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VANGUARD
ASSET ALLOCATION
FUND
Annual Report - September 30, 1998
[THE VANGUARD GROUP LOGO]
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AT VANGUARD, WE BELIEVE
THAT TRADITION MATTERS
Our 8,000 crew members embrace the traditional values on which our success is
built, including integrity, hard work, thrift, teamwork, and fair dealing on
behalf of our clients.
This year, our report cover pays homage to three anniversaries, each of great
significance to The Vanguard Group:
- - The 200th anniversary of the Battle of the Nile, which commenced on August 1,
1798. HMS Vanguard, the victorious British flagship at the Nile, is our
namesake. And its motto--"Leading the way"--serves as a guiding principle
for our company.
- - The 100th birthday, on July 23, of Walter L. Morgan, founder of Wellington
Fund, the oldest member of what became The Vanguard Group. Mr. Morgan was
friend and mentor to Vanguard founder John C. Bogle, and helped to shape the
standards and business principles that Mr. Bogle laid down for Vanguard at
its beginning nearly 25 years ago: a stress on balanced, diversified
investments; insistence on fair dealing and candor with clients; and a focus
on long-term investing. To our great regret, Mr. Morgan died on September 2.
- - The 70th anniversary, on December 28, of the incorporation of Vanguard
Wellington Fund. It was the nation's first balanced mutual fund, and is one
of only a handful of funds created in the 1920s that are still in operation.
Although Vanguard constantly tackles new challenges, adopts new technology, and
develops new services, we treasure the traditions and values that set us apart
in a crowded, competitive industry. And we salute our shareholders, whose
support and trust we strive to earn each and every day.
[PHOTO]
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CONTENTS
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A Message to Our Shareholders 1
The Markets in Perspective 6
Report From the Adviser 8
Fund Profile 10
Performance Summary 14
Financial Statements 15
Report of Independent Accountants 27
</TABLE>
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
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[PHOTO] [PHOTO]
John J. Brennan John C. Bogle
Chairman & CEO Senior Chairman
FELLOW SHAREHOLDER,
Vanguard Asset Allocation Fund adroitly moved through a volatile period for
financial markets to provide truly outstanding results for shareholders during
the fiscal year ended September 30, 1998. The fund's +15.2% return far surpassed
the +2.2% return of the average asset allocation fund and the +9.0% return of
the Standard & Poor's 500 Composite Stock Price Index. We also topped our
composite index of stocks and bonds.
As you know, the fund allocates assets among common stocks (as
represented by the S&P 500 Index), long-term U.S. Treasury bonds, and cash
equivalents. The table at right presents the fiscal-year total returns (capital
change plus reinvested dividends) of the Asset Allocation Fund, our average
competitor, a benchmark composite index, and each of the three asset classes.
<TABLE>
<CAPTION>
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TOTAL RETURNS
FISCAL YEAR ENDED
SEPTEMBER 30, 1998
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<S> <C>
Vanguard Asset Allocation Fund +15.2%
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Average Asset Allocation Fund + 2.2%
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Asset Allocation Composite Index* +14.2%
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S&P 500 Index + 9.0%
Lehman Brothers Long U.S. Treasury
Bond Index +22.1
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index + 5.2
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</TABLE>
*65% S&P 500 Index and 35% Lehman Long U.S. Treasury Index.
The fund's total return is based on an increase in net asset value from
$21.53 per share on September 30, 1997, to $22.90 on September 30, 1998, with
the ending net asset value adjusted for dividends totaling $0.74 per share paid
from net investment income and distributions totaling $1.01 per share paid from
net capital gains realized during 1997. We anticipate making a distribution of
roughly $1.20 per share in net realized capital gains in December 1998.
FINANCIAL MARKETS IN REVIEW
Through the first 9 1/2 months of the fiscal year that ended September 30, the
U.S. stock market continued the remarkable climb that began in August 1982. The
market's advance--spearheaded by a relatively few large-capitalization growth
stocks--had boosted the S&P 500 Index to a +26.8% gain as of July 17. However,
the market took back most of that gain during the following six weeks, and the
index earned +9.0% for the full fiscal year.
Within the S&P 500, there was a sharp split in returns for growth and
value stocks during our fiscal year: The growth issues in the index earned
+18.2%, while the value stocks met with a -0.2% decline--a remarkable difference
of some 18 percentage points in a single year. Smaller stocks did far worse: The
Wilshire 4500 Equity Index, representing stocks outside of the S&P 500, declined
- -12.1%, and the small-cap Russell 2000 Index fell -19.0%. In all, the total
stock market (as represented by the Wilshire 5000 Equity Index) eked out a gain
of just +3.4%. It was not an easy year!
Interest rates, meanwhile, fell sharply, providing some support for stock
valuations. The yield on the 30-year U.S. Treasury bond, which began the year at
6.40%, plummeted to 4.98% on September 30, the lowest level for long-term
Treasury bonds since way back in 1968. Of course, bond prices move in the
opposite direction from yields, resulting in a stellar +22.1% total return for
the Lehman Long U.S. Treasury Index. Yields on 3-month
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Treasury bills declined during the year by 74 basis points (0.74 percentage
point) to 4.36% on September 30.
For most of the fiscal year, investors shrugged off the serious economic
problems that had surfaced in Asia beginning in July 1997. The U.S. economy kept
expanding, propelled by strong consumer spending. Asia's economic woes seemed at
first to benefit the United States by helping to reduce prices for many
commodities and industrial products. These lower prices eased the inflationary
pressures that might have been expected to develop in response to low
unemployment (as low as 4.3% of the workforce) and rising wages.
However, investor attitudes shifted abruptly in mid-July. Among the
reasons analysts cited for the shift were the stubborn economic crisis in Asia,
which dampened demand for U.S. exports; worsening political and economic
troubles in Russia; and uncertainty about U.S. political leadership.
But there may be a simpler explanation for the market's summer swoon:
After 16 years of a bull market--the last three of which provided stupendous
gains--stock prices may just have gotten too far ahead of corporate profits.
Earnings are the key fundamental that ultimately drives the stock market, yet
earnings during the first half of 1998 were slightly below those reported during
the first half of 1997. Absent strong earnings growth, even optimists couldn't
justify stock prices that in mid-July were averaging some 25 times projected
earnings for the year ahead.
FISCAL 1998 PERFORMANCE OVERVIEW
The Asset Allocation Fund's +15.2% return during fiscal 1998 far exceeded the
+2.2% return earned by the average asset allocation fund, and it was comfortably
ahead of the +14.2% theoretical return of a portfolio invested in our "neutral
allocation" of 65% stocks and 35% bonds. Our edge over the composite index
benchmark derived from several marginal shifts in the fund's allocation,
designed to take advantage of brief imbalances in the relative pricing of
stocks, bonds, and cash reserves. The computer-driven asset allocation model
used by our investment adviser, Mellon Capital Management Corporation, guided
these changes from a 50% stocks/50% bonds allotment at the start of the fiscal
year to 80% stocks/20% bonds at the end. The Report from the Adviser starting on
page 8 contains details of the interim allocation shifts.
The fund's powerful performance versus real-world peers was due partly to
our concentration on large-capitalization stocks for our equity position. This
was a distinct advantage during the fiscal year over funds with larger stakes in
mid- and small-capitalization stocks. Another important factor was the fund's
reliance on long-term U.S. Treasury bonds. There was no better fixed-income
sector during fiscal 1998.
LONG-TERM PERFORMANCE OVERVIEW
Vanguard Asset Allocation Fund began operations almost a decade ago--on November
3, 1988--with a challenging objective: "to maximize long-term total return,
while exhibiting less risk than a portfolio consisting entirely of equities." As
our tenth anniversary draws near, the record of accomplishment is quite solid.
We have outpaced by a wide margin two of the three asset classes in which the
fund can invest (bonds and cash equivalents) while maintaining less volatility
than the third (common stocks). In fact, a shareholder in the Asset Allocation
Fund since its inception would have received 91% of the return of the S&P 500
Index while enduring only 72% of the volatility.
Of course, less volatility does not mean an absence of volatility. For
example, as the S&P 500 Index fell about 10% in value during the fiscal quarter
ended September 30, the
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Asset Allocation Fund declined -4.4%. Such declines are to be expected when
the prices of a major category of assets are tumbling. But over the long term,
we believe the fund's balance and conservative structure provide an appropriate
cushion against wild downswings.
Over the fund's lifetime--a glorious period for common stocks--our
average annual return of +15.6% exceeded the return of the average asset
allocation fund by 4.4 percentage points, resulting in a significant difference
in wealth. As the adjacent table shows, a $10,000 investment in Vanguard Asset
Allocation Fund at our inception would have grown to $42,203, versus $28,713 for
the same sum invested in the average asset allocation fund. This remarkable
advantage of $13,490 is equal to nearly 135% of the original investment.
<TABLE>
<CAPTION>
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TOTAL RETURNS
NOV. 3, 1988, TO SEP. 30, 1998
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AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
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<S> <C> <C>
Vanguard Asset Allocation Fund +15.6% $42,203
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Average Asset Allocation Fund +11.2% $28,713
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Asset Allocation Composite Index +15.8% $42,649
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S&P 500 Index +17.1% $47,853
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</TABLE>
Our low operating costs also provide a consistent and powerful edge over
competing asset allocation funds. Our expense ratio of 0.49% of average net
assets during the past year was a full percentage point below the 1.49% charged
by the average asset allocation fund, contributing nearly one-fourth of our
annual advantage in return. While this margin may seem small, it can have a
dramatic impact over time. Year after year, it gives us a nice tailwind in our
effort to produce superior returns.
We emphasize that the past decade is no guide to the future performance
of the Vanguard Asset Allocation Fund or the financial markets. It would not be
wise to expect the next ten years to match the last ten, when average annual
returns on stocks were greater than +17%, or better than 50% above the long-term
average of +11% a year. Long-term U.S. Treasury bonds likewise excelled during
the decade, with an +11.8% return--more than double the current yield on such
bonds.
IN SUMMARY
A year ago, noting that the bull market in U.S. stocks and bonds was 15 years
old, our letter suggested that investors be mindful of the considerable risks
that accompanied the high stock valuations and low bond yields prevailing at the
time. The stock market's volatility and the further decline in bond yields since
then have underscored that point. Those same events have reaffirmed our
longstanding belief in the importance of balanced investing--holding stock
funds, bond funds, and reserves in proportions suited to your goals, time
horizon, and tolerance for market fluctuations.
With such a balanced, long-term investment plan in place--precisely the
kind of plan that Vanguard Asset Allocation Fund embodies in a single
investment--you should be prepared to "stay the course" through fluctuations in
returns or investor psychology.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Senior Chairman Chairman and
Chief Executive Officer
October 15, 1998
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OUR TENTH ANNIVERSARY YEAR
At about the time you receive this annual report, Vanguard Asset Allocation Fund
will have completed ten full years of operations. As our letter notes, it has
been a remarkable period in terms of both our absolute returns and our
achievements relative to our peers and to the financial markets. While what the
markets do is clearly beyond our control, our relative performance is the
product of our investment objectives, policies, and strategies. At the outset,
we chose Mellon Capital Management Corporation to implement our policies, and we
have been delighted with their success.
When we selected Mellon Capital Management, we banked on the experience
and character of its founders, William L. Fouse and Thomas F. Loeb, and they
have rewarded our confidence with outstanding results. The fund's policies
remain firm, focusing on a forward-looking asset allocation model, implementing
it with a "plain vanilla" mix based primarily on long-term U.S. Treasury bonds
and a stock portfolio representing the S&P 500 Index, and making only gradual
and marginal--and never precipitate--changes in the mix.
In our first report to shareholders, in March 1989, we described our
skeptical approach to "stock market timing," and we clearly differentiated that
risky, discredited method from our fund's "tactical asset allocation" strategy.
Recounting our careful search for the best adviser to implement that strategy,
we stated: "At the conclusion of that process, there was no doubt in our minds
that Mellon Capital Management Corp. of San Francisco, California, was best
equipped to assume the responsibility." The firm has lived up to our
expectations and beyond, and we salute Bill Fouse, Tom Loeb, and their entire
organization for their accomplishments. We have no doubt that you share in our
expression of thanks.
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NOTICE TO SHAREHOLDERS
At a special meeting on May 1, 1998, shareholders of Vanguard Asset Allocation
Fund overwhelmingly approved three proposals. The proposals and voting results
were:
1. REORGANIZATION INTO A DELAWARE BUSINESS TRUST. Based on the fund's assets at
the time of the vote, this change will reduce the amount of state taxes the fund
pays annually by $328,305. Approved by 97.59% of the shares voted, as follows:
<TABLE>
<CAPTION>
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FOR AGAINST ABSTAIN
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<S> <C> <C>
146,063,630 1,655,992 1,954,034
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</TABLE>
2A. INVESTMENT LIMITATION CHANGES--INTERFUND LENDING PROGRAM. This change
permits the Asset Allocation Fund to participate in Vanguard's interfund lending
program, which allows funds to loan money to each other if--and only if--it
makes good financial sense to do so on both sides of the transaction. The
interfund lending program won't be an integral part of your fund's investment
program; it is a contingency arrangement for managing unusual cash flows.
Approved by 95.15% of shares voted, as follows:
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FOR AGAINST ABSTAIN
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<S> <C> <C>
142,406,426 4,480,681 2,786,548
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2B. INVESTMENT LIMITATION CHANGES--BORROWING MONEY AND PLEDGING ASSETS. This
change sets standard limits of 15% of net assets on the amount of money Vanguard
funds can borrow from all sources and on the amount of assets that can be
pledged to secure any loans. Approved by 94.13% of the shares voted, as follows:
<TABLE>
<CAPTION>
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FOR AGAINST ABSTAIN
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<S> <C> <C>
140,890,108 5,520,568 3,262,980
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</TABLE>
5
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THE MARKETS IN PERSPECTIVE
YEAR ENDED SEPTEMBER 30, 1998
U.S. financial markets displayed both bull-market ebullience and bear-market
jitters during the fiscal year ended September 30. Investor sentiment, which had
been relentlessly upbeat for most of the fiscal year, abruptly changed in July
and August.
Several factors combined to make investors less sanguine about the risks
facing them. Among these were a drearier outlook for corporate earnings,
political uncertainty in the United States, a debt moratorium in Russia, sharp
fluctuations in the values of many currencies, and a murkier global economic
picture. Asia's economic troubles--which began more than a year ago--not only
were persistent but were spreading and beginning to look like more than a minor
threat to the powerhouse U.S. economy and to the recovering economies of Europe.
As the fiscal year ended, the big question for U.S. markets was whether
U.S. consumers--whose robust spending had been "the little engine that could"
keep economic activity expanding both at home and abroad--would become more
cautious. For most of the fiscal year, consumers spent freely, encouraged by low
unemployment, which fell to levels last seen in 1970, and by wages that had
increased on average by more than twice the 1.5% inflation rate.
<TABLE>
<CAPTION>
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AVERAGE ANNUALIZED RETURNS
PERIODS ENDED SEPTEMBER 30, 1998
--------------------------------
1 YEAR 3 YEARS 5 YEARS
- --------------------------------------------------------------------------
<S> <C> <C> <C>
STOCKS
S&P 500 Index 9.0% 22.6% 19.9%
Russell 2000 Index -19.0 6.9 9.1
MSCI EAFE Index -8.1 4.0 5.6
- --------------------------------------------------------------------------
BONDS
Lehman Aggregate Bond Index 11.5% 8.7% 7.2%
Lehman 10-Year Municipal Bond Index 8.8 7.7 6.6
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 5.2 5.3 5.0
- --------------------------------------------------------------------------
OTHER
Consumer Price Index 1.5% 2.2% 2.4%
- --------------------------------------------------------------------------
</TABLE>
U.S. STOCK MARKETS
The S&P 500 Index, which is dominated by large-capitalization stocks, returned
9.0% for the fiscal year, close to its long-term average return of about 11.0% a
year. Events during the year reminded investors that volatility is a normal part
of owning stocks. After rising strongly to a record high on July 17, the S&P 500
began retracing its steps. During the following six weeks, it fell 19.2%, just
shy of the 20% mark generally considered the "boundary" that separates a bear
market from a mere "correction." However, declines for most smaller stocks were
certifiably bearish. The Russell 2000 Index, which peaked in April, fell by 31%
from its high to end the fiscal year with a 19.0% decline.
There also was a big gap between returns on growth and value stocks. Value
stocks, reflecting modest market expectations for future growth, typically sell
at below-average prices in comparison to earnings, dividends, and book value.
Growth stocks, by contrast, tend to sell at high multiples of earnings and
dividends. In the past, value stocks have usually trailed growth stocks during
rising markets, but held up better during slumps. But this year growth stocks
did better in both up and down phases, and for the twelve months gained 18.2%,
while value stocks declined 0.2%.
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Although analysts can point to many factors to "explain" any move in the
market, actual and expected corporate earnings hold the long-term key to stock
prices. Early in the fiscal year, stocks seemed to be "priced for perfection"--a
continuance of strong growth in corporate profits and economic growth in an
environment of low interest rates and inflation.
Perfection, as it turned out, was not in the cards. Economic problems
abroad threatened to depress profits for U.S. companies by weakening overseas
demand for their products and by boosting price competition at home, as foreign
companies flocked to the relatively strong U.S. market. Slower revenue growth
combined with rising wages in a strong job market make it tough to generate
higher profits.
For the year, the S&P 500's strongest performers were utilities (up 42%)
and health-care companies (up 37%), two groups believed to be less vulnerable to
recessions, weak foreign markets, and strong foreign competition. The
worst-performing sectors were those hurt most by falling prices for commodities
and basic industrial goods. Victims included oil services and exploration
companies (down 35%); makers of producer durables such as machinery and aircraft
(-22%); and makers and processors of such materials as steel, paper, and
chemicals (-14%).
U.S. BOND MARKETS
Interest rates declined significantly during the fiscal year. Inflation, the
bugbear of bond investors, was surprisingly well-behaved. Lower rates mean
higher prices for bonds, and the Lehman Brothers Aggregate Bond Index, a
benchmark for the overall market for taxable bonds, earned a total return of
11.5%, equal to an astounding 10% after inflation.
The rate decline was steepest for U.S. Treasury notes and bonds, whose
yields fell by 1.4 to 1.7 percentage points. Treasury prices benefited from a
slight decline in supply due to the $70 billion surplus achieved by the federal
government, its first year "in the black" since 1969. Also, Treasury securities
benefited late in the fiscal year from a "flight to safety" among investors
shying away from riskier investments, including U.S. and foreign stocks and
lower-quality bonds. The result was a widening in interest-rate spreads between
Treasuries and corporate or mortgage-backed bonds. Treasury yields fell so far
that by fiscal year-end, they were nearly as low as yields on comparable
municipal bonds, even though interest on municipals is exempt from federal
income tax.
INTERNATIONAL STOCK MARKETS
The general downturn of the world's stock markets in July and August changed
returns for the fiscal year from marvelous to mediocre for investors in U.S. and
European stocks. Elsewhere, the slump changed things from bad to horrendous.
As a group, European stocks earned 8.8% in U.S.-dollar terms, thanks to a
gain of about 5% from a strengthening of most currencies against the dollar.
European stocks benefited from firmer economic growth, increased corporate
restructuring and merger activity, and heightened optimism about the long-term
impact of the euro, a common currency due to be adopted in 1999 by 11 nations.
Markets in Norway (-40%) and Sweden (-11%) were notable exceptions to the
general rise in European equities.
Japan's stock market, wracked by recession and a shaky banking system,
declined 33% in U.S.-dollar terms. As bad as it was, Japan's showing actually
was the Pacific region's second-best, after Australia (-18%). Declines elsewhere
ranged from about 40% in Taiwan to more than 60% in South Korea, Thailand, and
Malaysia. Most of the world's emerging markets--which are particularly
vulnerable to slowing global growth and currency instability--suffered sharp
reverses, including our neighbor and key trading partner, Mexico (-42%), as well
as Venezuela (-66%), Argentina (-35%), and Brazil and Chile (both -48%).
7
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REPORT FROM THE ADVISER
Vanguard Asset Allocation Fund's total return was 15.2% for the fiscal year
ended September 30, 1998. This compares with returns of 9.0% for the S&P 500
Index and 22.1% for long-term U.S. Treasury bonds.
During the October-December quarter of 1997, the meltdown of Asian equity
and currency markets reverberated through U.S. financial markets. On just one
day--October 27, 1997--the stock market fell 7%. Treasury bonds rose during
that month because of a "flight to quality" by investors. Thereafter, financial
markets reacted favorably to the realization that, despite the Asian financial
crisis, the U.S. economy remained on its path of steady, low-inflation growth.
During our second fiscal quarter (January-March), the S&P 500 Index rose
14%, only the third time in the past decade that the index had achieved a
quarterly gain of more than 10%. This performance was especially remarkable in
that it occurred in the midst of warnings from several corporations that future
earnings would fall short of expectations. Domestic demand remained strong, so
the economy kept growing despite a falloff in exports because of the Asian
crisis. News on the inflation front remained favorable, with producer prices
falling at the fastest pace in five years.
In the April-June quarter, low inflation continued despite tight labor
markets and a strong economy. For most of the quarter, U.S. bonds benefited from
a continued flight to quality and from signs that activity in the manufacturing
sector was slowing, both of which stemmed from the crisis in Asia.
During the final quarter of the fiscal year, financial markets were
jittery, even though inflation remained low. The stock market's sharp selloff in
August reflected fear that the collapse of Russian financial assets and the
continuing Asian crisis could cause problems in other economies, ultimately
depressing U.S. corporate profits. Indeed, there were signs that a slowing in
manufacturing was curtailing overall economic activity in the United States. To
help minimize the effects of the deepening global crisis on the domestic
economy, the Federal Reserve Board lowered the federal funds rate by 0.25
percentage point at the end of the quarter.
Vanguard Asset Allocation Fund began the fiscal year with an asset mix of
50% stocks and 50% bonds. The sharp fall in stock prices during October 1997
increased the expected return on equities while the bond market's rally lowered
expected returns on bonds. This caused our tactical asset allocation (TAA) model
to signal a shift of 10% of assets from bonds into stocks, a move that we
implemented on October 28, creating an allocation of 60% stocks/40% bonds. Bonds
continued to rally through the quarter, while yields on short-term cash
instruments rose substantially during early December. This narrowed the spread
between expected returns on bonds and cash, and prompted the TAA model to call
for another 10% shift out of bonds into cash; this was made on December 15,
resulting in an allocation of 60% stocks/30% bonds/10% cash.
8
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During the second fiscal quarter, the TAA model recommended several
allocation shifts because of the rapidly changing markets. The shifts were
modest and our allocation to equities remained between 60% and 70% throughout
the quarter. The fund began the quarter at 60% stocks/30% bonds/10% cash, but we
shifted to a 60%/20%/20% mix on January 7 in response to declining bond yields.
A sharp retreat in stock prices during early January prompted the model to
recommend a 10% shift from cash into stocks, so on January 12 the fund's mix
changed to 70% stocks/20% bonds/10% cash. On January 26, it shifted to 70%
stocks/30% bonds because cash yields were stagnant while bond yields had
rebounded. During February, stock prices rose sharply while cash and bond yields
held relatively steady, prompting the model to recommend a 10% shift from stocks
to cash. This move, implemented on February 19, resulted in an asset mix of
60%/30%/10%. During March, stock prices kept rising; consequently, their
expected returns declined. A downturn in bond prices that had begun in
mid-February continued into early March, raising expected returns on bonds.
These trends prompted the TAA model to recommend a 10% shift from cash into
bonds, which we implemented on March 4, moving to a mix of 60% stocks/40% bonds.
During the third fiscal quarter, the fast-moving financial markets
prompted several more shifts in the fund's mix. After a bond market rally in
early April, the TAA model recommended a 10% shift from bonds into cash. This
step was taken April 6, shifting the fund's allocation from 60% stocks/40% bonds
to 60% stocks/30% bonds/10% cash. The stock market moved higher through
mid-April, while bond yields were relatively stable. As a result, the model
recommended a 10% move out of stocks into cash and we shifted the fund's mix on
April 16 to 50%/30%/20%. In late April, bond prices fell, increasing their
expected returns and causing the TAA model to call for a 10% move from cash into
bonds. Therefore, on April 28 the fund's asset mix shifted to 50%/40%/10%, where
it stayed throughout May. After a decline in stock prices in late May, the TAA
model signaled a shift from cash into stocks. We took this step on June 1, for
an allocation of 60% stocks/40% bonds. A steady decline in bond yields
throughout June prompted two 10% shifts from bonds to cash. On June 11, the
fund's asset allocation changed to 60% stocks/30% bonds/10% cash; on June 16 the
mix shifted to 60%/20%/20%.
During our final quarter, the TAA model recommended two changes, both
consisting of 10% shifts from cash to stocks in response to a sharp downturn in
stock prices that began in mid-July. On August 12, we made the fund's allocation
70% stocks/20% bonds/10% cash. Stock prices kept tumbling through August 31,
increasing the expected return on equities, so on September 1 the fund's asset
mix was changed to 80% stocks/20% bonds.
During the fiscal year, upward revisions in earnings forecasts had a
positive effect on the long-run expected returns from equities. Our long-run
expectation for stock returns remains above 10% annually, and our TAA model
continues to recommend an overweight in stocks relative to bonds. Although the
Asian economic turmoil and the near collapse of a prominent hedge fund have
temporarily increased economic uncertainty, it is our view that U.S. investors
have overreacted, given the sound long-run prospects for our economy. During
August and September, volatility in the equity market rose to levels not seen
since 1987. In our view, the intermediate- and long-term outlook for corporate
profits does not justify this increase in volatility.
William L. Fouse, CFA
Mellon Capital Management Corporation
October 13, 1998
INVESTMENT PHILOSOPHY
The adviser believes that, although the financial markets are very efficient,
imbalances can be identified in the relative pricing of stocks, bonds, and money
market instruments. Implicit in this approach is a belief that such imbalances
occur only periodically and do not persist for long periods. The adviser
attempts to identify these windows of opportunity and to structure the portfolio
to take advantage of them.
9
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FUND PROFILE
ASSET ALLOCATION FUND
This Profile provides a snapshot of the fund's characteristics as of September
30, 1998, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on pages 12 and 13.
<TABLE>
<CAPTION>
TOTAL FUND CHARACTERISTICS
- --------------------------------------------------
<S> <C>
Turnover Rate 60%
Expense Ratio 0.49%
Cash Reserves 0.9%
</TABLE>
<TABLE>
<CAPTION>
FUND ASSET ALLOCATION*
- --------------------------------------------------
STOCKS BONDS CASH RESERVES
<S> <C> <C>
79 20 1
</TABLE>
*Actual allocation may vary slightly from target allocation because of
day-to-day market fluctuations.
<TABLE>
<CAPTION>
TOTAL FUND VOLATILITY MEASURES
- --------------------------------------------------
ASSET ALLOCATION S&P 500
- --------------------------------------------------
<S> <C> <C>
R-Squared 0.94 1.00
Beta 0.67 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST STOCKS (% OF EQUITIES)
- --------------------------------------------------
<S> <C>
Microsoft Corp. 3.3%
General Electric Co. 3.2
Exxon Corp. 2.1
Merck & Co., Inc. 1.9
Intel Corp. 1.8
The Coca-Cola Co. 1.8
Pfizer, Inc. 1.7
Wal-Mart Stores, Inc. 1.5
International Business Machines Corp. 1.5
Philip Morris Cos., Inc. 1.4
- --------------------------------------------------
Top Ten 20.2%
- --------------------------------------------------
Top Ten as % of Total Net Assets 6.7%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCKS)
- ---------------------------------------------------------------------------------------------------
SEPTEMBER 30, 1997 SEPTEMBER 30, 1998
---------------------------------------------------
ASSET ALLOCATION ASSET ALLOCATION S&P 500
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Auto & Transportation 3.6% 3.0% 3.0%
Consumer Discretionary 9.6 10.3 10.3
Consumer Staples 10.8 9.5 9.5
Financial Services 17.0 16.3 16.3
Health Care 10.7 13.4 13.4
Integrated Oils 7.8 7.0 7.0
Other Energy 1.5 1.1 1.1
Materials & Processing 6.8 4.4 4.4
Producer Durables 4.6 3.2 3.2
Technology 13.1 14.7 14.8
Utilities 9.1 11.7 11.7
Other 5.4 5.4 5.3
- ---------------------------------------------------------------------------------------------------
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
EQUITY CHARACTERISTICS
- -----------------------------------------------------
ASSET ALLOCATION S&P 500
- -----------------------------------------------------
<S> <C> <C>
Number of Stocks 504 500
Median Market Cap $43.4B $43.4B
Price/Earnings Ratio 22.3x 22.3x
Price/Book Ratio 4.0x 4.0x
Dividend Yield 1.6% 1.6%
Return on Equity 21.9% 21.9%
Earnings Growth Rate 16.9% 16.9%
Foreign Holdings 1.7% 1.7%
</TABLE>
EQUITY INVESTMENT FOCUS
- -----------------------------------
[GRAPH]
<TABLE>
<CAPTION>
FIXED-INCOME CHARACTERISTICS
- --------------------------------------------------
ASSET LEHMAN
ALLOCATION INDEX*
- --------------------------------------------------
<S> <C> <C>
Number of Bonds 24 6,932
Average Coupon 8.4% 7.0%
Average Duration 11.6 years 4.3 years
Average Maturity 21.5 years 8.5 years
Average Quality U.S. Treasury Aaa
</TABLE>
*Lehman Aggregate Bond Index.
FIXED-INCOME INVESTMENT FOCUS
- -----------------------------------
[GRAPH]
11
<PAGE> 14
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 MATURITY. The average length of time until bonds held by a fund reach
maturity (or are called) and are repaid. In general, the longer the average
maturity, the more a fund's share price will fluctuate in response to changes in
market interest rates.
AVERAGE QUALITY. An indicator of credit risk, this figure is the average of the
ratings assigned to a 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 and A-1 or MIG-1 indicating the most creditworthy
issuers of money market securities. U.S. Treasury and agency securities are
considered to have the highest credit quality.
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 and
bond investment.
DIVIDEND YIELD. The current, annualized rate of dividends paid on a share of
stock, divided by its current share price. For a fund, the weighted average
yield for stocks it holds.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a fund.
EQUITY 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).
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.
FIXED-INCOME INVESTMENT FOCUS. This grid indicates the focus of a fund in terms
of two attributes: average maturity (short, medium, or long) and average credit
quality (high, medium, or low).
FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks
or American Depositary Receipts of companies based outside the United States.
FUND ASSET ALLOCATION. This chart shows the proportions of a fund's holdings
allocated to different types of assets.
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 BONDS. 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 issue.
12
<PAGE> 15
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 STOCKS. The percentage of equity assets that a fund has invested in
its ten largest stocks. 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).
13
<PAGE> 16
PERFORMANCE SUMMARY
ASSET ALLOCATION FUND
All of the data on this page represent past performance, which cannot be used to
predict future returns that may be achieved by the fund. Note, too, that both
share price and return can fluctuate widely, so an investment in the fund could
lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: NOVEMBER 3, 1988-SEPTEMBER 30, 1998
- -------------------------------------------------------------
ASSET ALLOCATION FUND COMPOSITE
INDEX*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- -------------------------------------------------------------
<S> <C> <C> <C> <C>
1989 21.1% 2.8% 23.9% 27.8%
1990 -8.6 4.0 -4.6 -5.1
1991 20.9 6.4 27.3 27.5
1992 7.2 5.0 12.2 12.2
1993 10.7 4.7 15.4 15.5
1994 -5.2 3.1 -2.1 -1.5
1995 23.6 5.0 28.6 27.4
1996 11.1 4.2 15.3 13.9
1997 24.7 4.7 29.4 30.4
1998 11.5 3.7 15.2 14.2
- -------------------------------------------------------------
</TABLE>
* 65% S&P 500 Index, 35% Lehman Long U.S. Treasury Index.
See Financial Highlights table on page 24 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: NOVEMBER 3, 1988-SEPTEMBER 30, 1998
- --------------------------------------------------------------
Vanguard Average
Asset Asset Composite
Allocation Allocation Index S&P 500
- --------------------------------------------------------------
<S> <C> <C> <C> <C>
11/3/88 10000 10000 10000 10000
198812 10320 10038 10343 10014
198903 10722 10389 10857 10724
198906 11738 10999 11954 11671
198909 12393 11704 12776 12921
198912 12764 11749 13167 13188
199003 12285 11533 12715 12791
199006 12898 11962 13438 13596
199009 11827 10968 12123 11728
199012 12877 11600 13199 12779
199103 14068 12734 14524 14635
199106 14066 12680 14529 14601
199109 15058 13476 15460 15382
199112 16172 14462 16677 16672
199203 15677 14253 16192 16251
199206 16141 14240 16631 16560
199209 16888 14831 17352 17082
199212 17387 15558 17977 17942
199303 18368 16066 18901 18726
199306 18754 16216 19317 18817
199309 19491 16919 20049 19303
199312 19732 17408 20240 19750
199403 18831 16702 19309 19001
199406 18634 16366 19175 19081
199409 19091 16921 19741 20014
199412 19275 16948 19867 20011
199503 20827 17848 21567 21959
199506 23005 19028 23726 24055
199509 24547 20200 25155 25967
199512 26109 21199 26861 27530
199603 26844 21631 27137 29008
199606 27536 22074 27919 30310
199609 28295 22690 28640 31247
199612 30217 24080 30673 33851
199703 30537 23823 30869 34758
199706 34359 26153 34941 40826
199709 36621 28095 37352 43884
199712 38473 28580 38919 45144
199803 42384 30664 42626 51442
199806 44138 30903 44244 53140
199809 42203 28713 42649 47853
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED SEPTEMBER 30, 1998
--------------------------------
SINCE FINAL VALUE OF A
1 YEAR 5 YEARS INCEPTION $10,000 INVESTMENT
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Asset Allocation Fund 15.24% 16.71% 15.64% $42,203
Average Asset Allocation Fund 2.20 11.16 11.23 28,713
Asset Allocation Composite Index* 14.18 16.30 15.77 42,649
S&P 500 Index 9.05 19.91 17.12 47,853
- -----------------------------------------------------------------------------------------------------
</TABLE>
*65% S&P 500 Index, 35% Lehman Long U.S. Treasury Index.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED SEPTEMBER 30, 1998
- ---------------------------------------------------------------------------------------------------------
SINCE INCEPTION
INCEPTION ----------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Asset Allocation Fund 11/3/1988 15.24% 16.71% 11.24% 4.40% 15.64%
- ---------------------------------------------------------------------------------------------------------
</TABLE>
14
<PAGE> 17
FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
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.), with the
fund's S&P 500 Index common stocks listed in descending market value order.
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. 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.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
MARKET
VALUE*
ASSET ALLOCATION FUND SHARES (000)
- ----------------------------------------------------------------------
COMMON STOCKS (33.0%)(1)
- ----------------------------------------------------------------------
<S> <C> <C>
- - Microsoft Corp. 565,300 $62,218
General Electric Co. 746,600 59,401
Exxon Corp. 561,000 39,375
Merck & Co., Inc. 273,300 35,409
Intel Corp. 385,300 33,039
The Coca-Cola Co. 565,900 32,610
Pfizer, Inc. 299,700 31,749
Wal-Mart Stores, Inc. 512,600 28,001
International Business
Machines Corp. 214,300 27,430
Philip Morris Cos., Inc. 558,000 25,703
AT&T Corp. 414,484 24,221
Johnson & Johnson 308,600 24,148
Bristol-Myers Squibb Co. 228,280 23,713
Royal Dutch Petroleum Co. ADR 492,100 23,436
- - Cisco Systems, Inc. 356,500 22,036
Procter & Gamble Co. 307,744 21,831
Lucent Technologies, Inc. 301,648 20,833
- - MCI WorldCom, Inc. 407,412 19,912
Eli Lilly & Co. 252,300 19,758
- - Dell Computer Corp. 293,400 19,291
SBC Communications Inc. 421,546 18,732
American International
Group, Inc. 240,936 18,552
Schering-Plough Corp. 168,400 17,440
Bell Atlantic Corp. 356,530 17,269
BellSouth Corp. 224,800 16,916
American Home Products Corp. 301,800 15,807
Fannie Mae 241,300 15,504
Abbott Laboratories 353,300 15,346
E.I. du Pont de Nemours & Co. 259,700 14,576
Warner-Lambert Co. 188,300 14,217
Mobil Corp. 178,700 13,570
Home Depot, Inc. 337,100 13,315
Ford Motor Co. 277,900 13,044
Hewlett-Packard Co. 238,500 12,626
Chevron Corp. 149,500 12,567
GTE Corp. 221,100 12,160
Compaq Computer Corp. 383,348 12,123
Time Warner, Inc. 137,300 12,022
Ameritech Corp. 252,900 11,981
Amoco Corp. 222,200 11,971
The Walt Disney Co. 469,900 11,894
NationsBank Corp. 220,734 11,809
First Union Corp. 222,332 11,381
PepsiCo, Inc. 339,700 10,000
Travelers Group Inc. 265,201 9,945
Gillette Co. 257,600 9,853
Citicorp 104,404 9,703
BankAmerica Corp. 157,702 9,482
McDonald's Corp. 156,200 9,323
Unilever NV ADR 146,900 8,998
The Chase Manhattan Corp. 196,322 8,491
General Motors Corp. 151,831 8,303
Allstate Corp. 198,754 8,286
American Express Co. 105,945 8,224
The Boeing Co. 231,786 7,953
Freddie Mac 159,500 7,885
Texaco Inc. 124,700 7,817
Monsanto Co. 137,800 7,768
- - AirTouch Communications, Inc. 131,500 7,495
</TABLE>
15
<PAGE> 18
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
MARKET
VALUE*
ASSET ALLOCATION FUND SHARES (000)
- ----------------------------------------------------------------------
<S> <C> <C>
Tyco International Ltd. 134,200 $7,414
Wells Fargo & Co. 20,081 7,129
Chrysler Corp. 147,380 7,056
Sprint Corp. 97,800 7,042
Minnesota Mining &
Manufacturing Co. 93,600 6,897
Banc One Corp. 161,748 6,895
- - EMC Corp. 114,600 6,554
- - Oracle Corp. 220,900 6,434
Xerox Corp. 75,248 6,377
Waste Management, Inc. 131,110 6,301
Norwest Corp. 175,600 6,289
Schlumberger Ltd. 124,800 6,279
Emerson Electric Co. 100,100 6,231
- - MediaOne Group, Inc. 139,530 6,200
Medtronic, Inc. 106,700 6,175
U.S. Bancorp 171,503 6,099
U S West, Inc. 115,082 6,035
Anheuser-Busch Cos., Inc. 110,814 5,984
Motorola, Inc. 137,200 5,857
Sara Lee Corp. 108,400 5,854
Pharmacia & Upjohn, Inc. 116,590 5,851
Eastman Kodak Co. 75,100 5,806
Morgan Stanley
Dean Witter & Co. 134,700 5,801
Duke Energy Corp. 82,081 5,433
Atlantic Richfield Co. 73,700 5,228
Campbell Soup Co. 103,600 5,199
Associates First Capital Corp. 78,456 5,119
Kimberly-Clark Corp. 125,892 5,099
Automatic Data Processing, Inc. 68,100 5,090
Walgreen Co. 112,800 4,970
National City Corp. 74,691 4,925
Computer Associates
International, Inc. 128,700 4,762
- - Viacom Inc. Class B 82,100 4,762
- - Tele-Communications-
TCI Group A 121,620 4,758
The Gap, Inc. 89,950 4,745
Fleet Financial Group, Inc. 64,477 4,735
Northern Telecom Ltd. 147,760 4,728
The Bank of New York Co., Inc. 172,400 4,719
Southern Co. 160,000 4,710
Texas Instruments, Inc. 88,800 4,684
Colgate-Palmolive Co. 67,200 4,603
AlliedSignal Inc. 128,500 4,546
First Chicago NBD Corp. 66,165 4,532
Lockheed Martin Corp. 44,541 4,490
Dow Chemical Co. 52,550 4,490
- - Amgen, Inc. 59,100 4,466
- - Sun Microsystems, Inc. 86,100 4,289
Household International, Inc. 112,988 4,237
H.J. Heinz Co. 82,500 4,218
United Technologies Corp. 54,300 4,151
Raytheon Co. Class B 76,900 4,148
CBS Corp. 164,300 3,984
Wachovia Corp. 46,500 3,964
Enron Corp. 74,700 3,945
Sears, Roebuck & Co. 89,000 3,933
Comcast Corp. Class A Special 83,700 3,929
CVS Corp. 89,300 3,912
Baxter International, Inc. 65,400 3,891
Caterpillar, Inc. 85,800 3,823
Merrill Lynch & Co., Inc. 78,600 3,724
Electronic Data Systems Corp. 111,600 3,704
American General Corp. 57,695 3,685
General Re Corp. 18,100 3,674
Dayton Hudson Corp. 99,218 3,547
Fifth Third Bancorp 61,350 3,528
J.P. Morgan & Co., Inc. 41,542 3,515
Burlington Northern
Santa Fe Corp. 108,696 3,478
Pitney Bowes, Inc. 66,000 3,469
Gannett Co., Inc. 64,600 3,460
CIGNA Corp. 51,000 3,372
Mellon Bank Corp. 59,800 3,293
MBNA Corp. 115,000 3,292
International Paper Co. 68,900 3,212
Cardinal Health, Inc. 30,400 3,139
Bestfoods 64,600 3,129
PNC Bank Corp. 69,300 3,119
Kellogg Co. 94,300 3,106
SunTrust Banks, Inc. 49,700 3,081
Illinois Tool Works, Inc. 56,500 3,079
Albertson's, Inc. 56,300 3,047
Aluminum Co. of America 42,800 3,039
ConAgra, Inc. 111,900 3,014
Columbia/HCA Healthcare Corp. 149,645 3,002
Texas Utilities Co. 63,841 2,973
Washington Mutual, Inc. 87,841 2,965
KeyCorp 102,400 2,957
ALLTEL Corp. 62,300 2,951
- - The Kroger Co. 58,800 2,940
Marsh & McLennan Cos., Inc. 58,050 2,888
May Department Stores Co. 55,600 2,863
HBO & Co. 98,700 2,850
Halliburton Co. 99,600 2,845
FPL Group, Inc. 40,800 2,843
Williams Cos., Inc. 97,400 2,800
PG&E Corp. 86,900 2,775
Consolidated Edison Inc. 52,400 2,731
SunAmerica Inc. 44,200 2,696
Phillips Petroleum Co. 58,800 2,653
- - Clear Channel
Communications, Inc. 55,800 2,650
Lowe's Cos., Inc. 80,700 2,567
The Hartford Financial
Services Group Inc. 54,100 2,566
Guidant Corp. 34,500 2,562
J.C. Penney Co., Inc. 56,800 2,552
Norfolk Southern Corp. 87,100 2,531
General Mills, Inc. 35,500 2,485
Aon Corp. 38,150 2,461
The Chubb Corp. 38,900 2,451
- - 3Com Corp. 80,900 2,432
NIKE, Inc. Class B 65,700 2,419
Charles Schwab Corp. 61,150 2,408
The Seagram Co. Ltd. 83,600 2,398
Union Pacific Corp. 55,900 2,383
- - Costco Cos., Inc. 49,656 2,352
First Data Corp. 99,900 2,348
IMS Health, Inc. 37,900 2,347
</TABLE>
16
<PAGE> 19
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ----------------------------------------------------------------------
<S> <C> <C>
Aetna Inc. 33,706 $2,343
Hershey Foods Corp. 34,200 2,341
- - AMR Corp. 41,900 2,323
USX-Marathon Group 64,200 2,275
Becton, Dickinson & Co. 55,300 2,274
Textron, Inc. 37,400 2,267
PPG Industries, Inc. 41,500 2,264
Archer-Daniels-Midland Co. 134,476 2,252
- - Cendant Corp. 193,334 2,248
BankBoston Corp. 67,802 2,237
- - Boston Scientific Corp. 43,500 2,235
Conseco Inc. 70,745 2,162
Loews Corp. 25,600 2,160
American Electric Power Co., Inc. 43,800 2,138
Public Service Enterprise
Group, Inc. 54,300 2,135
Edison International 82,600 2,122
Houston Industries, Inc. 67,922 2,114
American Stores Co. 65,100 2,095
- - Applied Materials, Inc. 82,700 2,088
Rite Aid Corp. 58,700 2,084
Comerica, Inc. 37,950 2,080
Ralston-Ralston Purina Group 70,900 2,074
CSX Corp. 49,000 2,061
Unocal Corp. 55,439 2,010
Dominion Resources, Inc. 44,950 2,006
- - Ascend Communications, Inc. 43,900 1,997
- - Tenet Healthcare Corp. 69,400 1,995
State Street Corp. 36,400 1,986
Wrigley, (Wm.) Jr. Co. 25,900 1,967
BB&T Corp. 64,900 1,943
Computer Sciences Corp. 35,200 1,918
Lincoln National Corp. 23,300 1,916
Sysco Corp. 80,800 1,904
The Clorox Co. 23,000 1,898
Weyerhaeuser Co. 44,300 1,869
Masco Corp. 75,200 1,852
- - Gateway 2000, Inc. 35,300 1,840
Mattel, Inc. 65,687 1,839
Honeywell, Inc. 28,400 1,819
PECO Energy Corp. 49,700 1,817
Service Corp. International 57,000 1,817
Progressive Corp. of Ohio 16,100 1,815
The Quaker Oats Co. 30,500 1,800
Unicom Corp. 48,100 1,798
Occidental Petroleum Corp. 83,300 1,791
The Goodyear Tire & Rubber Co. 34,800 1,788
Providian Financial Corp. 20,900 1,773
The McGraw-Hill Cos., Inc. 22,300 1,767
- - Tellabs, Inc. 44,300 1,764
Regions Financial Corp. 48,600 1,762
Rockwell International Corp. 48,600 1,756
Omnicom Group Inc. 38,900 1,751
AMP, Inc. 48,944 1,750
Deere & Co. 57,600 1,742
Northern Trust Corp. 25,400 1,734
Franklin Resources Corp. 57,300 1,719
Entergy Corp. 55,600 1,710
St. Paul Cos., Inc. 52,556 1,708
Delta Air Lines, Inc. 17,400 1,692
- - Federated Department Stores, Inc. 46,400 1,688
Interpublic Group of Cos., Inc. 31,250 1,686
Barrick Gold Corp. 84,100 1,682
Mercantile Bancorp, Inc. 34,700 1,679
Avon Products, Inc. 59,300 1,664
Fort James Corp. 50,500 1,657
Coastal Corp. 48,800 1,647
Newell Co. 35,500 1,635
FirstEnergy Corp. 52,500 1,631
UNUM Corp. 32,500 1,615
Air Products & Chemicals, Inc. 53,100 1,580
Dover Corp. 50,900 1,572
Carolina Power & Light Co. 33,900 1,566
Transamerica Corp. 14,700 1,558
Southwest Airlines Co. 77,000 1,540
Capital One Financial Corp. 14,800 1,532
Corning, Inc. 51,300 1,510
Summit Bancorp. 40,000 1,500
Baker Hughes, Inc. 71,560 1,498
United Healthcare Corp. 42,700 1,495
Burlington Resources, Inc. 39,885 1,491
- - FDX Corp. 32,760 1,478
DTE Energy Co. 32,500 1,469
Pioneer Hi-Bred International, Inc. 55,640 1,461
General Dynamics Corp. 29,000 1,455
Jefferson-Pilot Corp. 23,900 1,446
Browning-Ferris Industries, Inc. 47,200 1,428
- - Micron Technology, Inc. 46,600 1,418
Sempra Energy 54,320 1,416
- - Kohls Corp. 35,800 1,396
Tandy Corp. 26,064 1,394
- - Seagate Technology 55,400 1,388
H.F. Ahmanson & Co. 25,000 1,388
Ingersoll-Rand Co. 36,550 1,387
Tribune Co. 27,400 1,379
Marriott International, Inc. Class A 57,300 1,368
- - Tricon Global Restaurants, Inc. 35,000 1,365
- - Fred Meyer Inc. 34,800 1,353
Cinergy Corp. 35,318 1,351
Central & South West Corp. 47,000 1,342
SAFECO Corp. 32,100 1,338
Dana Corp. 35,659 1,331
TJX Cos., Inc. 73,900 1,316
The Limited, Inc. 59,995 1,316
Ameren Corp. 31,200 1,308
- - Kmart Corp. 108,700 1,298
- - Unisys Corp. 56,900 1,294
TRW, Inc. 28,700 1,274
PacifiCorp 66,000 1,266
Winn-Dixie Stores, Inc. 33,900 1,261
Bankers Trust Corp. 21,300 1,257
Tenneco, Inc. 38,200 1,256
- - NEXTEL Communications, Inc. 62,100 1,254
GPU, Inc. 29,400 1,250
SLM Holding Corp. 38,500 1,249
Union Carbide Corp. 28,900 1,246
UST, Inc. 41,900 1,239
Genuine Parts Co. 40,550 1,219
The Times Mirror Co. Class A 22,800 1,211
Equifax, Inc. 33,900 1,210
Amerada Hess Corp. 20,900 1,206
Huntington Bancshares Inc. 47,970 1,205
Rohm & Haas Co. 43,200 1,202
Torchmark Corp. 33,400 1,200
</TABLE>
17
<PAGE> 20
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
MARKET
VALUE*
ASSET ALLOCATION FUND SHARES (000)
- ----------------------------------------------------------------------
<S> <C> <C>
R.R. Donnelley & Sons Co. 34,100 $1,200
New York Times Co. Class A 43,500 1,196
MBIA, Inc. 22,200 1,192
Alcan Aluminium Ltd. 50,750 1,189
Consolidated Natural Gas Co. 21,700 1,183
Synovus Financial Corp. 59,450 1,174
Maytag Corp. 24,400 1,165
Avery Dennison Corp. 26,500 1,158
- - US Airways Group, Inc. 22,800 1,154
Cincinnati Financial Corp. 37,300 1,147
Praxair, Inc. 35,000 1,144
Baltimore Gas & Electric Co. 34,250 1,143
Fortune Brands, Inc. 38,100 1,129
Northrop Grumman Corp. 15,100 1,102
- - Apple Computer, Inc. 28,900 1,102
Dollar General Corp. 40,825 1,087
Cooper Industries, Inc. 26,657 1,086
Columbia Energy Group 18,500 1,085
Eaton Corp. 17,200 1,078
Countrywide Credit Industries, Inc. 25,800 1,074
Anadarko Petroleum Corp. 27,000 1,061
Golden West Financial Corp. 12,900 1,055
VF Corp. 28,228 1,048
- - Toys R Us, Inc. 64,300 1,041
Provident Cos., Inc. 30,700 1,036
- - Ceridian Corp. 18,000 1,033
Dun & Bradstreet Corp. 38,100 1,029
- - HEALTHSOUTH Corp. 96,700 1,021
Dow Jones & Co., Inc. 21,700 1,009
Frontier Corp. 36,700 1,005
W.W. Grainger, Inc. 23,600 994
PP&L Resources Inc. 37,800 978
Republic New York Corp. 24,700 976
MGIC Investment Corp. 26,300 970
- - Novell, Inc. 78,800 965
H & R Block, Inc. 23,100 956
Brown-Forman Corp. Class B 15,900 954
Northern States Power Co. 33,900 951
Knight Ridder 21,200 943
Nordstrom, Inc. 38,100 943
Hilton Hotels Corp. 55,100 940
Georgia Pacific Group 20,400 931
ITT Industries, Inc. 27,400 928
Biomet, Inc. 26,700 926
Black & Decker Corp. 21,800 907
Johnson Controls, Inc. 19,200 893
Eastman Chemical Co. 17,550 885
- - Owens-Illinois, Inc. 35,100 878
Allergan, Inc. 14,800 864
Newmont Mining Corp. 35,546 862
Sherwin-Williams Co. 39,700 859
Hasbro, Inc. 28,900 853
Ecolab, Inc. 29,600 842
- - ALZA Corp. 19,300 837
Reynolds Metals Co. 16,400 833
- - AutoZone Inc. 33,700 830
International Flavors &
Fragrances, Inc. 24,800 818
Whirlpool Corp. 17,300 813
Allegheny Teledyne Inc. 45,210 805
Bear Stearns Co., Inc. 25,800 798
Rubbermaid, Inc. 33,300 797
Nucor Corp. 19,600 796
Harcourt General, Inc. 16,263 787
Ashland, Inc. 16,900 782
Fluor Corp. 18,700 768
Crown Cork & Seal Co., Inc. 28,700 768
Phelps Dodge Corp. 14,600 762
Parker Hannifin Corp. 25,625 761
Lehman Brothers Holdings, Inc. 26,800 757
SuperValu Inc. 32,400 755
- - General Instrument Corp. 34,700 750
Circuit City Stores, Inc. 22,500 750
PACCAR, Inc. 18,140 747
Sonat, Inc. 25,000 747
Dillard's Inc. 26,300 745
Placer Dome, Inc. 53,500 739
Hercules, Inc. 23,800 715
Willamette Industries, Inc. 24,700 709
Perkin-Elmer Corp. 10,200 701
Morton International, Inc. 31,700 693
Union Pacific Resources
Group, Inc. 55,922 689
RJR Nabisco Holdings Corp. 27,300 688
U.S. Surgical Corp. 16,477 687
Sun Co., Inc. 21,367 684
The Mead Corp. 23,200 683
American Greetings Corp. Class A 17,200 680
Laidlaw, Inc. 71,400 674
Champion International Corp. 21,500 673
Sigma-Aldrich Corp. 23,200 670
- - Mirage Resorts, Inc. 39,900 668
Wendy's International, Inc. 29,900 663
- - Niagara Mohawk Power Corp. 42,600 655
Temple-Inland Inc. 13,000 622
The Stanley Works 20,900 622
Union Camp Corp. 15,400 606
- - Advanced Micro Devices, Inc. 32,600 605
Engelhard Corp. 33,650 595
Pall Corp. 26,766 594
- - Sealed Air Corp. 18,615 593
- - Humana, Inc. 36,200 593
Darden Restaurants Inc. 37,000 592
Harris Corp. 18,400 589
Homestake Mining Co. 48,100 583
- - Parametric Technology Corp. 57,100 575
Giant Food, Inc. Class A 13,300 574
Westvaco Corp. 23,500 564
Adobe Systems, Inc. 16,000 555
Great Lakes Chemical Corp. 14,100 548
Apache Corp. 20,400 547
Deluxe Corp. 19,000 540
The BFGoodrich Co. 16,300 533
Bausch & Lomb, Inc. 13,500 532
Freeport-McMoRan Copper &
Gold Inc. Class B 43,600 518
- - Thermo Electron Corp. 33,500 505
NICOR, Inc. 12,000 497
Centex Corp. 14,400 497
Kerr-McGee Corp. 10,900 496
Louisiana-Pacific Corp. 24,200 493
C.R. Bard, Inc. 13,300 490
Raychem Corp. 19,800 483
Armstrong World Industries Inc. 9,000 482
</TABLE>
18
<PAGE> 21
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ----------------------------------------------------------------------
<S> <C> <C>
- - Consolidated Stores, Inc. 24,400 $479
- - St. Jude Medical, Inc. 20,500 474
USX-U.S. Steel Group 19,840 474
Nalco Chemical Co. 16,000 472
- - KLA-Tencor Corp. 18,800 468
Thomas & Betts Corp. 12,100 461
Ryder System, Inc. 18,300 455
- - King World Productions, Inc. 17,400 455
Snap-On Inc. 14,650 451
- - FMC Corp. 8,500 438
Liz Claiborne, Inc. 16,300 427
- - HCR Manor Care, Inc. 14,500 425
Bemis Co., Inc. 12,100 424
Meredith Corp. 12,900 413
Adolph Coors Co. Class B 8,800 404
- - LSI Logic Corp. 31,900 403
- - Navistar International Corp. 17,280 391
- - Cabletron Systems, Inc. 34,300 386
Inco Ltd. 37,598 385
Longs Drug Stores, Inc. 9,500 382
General Signal Corp. 11,200 380
Owens Corning 11,600 378
Crane Co. 16,037 377
- - Silicon Graphics, Inc. 40,146 376
Pennzoil Co. 10,700 375
Scientific-Atlanta, Inc. 17,700 374
National Service Industries, Inc. 11,400 363
- - National Semiconductor Corp. 36,600 355
Case Corp. 16,200 352
Cooper Tire & Rubber Co. 19,200 346
Mallinckrodt, Inc. 16,600 337
McDermott International, Inc. 12,400 334
Battle Mountain Gold Co. Class A 53,800 326
- - Harrah's Entertainment, Inc. 23,700 316
Alberto-Culver Co. Class B 13,200 309
Pulte Corp. 12,200 300
- - Oryx Energy Co. 23,100 299
Peoples Energy Corp. 8,100 292
Brunswick Corp. 22,500 291
Cyprus Amax Minerals Co. 21,711 288
Shared Medical Systems Corp. 5,400 287
Autodesk, Inc. 10,900 286
Boise Cascade Corp. 11,200 284
Cummins Engine Co., Inc. 9,400 280
- - Fruit of the Loom, Inc. 17,800 268
- - Venator Group, Inc. 30,800 268
Briggs & Stratton Corp. 6,500 267
- - Andrew Corp. 20,075 266
Worthington Industries, Inc. 21,250 266
Polaroid Corp. 10,762 264
Fleetwood Enterprises, Inc. 8,175 247
Russell Corp. 9,300 244
Moore Corp. Ltd. 23,100 244
Ball Corp. 6,900 243
Helmerich & Payne, Inc. 11,500 242
EG&G, Inc. 10,500 238
Potlatch Corp. 6,800 232
- - Rowan Cos., Inc. 19,600 219
The Timken Co. 14,400 218
Great Atlantic & Pacific Tea
Co., Inc. 8,900 216
ONEOK, Inc. 6,300 214
- - Bethlehem Steel Corp. 25,700 212
IKON Office Solutions, Inc. 29,200 210
Jostens Inc. 10,000 208
W.R. Grace & Co. 16,500 205
Eastern Enterprises 4,700 198
Aeroquip-Vickers Inc. 6,700 193
The Pep Boys
(Manny, Moe & Jack) 14,400 193
ASARCO, Inc. 9,900 189
- - Stone Container Corp. 21,910 189
Tektronix, Inc. 12,050 187
NACCO Industries, Inc. Class A 1,860 186
Kaufman & Broad Home Corp. 7,900 185
Millipore Corp. 9,600 183
- - Reebok International Ltd. 12,800 174
Tupperware Corp. 13,900 163
Springs Industries Inc. Class A 4,300 149
Harnischfeger Industries Inc. 11,400 128
Cincinnati Milacron, Inc. 8,200 127
Foster Wheeler Corp. 9,200 127
- - Armco, Inc. 24,300 122
- - Data General Corp. 10,000 109
- - BMC Software, Inc. 1,200 72
Paychex, Inc. 1,000 52
Union Planters Corp. 800 40
- - Siebel Systems, Inc. 102 3
- ----------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost $1,059,891) 1,863,044
- ----------------------------------------------------------------------
<CAPTION>
- ----------------------------------------------------------------------
FACE
AMOUNT
(000)
- ----------------------------------------------------------------------
<S> <C> <C>
U.S. GOVERNMENT OBLIGATIONS (20.1%)
- ----------------------------------------------------------------------
U.S. Treasury Bonds
6.375%, 8/15/2027 $21,870 25,809
6.50%, 11/15/2026 83,675 99,716
6.875%, 8/15/2025 13,265 16,452
7.125%, 2/15/2023 9,085 11,471
7.25%, 5/15/2016 60,325 74,920
7.50%, 11/15/2016 280 356
7.50%, 11/15/2024 66,110 87,678
7.625%, 11/15/2022 39,220 52,141
7.625%, 2/15/2025 10,790 14,541
8.00%, 11/15/2021 54,680 75,028
8.125%, 8/15/2019 56,620 77,576
8.125%, 5/15/2021 44,815 62,091
8.75%, 5/15/2017 3,100 4,422
8.75%, 5/15/2020 39,910 58,222
8.75%, 8/15/2020 60,890 88,985
8.875%, 8/15/2017 85,780 123,844
8.875%, 2/15/2019 67,285 98,260
10.375%, 11/15/2012 7,213 10,211
10.625%, 8/15/2015 20,070 32,810
11.25%, 2/15/2015 7,340 12,499
11.75%, 11/15/2014 42,825 68,307
12.00%, 8/15/2013 7,460 11,685
12.75%, 11/15/2010 7,220 10,757
14.00%, 11/15/2011 8,250 13,427
- ----------------------------------------------------------------------
TOTAL U.S. GOVERNMENT OBLIGATIONS
(Cost $984,835) 1,131,208
- ----------------------------------------------------------------------
</TABLE>
19
<PAGE> 22
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
ASSET ALLOCATION FUND (000) (000)
- ----------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (50.8%)
- ----------------------------------------------------------------------
<C> <C> <C>
U.S. TREASURY BILLS (2.8%)
(2) 4.97%, 10/8/1998 $69,500 $69,456
(2) 5.168%, 10/15/1998 50,100 50,033
(2) 5.512%, 12/10/1998 36,000 35,711
----------
155,200
----------
COMMERCIAL PAPER (27.2%)
FINANCE (13.7%)
A.I. Credit Corp.
5.105%, 11/30/1998 25,000 24,787
5.52%, 10/7/1998 25,000 24,977
American Honda Finance Corp.
5.50%, 10/1/1998 40,000 40,000
Associates First Capital Corp.
5.43%, 11/19/1998 50,000 49,647
Ciesco LP
5.50%, 10/5/1998 25,000 24,985
5.50%, 10/19/1998 50,000 49,863
EDS Finance
5.31%, 12/2/1998 50,000 49,558
Ford Motor Credit Co.
5.25%, 12/8/1998 40,000 39,614
5.37%, 12/11/1998 40,000 39,595
General Electric Capital Corp.
5.42%, 11/19/1998 70,000 69,511
General Motors Acceptance Corp.
5.23%, 12/8/1998 70,000 69,324
IBM Credit Corp.
5.50%, 10/6/1998 40,000 39,969
Motorola Credit Corp.
5.28%, 11/24/1998 33,850 33,582
Paccar, Inc.
5.50%, 10/6/1998 10,000 9,992
5.50%, 10/7/1998 40,500 40,463
Repsol International Finance
5.34%, 11/27/1998 50,000 49,594
Toyota Motor Credit
5.583%, 10/20/1998 40,000 39,890
USAA Capital Corp.
5.32%, 12/18/1998 25,000 24,723
Xerox Capital Europe PLC
5.51%, 10/1/1998 25,000 25,000
Xerox Credit Corp.
5.27%, 12/14/1998 30,000 29,683
OTHER (13.5%)
Abbott Laboratories, Inc.
5.47%, 10/7/1998 50,000 49,954
Allied Domecq PLC
5.27%, 11/5/1998 30,000 29,846
Amoco Corp.
5.05%, 12/28/1998 25,000 24,691
Bell Atlantic Corp.
5.53%, 10/5/1998 50,000 49,969
Campbell Soup Co.
5.42%, 11/2/1998 30,000 29,855
Canadian Wheat Board
5.40%, 10/26/1998 30,000 29,888
Caterpillar Inc.
5.48%, 10/20/1998 30,500 30,412
Coca-Cola Co.
5.42%, 10/26/1998 20,000 19,925
5.42%, 10/30/1998 50,000 49,782
Disney Enterprises, Inc.
5.31%, 11/20/1998 70,000 69,498
DuPont International Ltd., Inc.
5.50%, 10/6/1998 60,000 59,954
Hershey Foods Corp.
5.33%, 11/20/1998 20,500 20,353
Lucent Technologies, Inc.
5.40%, 11/6/1998 30,000 29,838
McGraw-Hill Companies, Inc.
5.48%, 11/5/1998 50,000 49,734
Minnesota Mining &
Manufacturing Co.
5.35%, 12/21/1998 30,000 29,655
Motorola Inc.
5.53%, 10/6/1998 30,000 29,977
Procter & Gamble Co.
5.30%, 12/21/1998 44,000 43,494
5.48%, 10/13/1998 25,000 24,954
U S West Inc.
5.42%, 11/23/1998 40,000 39,696
Weyerhaeuser Co.
5.50%, 10/23/1998 19,000 18,936
Xerox Corp.
5.50%, 10/9/1998 30,000 29,963
----------
1,535,131
----------
REPURCHASE AGREEMENTS (20.8%)
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.46%, 10/1/1998 1,107,091 1,107,091
5.55%, 10/1/1998--Note F 63,870 63,870
----------
1,170,961
----------
- ----------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $2,860,999) 2,861,292
- ----------------------------------------------------------------------
TOTAL INVESTMENTS (103.9%)
(Cost $4,905,725) 5,855,544
- ----------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-3.9%)
Other Assets--Note C 134,480
Payables for Investment Securities Purchased (195,248)
Other Liabilities--Note F (158,261)
----------
(219,029)
- ----------------------------------------------------------------------
NET ASSETS (100%)
- ----------------------------------------------------------------------
Applicable to 246,189,466 outstanding
$0.001 par value shares of beneficial
interest (unlimited authorization) $5,636,515
======================================================================
NET ASSET VALUE PER SHARE $22.90
======================================================================
</TABLE>
* See Note A in Notes to Financial Statements.
- - Non-Income-Producing Security.
(1)The combined market value of common stocks and index
futures contracts represents 79.0% of net assets. See
Note E in Notes to Financial Statements.
(2)Security segregated as initial margin for open futures
contracts.
ADR--American Depositary Receipt.
20
<PAGE> 23
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- ----------------------------------------------------------------------
AT SEPTEMBER 30, 1998, NET ASSETS CONSISTED OF:
- ----------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $4,394,259 $17.85
Undistributed Net
Investment Income 94,543 .38
Accumulated Net
Realized Gains 137,081 .56
Unrealized Appreciation--Note E
Investment Securities 949,819 3.86
Futures Contracts 60,813 .25
======================================================================
NET ASSETS $5,636,515 $22.90
======================================================================
</TABLE>
21
<PAGE> 24
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.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
ASSET ALLOCATION FUND
YEAR ENDED SEPTEMBER 30, 1998
(000)
- --------------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
<S> <C>
Dividends $27,410
Interest 174,270
Security Lending 433
--------
Total Income 202,113
--------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 5,466
Performance Adjustment (1,404)
The Vanguard Group--Note C
Management and Administrative 17,431
Marketing and Distribution 1,124
Taxes (other than income taxes) 222
Custodian Fees 58
Auditing Fees 23
Shareholders' Reports 87
Annual Meeting and Proxy Costs 41
Trustees' Fees and Expenses 9
--------
Total Expenses 23,057
- --------------------------------------------------------------------------------------
NET INVESTMENT INCOME 179,056
- --------------------------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold 156,208
Futures Contracts 7,672
- --------------------------------------------------------------------------------------
REALIZED NET GAIN 163,880
- --------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 183,933
Futures Contracts 58,782
- --------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 242,715
- --------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $585,651
======================================================================================
</TABLE>
22
<PAGE> 25
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>
- ----------------------------------------------------------------------------------------------------------------
ASSET ALLOCATION FUND
YEAR ENDED SEPTEMBER 30,
----------------------------------
1998 1997
(000) (000)
- ----------------------------------------------------------------------------------------------------------------
INCREASE IN NET ASSETS
OPERATIONS
<S> <C> <C>
Net Investment Income $179,056 $118,433
Realized Net Gain 163,880 180,914
Change in Unrealized Appreciation (Depreciation) 242,715 474,305
----------------------------------
Net Increase in Net Assets Resulting from Operations 585,651 773,652
----------------------------------
DISTRIBUTIONS
Net Investment Income (141,316) (101,081)
Realized Capital Gain (181,623) (137,804)
----------------------------------
Total Distributions (322,939) (238,885)
----------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 1,956,353 1,014,872
Issued in Lieu of Cash Distributions 310,969 229,554
Redeemed (631,912) (381,985)
----------------------------------
Net Increase from Capital Share Transactions 1,635,410 862,441
- ----------------------------------------------------------------------------------------------------------------
Total Increase 1,898,122 1,397,208
- ----------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 3,738,393 2,341,185
----------------------------------
End of Year $5,636,515 $3,738,393
================================================================================================================
(1)Shares Issued (Redeemed)
Issued 85,659 52,552
Issued in Lieu of Cash Distributions 14,684 12,599
Redeemed (27,756) (19,710)
----------------------------------
Net Increase in Shares Outstanding 72,587 45,441
================================================================================================================
</TABLE>
23
<PAGE> 26
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>
- -----------------------------------------------------------------------------------------------------------------------------------
ASSET ALLOCATION FUND
YEAR ENDED SEPTEMBER 30,
-----------------------------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $21.53 $18.27 $17.03 $13.78 $15.08
- -----------------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .79 .74 .69 .64 .52
Net Realized and Unrealized Gain (Loss) on Investments 2.33 4.29 1.82 3.18 (.81)
-----------------------------------------------------------------------
Total from Investment Operations 3.12 5.03 2.51 3.82 (.29)
DISTRIBUTIONS
Dividends from Net Investment Income (.74) (.72) (.66) (.57) (.48)
Distributions from Realized Capital Gains (1.01) (1.05) (.61) -- (.53)
-----------------------------------------------------------------------
Total Distributions (1.75) (1.77) (1.27) (.57) (1.01)
- -----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $22.90 $21.53 $18.27 $17.03 $13.78
===================================================================================================================================
TOTAL RETURN 15.24% 29.42% 15.27% 28.57% -2.05%
===================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $5,637 $3,738 $2,341 $1,593 $1,120
Ratio of Total Expenses to Average Net Assets 0.49% 0.49% 0.47% 0.49% 0.50%
Ratio of Net Investment Income to Average Net Assets 3.80% 3.96% 4.17% 4.41% 3.68%
Portfolio Turnover Rate 60% 10% 47% 34% 51%
===================================================================================================================================
</TABLE>
24
<PAGE> 27
NOTES TO FINANCIAL STATEMENTS
Vanguard Asset Allocation 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, and 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 futures contracts, with the
objectives of maintaining full exposure to the stock market, enhancing returns,
maintaining liquidity, and minimizing transaction costs. The fund may purchase
futures contracts to immediately invest incoming cash in the market, or sell
futures in response to cash outflows, thereby simulating a fully invested
position in the underlying index while maintaining a cash balance for liquidity.
The fund may seek to enhance returns by using futures contracts instead of the
underlying securities when futures are believed to be priced more attractively
than the underlying securities. 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. Premiums and discounts on
debt securities purchased are amortized and accreted, respectively, to interest
income over the lives of the respective securities.
B. Mellon Capital Management Corporation 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
25
<PAGE> 28
NOTES TO FINANCIAL STATEMENTS (continued)
adjustments based on performance for the preceding three years relative to a
combined index comprising the S&P 500 Index and the Lehman Brothers Long U.S.
Treasury Bond Index. For the year ended September 30, 1998, the advisory fee
represented an effective annual basic rate of 0.12% of the fund's average net
assets before a decrease of $1,404,000 (0.03%) 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, 1998, the fund had contributed capital of $1,071,000
to Vanguard (included in Other Assets), representing 0.02% of the fund's net
assets and 1.5% of Vanguard's capitalization. The fund's Trustees and officers
are also Directors and officers of Vanguard.
D. During the year ended September 30, 1998, the fund purchased $179,489,000 of
investment securities and sold $20,548,000 of investment securities, other than
U.S. government securities and temporary cash investments. Purchases and sales
of U.S. government securities were $1,741,670,000 and $2,627,961,000,
respectively.
E. At September 30, 1998, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $949,819,000,
consisting of unrealized gains of $986,673,000 on securities that had risen in
value since their purchase and $36,854,000 in unrealized losses on securities
that had fallen in value since their purchase.
At September 30, 1998, the aggregate settlement value of open futures
contracts expiring in December 1998 and the related unrealized appreciation
were:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------
(000)
---------------------------------------
AGGREGATE
NUMBER OF SETTLEMENT UNREALIZED
FUTURES CONTRACTS LONG CONTRACTS VALUE APPRECIATION
---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
S&P 500 Index 10,104 $2,591,676 $60,813
---------------------------------------------------------------------------------------------------
</TABLE>
Unrealized appreciation on open futures contracts is required to be treated as
realized gain for federal income tax purposes.
F. The market value of securities on loan to broker/dealers at September 30,
1998, was $153,681,000, for which the fund had received as collateral cash of
$63,870,000 and U.S. Treasury securities with a market value of $91,615,000.
Cash collateral received is invested in repurchase agreements. Security loans
are required to be secured at all times by collateral at least equal to the
market value of securities loaned; 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.
26
<PAGE> 29
REPORT OF INDEPENDENT [PHOTO]
ACCOUNTANTS
To the Shareholders and
Board of Trustees of
Vanguard Asset Allocation 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 Asset Allocation Fund (the "Fund") at September 30, 1998, 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, 1998 by
correspondence with the custodian, provide a reasonable basis for the opinion
expressed above.
PricewaterhouseCoopers LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
October 30, 1998
27
<PAGE> 30
SPECIAL 1998 TAX INFORMATION (UNAUDITED) FOR VANGUARD ASSET ALLOCATION FUND
This information for the fiscal year ended September 30, 1998, is included
pursuant to provisions of the Internal Revenue Code.
The fund distributed $101,601,000 as capital gain dividends (from net
long-term capital gains) to shareholders in December 1997. Of the $101,601,000
capital gain dividends, the fund designates $56,298,000 as a 20% rate gain
distribution.
For corporate shareholders, 8.7% of investment income (dividend income plus
short-term gains, if any) qualifies for the dividends-received deduction.
28
<PAGE> 31
TRUSTEES AND OFFICERS
JOHN C. BOGLE
Founder, Senior Chairman of the Board, and Director of The Vanguard Group, Inc.,
and Trustee of each of the investment companies in The Vanguard Group.
JOHN J. BRENNAN
Chairman, Chief Executive Officer, and Director of The Vanguard Group, Inc., and
Trustee of each of the investment companies in The Vanguard Group.
BARBARA BARNES HAUPTFUHRER
Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions, Inc.,
Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance Co., and
Ladies Professional Golf Association; Trustee Emerita of Wellesley College.
JOANN HEFFERNAN HEISEN
Vice President, Chief Information Officer, and a member of the Executive
Committee of Johnson & Johnson; Director of Johnson & Johnson-Merck Consumer
Pharmaceuticals Co., Women First HealthCare, Inc., Recording for the Blind and
Dyslexic, The Medical Center at Princeton, and Women's Research and Education
Institute.
BRUCE K. MacLAURY
President Emeritus of The Brookings Institution; Director of American Express
Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp.
BURTON G. MALKIEL
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Banco Bilbao Gestinova, Baker Fentress &
Co., The Jeffrey Co., and Southern New England Telecommunications Co.
ALFRED M. RANKIN, JR.
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co.
JOHN C. SAWHILL
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co. and President of New York
University; Director of Pacific Gas and Electric Co., Procter & Gamble Co.,
NACCO Industries, and Newfield Exploration Co.
JAMES O. WELCH, JR.
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of
RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON
Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins
Engine Co. and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director and Secretary of The Vanguard Group, Inc.;
Secretary of each of the investment companies in The Vanguard Group.
THOMAS J. HIGGINS
Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the
investment companies in The Vanguard Group.
KAREN E. WEST
Controller; Principal of The Vanguard Group, Inc.; Controller of each of the
investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
R. GREGORY BARTON
Managing Director, Legal Department.
ROBERT A. DiSTEFANO
Managing Director, Information Technology.
JAMES H. GATELY
Managing Director, Individual Investor Group.
KATHLEEN C. GUBANICH
Managing Director, Human Resources.
IAN A. MacKINNON
Managing Director, Fixed Income Group.
F. WILLIAM McNABB, III
Managing Director, Institutional Investor Group.
MICHAEL S. MILLER
Managing Director, Planning and Development.
RALPH K. PACKARD
Managing Director and Chief Financial Officer.
GEORGE U. SAUTER
Managing Director, Core Management Group.
"Standard & Poor's(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.
<PAGE> 32
VANGUARD
MILESTONES
[PHOTO]
The Vanguard Group is named for HMS Vanguard, Admiral Horatio Nelson's flagship
at the Battle of the Nile on August 1, 1798. Our founder, John C. Bogle, chose
the name after reading Nelson's inspiring tribute to his fleet: "Nothing could
withstand the squadron . . . with the judgment of the captains, together with
their valour, and that of the officers and men of every description, it was
absolutely irresistible."
[PHOTO]
Walter L. Morgan, founder of Wellington Fund, the nation's first balanced mutual
fund and forerunner of today's family of some 100 Vanguard funds, celebrated his
100th birthday on July 23, 1998. Mr. Morgan, a true investment pioneer, died six
weeks later on September 2.
[PHOTO]
Wellington Fund, The Vanguard Group's oldest fund, was incorporated by Mr.
Morgan 70 years ago, on December 28, 1928. The fund was named after the Duke of
Wellington, whose forces defeated Napoleon Bonaparte at the Battle of Waterloo
in 1815.
[THE VANGUARD GROUP LOGO]
Post Office Box 2600
Valley Forge, Pennsylvania 19482
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
www.vanguard.com
[email protected]
All Vanguard funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other expenses
and should be read carefully before you invest or send money. Prospectuses can
be obtained directly from The Vanguard Group.
Q780-11/12/1998
(C) 1998 Vanguard Marketing
Corporation, Distributor.
All rights reserved.
