realized Gains 97,804 .78
Unrealized Appreciation
(Depreciation)--Note F
Investment Securities 803,125 6.45
Futures Contracts (6,622) (.05)
- -----------------------------------------------------
NET ASSETS $3,008,743 $24.14
=====================================================
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. If the
fund invested in futures contracts during the period, the results of these
investments are shown separately.
- --------------------------------------------------------------------------------
EQUITY INCOME FUND
YEAR ENDED SEPTEMBER 30, 1999
(000)
- --------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
Dividends $ 76,462
Interest 11,196
Security Lending 86
---------
Total Income 87,744
---------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 4,568
Performance Adjustment (517)
The Vanguard Group--Note C
Management and Administrative 7,405
Marketing and Distribution 492
Custodian Fees 54
Auditing Fees 17
Shareholders' Reports 81
Trustees' Fees and Expenses 4
---------
Total Expenses 12,104
Expenses Paid Indirectly--Note D (265)
---------
Net Expenses 11,839
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 75,905
- --------------------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold 78,897
Futures Contracts 30,354
- --------------------------------------------------------------------------------
REALIZED NET GAIN 109,251
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 115,501
Futures Contracts (7,081)
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 108,420
- --------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $293,576
================================================================================
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.
- --------------------------------------------------------------------------------
EQUITY INCOME FUND
YEAR ENDED SEPTEMBER 30,
---------------------------
1999 1998
(000) (000)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 75,905 $ 63,904
Realized Net Gain 109,251 84,810
Change in Unrealized Appreciation (Depreciation) 108,420 36,596
---------------------------
Net Increase in Net Assets Resulting from
Operations 293,576 185,310
---------------------------
DISTRIBUTIONS
Net Investment Income (78,305) (65,293)
Realized Capital Gain (87,951) (78,880)
---------------------------
Total Distributions (166,256) (144,173)
---------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 931,840 691,426
Issued in Lieu of Cash Distributions 149,024 129,534
Redeemed (576,972) (432,576)
---------------------------
Net Increase from Capital Share Transactions 503,892 388,384
- --------------------------------------------------------------------------------
Total Increase 631,212 429,521
- --------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 2,377,531 1,948,010
---------------------------
End of Year $3,008,743 $2,377,531
================================================================================
(1)Shares Issued (Redeemed)
Issued 37,304 29,627
Issued in Lieu of Cash Distributions 6,175 5,766
Redeemed (23,137) (18,560)
---------------------------
Net Increase in Shares Outstanding 20,342 16,833
================================================================================
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>
- ----------------------------------------------------------------------------------------------------------
EQUITY INCOME FUND
YEAR ENDED SEPTEMBER 30,
------------------------------------------------
<S> <C> <C> <C> <C> <C>
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $22.80 $22.28 $17.69 $15.65 $13.16
- ----------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .64 .64 .64 .63 .60
Net Realized and Unrealized Gain (Loss) on Investments 2.20 1.44 5.17 2.18 2.56
------------------------------------------------
Total from Investment Operations 2.84 2.08 5.81 2.81 3.16
------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.67) (.67) (.64) (.60) (.58)
Distributions from Realized Capital Gains (.83) (.89) (.58) (.17) (.09)
------------------------------------------------
Total Distributions (1.50) (1.56) (1.22) (.77) (.67)
- ----------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $24.14 $22.80 $22.28 $17.69 $15.65
==========================================================================================================
TOTAL RETURN 12.56% 9.54% 34.17% 18.22% 24.77%
==========================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $3,009 $2,378 $1,948 $1,309 $967
Ratio of Total Expenses to Average Net Assets 0.41% 0.39% 0.45% 0.42% 0.47%
Ratio of Net Investment Income to Average Net Assets 2.59% 2.80% 3.25% 3.69% 4.27%
Portfolio Turnover Rate 18% 23% 22% 21% 31%
==========================================================================================================
</TABLE>
17
<PAGE>
NOTES TO FINANCIAL STATEMENTS
Vanguard Equity Income 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. Temporary cash investments acquired over 60 days to maturity 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. Other temporary cash
investments are valued at amortized 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. FUTURES: The fund uses S&P 500 Index and S&P MidCap 400 Index futures
contracts to a limited extent, with the objective of maintaining full exposure
to the stock market while maintaining liquidity. The fund may purchase or sell
futures contracts to achieve a desired level of investment, whether to
accommodate portfolio turnover or cash flows from capital share transactions.
The primary risks associated with the use of futures contracts are imperfect
correlation between changes in market values of stocks held by the fund and the
prices of futures contracts, and the possibility of an illiquid market.
Futures contracts are valued at their quoted daily settlement prices. The
aggregate principal amounts of the contracts are not recorded in the financial
statements. Fluctuations in the value of the contracts are recorded in the
Statement of Net Assets as an asset (liability) and in the Statement of
Operations as unrealized appreciation (depreciation) until the contracts are
closed, when they are recorded as realized futures gains (losses).
5. 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.
6. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date 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.
B. Newell Associates; Spare, Kaplan, Bischel & Associates; and John A. Levin &
Co., Inc., provide investment advisory services to the fund for fees calculated
at an annual percentage rate of average net assets. The basic fee of Spare,
Kaplan, Bischel & Associates is subject to quarterly adjustments based on
performance relative to the S&P/BARRA Value Index for the preceding three years;
the basic fee for John A. Levin & Co., Inc., is subject to quarterly adjustments
based on performance for the preceding three years relative to the S&P 500
Index.
18
<PAGE>
The Vanguard Group manages the cash reserves of the fund on an at-cost
basis.
For the year ended September 30, 1999, the aggregate advisory fee
represented an effective annual basic rate of 0.16% of the fund's average net
assets before a decrease of $517,000 (0.02%) 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 September 30, 1999, the fund had contributed capital of $670,000 to
Vanguard (included in Other Assets), representing 0.02% of the fund's net assets
and 0.7% of Vanguard's capitalization. The fund's Trustees and officers are also
Directors and officers of Vanguard.
D. Vanguard has asked the fund's investment advisers to direct certain security
trades, subject to obtaining the best price and execution, to brokers who have
agreed to rebate to the fund part of the commissions generated. Such rebates are
used solely to reduce the fund's management and administrative expenses. The
fund's custodian bank has also agreed to reduce its fees when the fund maintains
cash on deposit in the non-interest-bearing custody account. For the year ended
September 30, 1999, directed brokerage and custodian fee offset arrangements
reduced expenses by $259,000 and $6,000, respectively. The total expense
reduction represented an effective annual rate of 0.01% of the fund's average
net assets.
E. During the year ended September 30, 1999, the fund purchased $861,757,000 of
investment securities and sold $487,529,000 of investment securities other than
temporary cash investments.
F. At September 30, 1999, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $803,125,000,
consisting of unrealized gains of $908,643,000 on securities that had risen in
value since their purchase and $105,518,000 in unrealized losses on securities
that had fallen in value since their purchase.
At September 30, 1999, the aggregate settlement value of open futures
contracts expiring in December 1999 and the related unrealized depreciation
were:
--------------------------------------------------------------------
(000)
--------------------------
AGGREGATE
NUMBER OF SETTLEMENT UNREALIZED
FUTURES CONTRACTS LONG CONTRACTS VALUE DEPRECIATION
--------------------------------------------------------------------
S&P 500 Index 332 $107,751 $(4,462)
S&P MidCap 400 Index 203 39,118 (2,160)
--------------------------------------------------------------------
Unrealized depreciation on open futures contracts is required to be treated as
realized loss for federal income tax purposes.
G. The market value of securities on loan to broker/dealers at September 30,
1999, was $5,322,000, for which the fund held cash collateral of $5,973,000.
Cash collateral received is invested in repurchase agreements.
19
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Trustees of
Vanguard Equity Income 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 Equity Income Fund (the "Fund") at September 30, 1999, 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 September 30, 1999 by
correspondence with the custodian and brokers, provide a reasonable basis for
the opinion expressed above.
PricewaterhouseCoopers LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
October 29, 1999
--------------------------------------------------------------------------
SPECIAL 1999 TAX INFORMATION (UNAUDITED) FOR
VANGUARD EQUITY INCOME FUND
This information for the fiscal year ended September 30, 1999, is included
pursuant to provisions of the Internal Revenue Code.
The fund distributed $61,989,000 as capital gain dividends (from net
long-term capital gains) to shareholders in December 1998, all of which is
designated as a 20% rate gain distribution.
For corporate shareholders, 61.54% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received
deduction.
--------------------------------------------------------------------------
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.
The majority of Vanguard's 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 C. BOGLE * (1967) Founder, Senior Chairman of the Board, and
Director/Trustee of The Vanguard Group, Inc., and each of the investment
companies in The Vanguard Group.
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.
ALFRED M. RANKIN, JR. * (1993) 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 * (1991) 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., NACCO Industries, and Newfield Exploration 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) 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.
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 * Core Management Group.
<PAGE>
ABOUT OUR COVER
Our cover art, depicting HMS VANGUARD at sea, is a
reproduction of LEADING THE WAY, a 1984 work created
and copyrighted by noted naval artist Tom Freeman,
of Forest Hill, Maryland.
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 4500" and "Wilshire 5000"
are trademarks of Wilshire Associates.
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Post Office Box 2600
Valley Forge, Pennsylvania 19482-2600
WORLD WIDE WEB
www.vanguard.com
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
This report is intended for the fund's
shareholders. It may not be distributed
to prospective investors unless it
is preceded or accompanied by the
current fund prospectus.
Q650-11/09/1999
(C) 1999 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing
Corporation, Distributor.
