<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT (NO. 33-32548) UNDER
THE SECURITIES ACT OF 1933
PRE-EFFECTIVE AMENDMENT NO.
POST-EFFECTIVE AMENDMENT NO. 12
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
AMENDMENT NO. 15
VANGUARD INTERNATIONAL EQUITY
INDEX FUND, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
P.O. BOX 2600, VALLEY FORGE, PA 19482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER (610) 669-1000
RAYMOND J. KLAPINSKY, ESQUIRE
P.O. BOX 876
VALLEY FORGE, PA 19482
IT IS PROPOSED THAT THIS AMENDMENT BECOME EFFECTIVE:
on March 28, 1997, pursuant to Rule 485(b) under the Securities Act of 1933.
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
As soon as practicable after this Registration Statement becomes effective.
WE HAVE ELECTED TO REGISTER AN INDEFINITE NUMBER OF SHARES PURSUANT TO
REGULATION 24F-2 UNDER THE INVESTMENT COMPANY ACT OF 1940. REGISTRANT FILED ITS
RULE 24F-2 NOTICE FOR THE YEAR ENDED DECEMBER 31, 1996 ON FEBRUARY 27, 1997.
================================================================================
<PAGE> 2
VANGUARD INTERNATIONAL EQUITY INDEX FUND, INC.
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
FORM N-1A
ITEM NUMBER LOCATION IN PROSPECTUS
<C> <S> <C>
Item 1. Cover Page.................................... Cover Page
Item 2. Synopsis...................................... N/A
Item 3. Condensed Financial Information............... Funds' Expenses; Financial Highlights
Item 4. General Description of Registrant............. Investment Objective; Investment
Limitations; Investment Policies;
General Information
Item 5. Management of the Funds....................... Management of the Funds; General
Information
Item 6. Capital Stock and Other Securities............ Opening an Account and Purchasing
Shares; Selling Your Shares; The
Share Price of Each Portfolio;
Dividends, Capital Gains and Taxes;
General Information
Item 7. Purchase of Securities Being Offered.......... Cover Page; Opening an Account and
Purchasing Shares
Item 8. Redemption or Repurchase...................... Selling Your Shares
Item 9. Pending Legal Proceedings..................... Not Applicable
<CAPTION>
FORM N-1A LOCATION IN STATEMENT
ITEM NUMBER OF ADDITIONAL INFORMATION
<C> <S> <C>
Item 10. Cover Page.................................... Cover Page
Item 11. Table of Contents............................. Cover Page
Item 12. General Information and History............... Investment Objective and Policies
Item 13. Investment Objective and Policies............. Investment Objective and Policies
Item 14. Management of the Fund........................ Management of the Fund
Item 15. Control Persons and Principal Holders of
Securities.................................... Management of the Fund
Item 16. Investment Advisory and Other Services........ Management of the Fund
Item 17. Brokerage Allocation.......................... Not Applicable
Item 18. Capital Stock and Other Securities............ Financial Statements
Item 19. Purchase, Redemption and Pricing of Securities
Being Offered................................. Purchase of Shares; Redemption of
Shares
Item 20. Tax Status.................................... Appendix
Item 21. Underwriters.................................. Not Applicable
Item 22. Calculations of Yield Quotations of Money
Market Fund................................... Not Applicable
Item 23. Financial Statements.......................... Financial Statements
</TABLE>
<PAGE> 3
- --------------------------------------------------------------------------------
LOGO
VANGUARD
INTERNATIONAL INDEX PORTFOLIOS
P R O S P E C T U S
MARCH 28, 1997
VANGUARD INTERNATIONAL EQUITY INDEX FUND -- EUROPEAN PORTFOLIO
VANGUARD INTERNATIONAL EQUITY INDEX FUND -- PACIFIC PORTFOLIO
VANGUARD INTERNATIONAL EQUITY INDEX FUND -- EMERGING MARKETS PORTFOLIO
VANGUARD STAR FUND -- TOTAL INTERNATIONAL PORTFOLIO
LOGO
- --------------------------------------------------------------------------------
<PAGE> 4
================================================================================
PROSPECTUS -- MARCH 28, 1997 A Member of The Vanguard Group
================================================================================
NEW ACCOUNT INFORMATION: INVESTOR INFORMATION DEPARTMENT -- 1-800-662-7447
(SHIP)
- --------------------------------------------------------------------------------
SHAREHOLDER ACCOUNT SERVICES: CLIENT SERVICES DEPARTMENT -- 1-800-662-2739
(CREW)
- --------------------------------------------------------------------------------
INVESTMENT OBJECTIVE AND POLICIES. Vanguard International Equity Index Fund is
an open-end diversified investment company that consists of three
Portfolios -- European, Pacific, and Emerging Markets. The Total International
Portfolio is part of Vanguard STAR Fund, which is an open-end non-diversified
investment company (information on STAR's other five Portfolios can be obtained
by calling Vanguard). The four Portfolios described in this prospectus are
designed as Index Funds.
The European Portfolio seeks investment results that parallel those of the
Morgan Stanley Capital International -- Europe Index, an index of companies in
14 European countries. The Pacific Portfolio seeks investment results that
parallel those of the Morgan Stanley Capital International -- Pacific (Free)
Index, an index of companies in Japan, Australia, New Zealand, Hong Kong,
Singapore and Malaysia. The Emerging Markets Portfolio seeks investment results
that parallel those of the Morgan Stanley Capital International -- Select
Emerging Markets (Free) Index, an index of companies located in 14 Asian, Latin
American, African, and European countries. These Portfolios use statistical
procedures to invest primarily in common stocks found in their indexes.
The Total International Portfolio seeks investment results that parallel
those of the Morgan Stanley Capital International Europe, Australia, and Far
East + Select Emerging Markets (Free) Index by investing in a combination of the
European, Pacific, and Emerging Markets Portfolios.
There is no assurance that any Portfolio will achieve its stated objective.
Shares of the Portfolios are neither insured nor guaranteed by any agency of the
U.S. Government, including the FDIC.
- --------------------------------------------------------------------------------
OPENING AN ACCOUNT. To open a non-retirement account, complete and return an
Account Registration Form. For assistance, call our Investor Information
Department. To open an Individual Retirement Account (IRA), use a Vanguard IRA
Adoption Agreement. To obtain a copy, call 1-800-662-7447, Monday through
Friday, from 8:00 a.m. to 9:00 p.m., and Saturday, from 9:00 a.m. to 4:00 p.m.
(Eastern time). To open an account by wire, call Client Services at
1-800-662-2739. The minimum initial investment for each Portfolio is $3,000
($1,000 for IRAs and Uniform Gifts/Transfers to Minors Act accounts). The
Portfolios are offered on a no-load basis (i.e., there are no sales commissions
or 12b-1 fees). However, the Portfolios incur expenses for investment advisory,
management, administrative and distribution services. Each Portfolio charges a
$10 annual account maintenance fee (waived for balances of $10,000 or more).
Each Portfolio charges a transaction fee on purchases (1.5% for the Emerging
Markets Portfolio, 1% for the European Portfolio, 0.5% for the Pacific
Portfolio, 0.75% for the Total International Portfolio); the Emerging Markets
Portfolio charges a 1% transaction fee on redemptions. These fees are paid to
the Portfolios to offset the costs of trading international securities.
- --------------------------------------------------------------------------------
ABOUT THIS PROSPECTUS. This Prospectus is designed to set forth concisely the
information you should know about the Portfolios before you invest. It should be
retained for future reference. A "Statement of Additional Information"
containing additional information about the Fund has been filed with the
Securities and Exchange Commission. This Statement is dated March 28, 1997 and
has been incorporated by reference into this Prospectus. A copy may be obtained
without charge by writing to the Fund or by calling the Investor Information
Department.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
<TABLE>
<S> <C>
Portfolio Expenses............... 2
Financial Highlights............. 5
Yield and Total Return........... 7
Investment Objective............. 8
Investment Policies.............. 8
Investment Risks................. 10
Who Should Invest................ 12
Implementation of Policies....... 13
Investment Limitations........... 16
Management of the Fund........... 16
Investment Adviser............... 17
Dividends, Capital Gains
and Taxes...................... 18
The Share Price of Each
Portfolio...................... 20
General Information.............. 21
Opening an Account and
Purchasing Shares.............. 22
When Your Account Will
Be Credited.................... 25
Selling Your Shares.............. 25
Exchanging Your Shares........... 28
Transferring Registration........ 29
</TABLE>
- --------------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 5
PORTFOLIO
EXPENSES The following table illustrates ALL expenses and fees
that you would incur as a shareholder of each
Portfolio. The expenses and fees set forth below are
for the 1996 fiscal year.
<TABLE>
<CAPTION>
EMERGING TOTAL
EUROPEAN PACIFIC MARKETS INTERNATIONAL
SHAREHOLDER TRANSACTION EXPENSES PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
<S> <C> <C> <C> <C>
----------------------------------------------------------------------------
Sales Load Imposed on Purchases............ None * None * None * None *
Sales Load Imposed on Reinvested
Dividends................................. None None None None
Redemption Fees............................ None None 1% None
Exchange Fees.............................. None None None None
</TABLE>
* Shareholders are charged a portfolio transaction
fee, payable directly to the Portfolio on each
purchase of shares.
<TABLE>
<CAPTION>
EMERGING TOTAL
EUROPEAN PACIFIC MARKETS INTERNATIONAL
ANNUAL FUND OPERATING EXPENSES PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
<S> <C> <C> <C> <C>
----------------------------------------------------------------------------
Management & Administrative Expenses**..... 0.26% 0.24% 0.23%
Investment Advisory Fees................... None None None None
12b-1 Fees................................. None None None None
Other Expenses
Distribution Costs........................ 0.02% 0.03% 0.03% 0.02%
Miscellaneous Expenses.................... 0.07 0.08 0.34 0.11
----- ------ ----- --------
Total Other Expenses....................... 0.09 0.11 0.37 0.13
----- ------ ----- --------
TOTAL OPERATING EXPENSES............ 0.35% 0.35% 0.60% 0.38%
===== ====== ===== ========
</TABLE>
** For accounts of less than $10,000, each Portfolio
assesses an annual account maintenance fee of $10.
This fee is in addition to the expenses set forth
above.
Because it invests in a combination of the European,
Pacific, and Emerging Markets Portfolios, the Total
International Portfolio does not have operating
expenses of its own. However, Total International
Portfolio shareholders bear indirectly the expenses of
the underlying Portfolios. The expenses set forth in
the table above represent an estimate of these expenses
for the Portfolio's first full year of operations. The
purpose of this table is to assist you in understanding
the various costs and expenses that you would bear
directly or indirectly as an investor in the
Portfolios.
EACH PORTFOLIO
CHARGES A
TRANSACTION FEE Each Portfolio assesses a portfolio transaction fee on
share purchases. These fees are as follows: 1% of the
dollar amount invested for the European Portfolio, 0.5%
of the dollar amount invested for the Pacific
Portfolio, 1.5% of the dollar amount invested for the
Emerging Markets Portfolio and 0.75% of the dollar
amount invested for the Total International Portfolio.
In all four Portfolios, the portfolio transaction fee
is paid directly to the respective Portfolio, not to
Vanguard (except that the Total International
Portfolio's fee is passed through to the underlying
Portfolios in which it invests). It is not a sales
charge. The fee applies to an initial investment in the
Portfolio and all subsequent purchases (including
purchases made by exchange from another Vanguard Fund
or from other Portfolios of Vanguard International
Equity Index Fund), but not to reinvested dividend or
capital gains distributions. The Portfolio transaction
fee is deducted automatically from the amount invested;
it cannot be paid separately.
2
<PAGE> 6
EMERGING MARKETS
PORTFOLIO CHARGES
A 1% REDEMPTION
TRANSACTION FEE The Emerging Markets Portfolio also assesses a 1%
portfolio transaction or share redemption fee. This 1%
charge applies to redemptions or exchanges from the
Portfolio. The 1% fee is deducted from redemption or
exchange proceeds and is paid directly to the
Portfolio, not to Vanguard. It is not a contingent
deferred sales charge.
The purpose of the purchase and redemption transaction
fees is to allocate transaction costs associated with
purchases and redemptions to investors making those
transactions, thus insulating existing shareholders
from those transaction costs. These costs include: (1)
brokerage costs; (2) market impact costs -- i.e., the
increase in market prices which may result when the
Portfolios purchase or sell thinly traded stocks; and
(3) the effect of the "bid-ask" spread in international
markets.
The fees represent Vanguard's estimate of the brokerage
and other transaction costs incurred by the Portfolios
in purchasing and selling international stocks. Without
the fee, each Portfolio would incur these costs
directly, resulting in reduced investment performance
for all shareholders of the Portfolio. With the fee,
the transaction costs of purchasing and selling
international stocks are borne not by all existing
shareholders, but only by those investors making
transactions. Because the purchaser, not the Portfolio,
bears these costs, the Portfolio is expected to track
its benchmark index more closely.
Transaction costs incurred when purchasing or selling
stocks of companies in emerging market countries are
extremely high. There are three components of
transaction costs -- brokerage fees, the difference
between the bid/ask spread and market impact. Each one
of these factors is significantly more expensive in
emerging market countries than in the United States,
because of less competition among brokers, lower
utilization of technology on the part of the exchanges
and brokers, the lack of derivative instruments and
generally less liquid markets. Consequently, brokerage
commissions are high, bid/ask spreads are wide, and
market impact is significant. In addition to these
customary costs, most foreign countries have exchange
fees or stamp taxes.
EACH PORTFOLIO WILL
CHARGE A $10 ACCOUNT
MAINTENANCE FEE Each Portfolio assesses an annual account maintenance
fee of $10 for each shareholder account. The purpose of
the $10 fee is to allocate part of the costs of
maintaining shareholder accounts equally to all
accounts. This fee, which is paid directly by
shareholders, is deducted from the Fund's annual
dividend. See "Dividends, Capital Gains and Taxes" for
more information on this fee. The $10 fee amounts to
1.00% on a $1,000 investment in the Fund, and 0.33% on
a $3,000 investment. This fee will be waived for
shareholders with an account balance of $10,000 or
more.
The following example illustrates the expenses that you
would incur on a $1,000 investment over various
periods, assuming (1) a 5% annual rate of
3
<PAGE> 7
return and (2) redemption at the end of each period. A
$10 annual fee payable on accounts of less than $10,000
is not included.
<TABLE>
<CAPTION>
3 YEARS 5 YEARS 10 YEARS
1 YEAR ------- ------- --------
-------
<S> <C> <C> <C> <C>
European Portfolio........ $14 $21 $29 $ 54
Pacific Portfolio......... $ 9 $16 $25 $ 49
Emerging Markets
Portfolio............... $31 $45 $60 $104
Total International
Portfolio............... $11 $20 $29 $ 55
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION
OF PAST OR FUTURE EXPENSES OR PERFORMANCE. ACTUAL
EXPENSES MAY BE HIGHER OR LOWER THAN THOSE SHOWN.
- --------------------------------------------------------------------------------
4
<PAGE> 8
FINANCIAL
HIGHLIGHTS The following financial highlights of the Portfolios
for a share outstanding throughout each period have
been audited by Price Waterhouse LLP, independent
accountants, whose report on the financial statements
including this information was unqualified. This
information should be read in conjunction with the
Fund's financial statements and notes thereto, which,
together with the remaining portions of the Fund's 1996
Annual Report to Shareholders, are incorporated by
reference in the Statement of Additional Information
and in this Prospectus, and which appear, along with
the report of Price Waterhouse LLP, in the Fund's 1996
Annual Report to Shareholders. For a more complete
discussion of the Fund's performance, please see the
Fund's 1996 Annual Report to Shareholders which may be
obtained without charge by writing to the Fund or by
calling our Investor Information Department at
1-800-662-7447.
<TABLE>
<CAPTION>
---------------------------------------------------------------
EUROPEAN PORTFOLIO
---------------------------------------------------------------
YEAR ENDED DECEMBER 31, MAY 1+ TO
---------------------------------------------------- DEC. 31,
1996 1995 1994 1993 1992 1991 1990
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD........................ $14.02 $11.76 $11.88 $9.33 $9.92 $9.06 $10.00
------- ------ ------ ----- ----- ----- --------
INVESTMENT OPERATIONS
Net Investment Income......... .34 .32 .28 .17 .25 .26 .16
Net Realized and Unrealized
Gain Loss) on Investments... 2.63 2.30 (.06) 2.55 (.58) .86 (.94)
------ ------ ------ ----- ----- ----- -------
TOTAL FROM INVESTMENT
OPERATIONS............. 2.97 2.62 .22 2.72 (.33) 1.12 (.78)
- -------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment
Income...................... (.36) (.32) (.28) (.17) (.26) (.26) (.16)
Distributions from Realized
Capital Gains............... (.06) (.04) (.06) -- -- -- --
------ ------ ------ ----- ----- ----- -------
TOTAL DISTRIBUTIONS....... (.42) (.36) (.34) (.17) (.26) (.26) (.16)
- -------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF
PERIOD........................ $16.57 $14.02 $11.76 $11.88 $9.33 $9.92 $9.06
=================================================================================================
TOTAL RETURN(1)................. 21.26% 22.28% 1.88% 29.13% (3.32)% 12.40% (7.23)%
=================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period
(Millions).................... $1,595 $1,017 $715 $601 $256 $161 $96
Ratio of Expenses to Average Net
Assets........................ 0.35% 0.35% 0.32% 0.32% 0.32% 0.33% 0.40%*
Ratio of Net Investment Income
to Average Net Assets......... 2.45% 2.66% 2.41% 2.05% 3.05% 3.06% 3.68%*
Portfolio Turnover Rate......... 4% 2% 6% 4% 1% 15%** 3%
Average Commission Rate Paid.... $.0395 N/A N/A N/A N/A N/A N/A
* Annualized.
** Portfolio turnover rate for 1991 excluding in-kind redemptions was 3% for the European Portfolio.
+ Commencement of operations.
(1) Total return figures do not reflect the 1% transaction fee on purchases or the annual account
maintenance fee of $10.
</TABLE>
5
<PAGE> 9
<TABLE>
<CAPTION>
-----------------------------------------------------------------
PACIFIC PORTFOLIO
-----------------------------------------------------------------
YEAR ENDED DECEMBER 31, MAY 1+ TO
------------------------------------------------------ DEC. 31,
1996 1995 1994 1993 1992 1991 1990
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD....................... $11.50 $11.31 $10.13 $7.56 $9.42 $8.56 $10.00
------ ------ ------ ----- ----- ----- --------
INVESTMENT OPERATIONS
Net Investment Income........ .10 .10 .08 .06 .05 .05 .05
Net Realized and Unrealized
Gain (Loss) on
Investments................ (1.00) .21 1.24 2.62 (1.76) .86 (1.44)
------ ------ ------ ----- ----- ----- ------
TOTAL FROM INVESTMENT
OPERATIONS............ (.90) .31 1.32 2.68 (1.71) .91 (1.39)
- -------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment
Income..................... (.09) (.12) (.08) (.06) (.05) (.05) (.05)
Distributions from Realized
Capital Gains.............. -- -- (.06) (.05) (.10) -- --
------ ------ ------ ----- ----- ----- -------
TOTAL DISTRIBUTIONS...... (.09) (.12) (.14) (.11) (.15) (.05) (.05)
- -------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF
PERIOD....................... $10.51 $11.50 $11.31 $10.13 $7.56 $9.42 $8.56
=======================================================================================================
TOTAL RETURN(1)................ (7.82)% 2.75% 13.04% 35.46% (18.17)% 10.65% (14.01)%
=======================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period
(Millions)................... $978 $831 $697 $493 $207 $84 $31
Ratio of Expenses to Average
Net Assets................... 0.35% 0.35% 0.32% 0.32% 0.32% 0.32% 0.35%*
Ratio of Net Investment Income
to Average Net Assets........ 0.89% 0.97% 0.71% 0.75% 0.92% 0.70% 1.02%*
Portfolio Turnover Rate........ 9% 1% 4% 7% 3% 21%** 2%
Average Commission Rate Paid... $.0156 N/A N/A N/A N/A N/A N/A
* Annualized.
** Portfolio turnover rate for 1991 excluding in-kind redemptions was 1% for the Pacific Portfolio.
+ Commencement of operations.
(1) Total return figures do not reflect the 1% transaction fee on purchases or the annual account
maintenance fee of $10.
</TABLE>
<TABLE>
<CAPTION>
--------------------------------------------
EMERGING MARKETS PORTFOLIO
--------------------------------------------
YEAR ENDED DECEMBER 31,
---------------------------- MAY 4, 1994+,
1996 1995 TO DEC. 31, 1994
<S> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD................. $10.75 $10.87 $10.00
--------- ------------ ------------
INVESTMENT OPERATIONS
Net Investment Income.............................. .18 .15 .06
Net Realized and Unrealized Gain (Loss) on
Investments...................................... 1.52 (.09) .92
-------- ----------- -----------
TOTAL FROM INVESTMENT OPERATIONS............... 1.70 .06 .98
- ----------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income............... (.17) (.18) (.07)
Distributions from Realized Capital Gains.......... -- -- (.04)
-------- ----------- -----------
TOTAL DISTRIBUTIONS............................ (.17) (.18) (.11)
- ----------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD....................... $12.28 $ 10.75 $10.87
==========================================================================================================
TOTAL RETURN**....................................... 15.83% 0.56% 9.81%
==========================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions)................. $637 $234 $83
Ratio of Expenses to Average Net Assets.............. 0.60% 0.60% 0.60%*
Ratio of Net Investment Income to Average Net
Assets............................................. 1.69% 2.00% 1.32%*
Portfolio Turnover Rate.............................. 1% 3% 6%
Average Commission Rate Paid......................... $.0004 N/A N/A
* Annualized.
** Total return does not reflect the 2% transaction fee on purchases, the 1% transaction fee on
redemptions, or the annual account maintenance fee of $10.
+ Commencement of operations.
</TABLE>
6
<PAGE> 10
<TABLE>
<CAPTION>
------------------------------
TOTAL INTERNATIONAL PORTFOLIO
------------------------------
APRIL 29+ TO
DECEMBER 31, 1996
<S> <C>
- -----------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD........................... $10.26
------------------
INVESTMENT OPERATIONS
Income Dividends Received.................................... .150
Capital Gain Distributions Received.......................... .015
-----------------
TOTAL DISTRIBUTIONS RECEIVED............................. .165
Net Realized and Unrealized Gain (Loss) on Investments....... (.110)
-----------------
TOTAL FROM INVESTMENT OPERATIONS......................... .055
- -----------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income......................... (.160)
Distributions from Realized Capital Gains.................... (.015)
-----------------
TOTAL DISTRIBUTIONS...................................... (.175)
- -----------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD................................. $10.14
===============================================================================================
TOTAL RETURN**................................................. 0.55%
===============================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions)........................... $280
Ratio of Expenses to Average Net Assets........................ 0%
Ratio of Net Investment Income to Average Net Assets........... 1.51%*
Portfolio Turnover Rate........................................ 0%
Average Commission Rate Paid................................... N/A
* Annualized.
** Total return figures do not reflect the 1% transaction fee on purchases or the annual account
maintenance fee of $10.
+ Commencement of operations.
</TABLE>
- --------------------------------------------------------------------------------
YIELD AND TOTAL
RETURN From time to time each Portfolio may advertise its
yield and total return. Both yield and total return
figures are based on historical earnings and are not
intended to indicate future performance. The "total
return" of a Portfolio refers to the average annual
compounded rates of return over one-, five- and
ten-year periods or for the life of the Portfolio (as
stated in the advertisement) that would equate an
initial amount invested at the beginning of a stated
period to the ending redeemable value of the
investment, assuming the reinvestment of all dividend
and capital gains distributions.
In accordance with industry guidelines set forth by the
U.S. Securities and Exchange Commission, the "30-day
yield" of a Portfolio is calculated by dividing the net
investment income per share earned during a 30-day
period by the net asset value per share on the last day
of the period. Net investment income includes interest
and dividend income earned on a Portfolio's securities;
it is net of all expenses and all recurring and
nonrecurring charges that have been applied to all
shareholder accounts. The yield calculation assumes
that the net investment income earned over 30 days is
compounded monthly for six months and then annualized.
Methods used to calculate advertised yields are
standardized for all stock and bond mutual funds.
However, these methods differ from the accounting
methods used by the Portfolio to maintain its books and
records, and so the advertised 30-day yield may not
fully reflect the income paid to an investor's account.
- --------------------------------------------------------------------------------
7
<PAGE> 11
INVESTMENT
OBJECTIVE
EACH PORTFOLIO SEEKS
TO MATCH THE
INVESTMENT
PERFORMANCE OF ITS
RESPECTIVE INDEX The European Portfolio attempts to match the
performance of the Morgan Stanley Capital International
(MSCI) -- Europe Index, which is made up of common
stocks of companies located in 14 European countries
(Austria, Belgium, Denmark, Finland, France, Germany,
Ireland, Italy, Netherlands, Norway, Spain, Sweden,
Switzerland, and United Kingdom).
The Pacific Portfolio tries to parallel the performance
of the Morgan Stanley Capital International
(MSCI) -- Pacific (Free) Index, which consists of
common stocks of companies located in Australia, Hong
Kong, Japan, Malaysia, New Zealand, and Singapore.
By combining the European and Pacific Portfolios in the
appropriate proportions, you can create a portfolio
that seeks to match the performance of another
international stock market index. The Morgan Stanley
Capital International (MSCI) -- Europe, Australasia,
and Far East (Free) Index, also known as the "EAFE"
Index, is a broad-based benchmark made up of more than
1,000 companies in Europe and the Pacific Rim. As of
December 31, 1996, the MSCI -- Pacific (Free) Index
represented some 44% of the EAFE, while the
MSCI -- Europe Index represented the remaining 56%.
The Emerging Markets Portfolio seeks to track the
performance of the Morgan Stanley Capital International
(MSCI) -- Select Emerging Markets (Free) Index, which
is made up of common stocks of companies located in 14
emerging markets of Europe, Asia, Africa and Latin
America (Argentina, Brazil, Greece, Hong Kong,
Indonesia, Israel, Malaysia, Mexico, Philippines,
Portugal, Singapore, South Africa, Thailand, and
Turkey).
The Total International Portfolio seeks to match the
performance of the Morgan Stanley Capital International
(MSCI) -- Europe, Australasia, and Far East + Select
Emerging Markets (Free) Index (the MSCI --
EAFE + Select EMF Index) by investing in a combination
of the European, Pacific, and Emerging Markets
Portfolios.
The Portfolios are neither sponsored by nor affiliated
with Morgan Stanley Capital International.
- --------------------------------------------------------------------------------
INVESTMENT
POLICIES
THE PORTFOLIOS USE A
"PASSIVE" APPROACH TO
INVEST IN INTERNATIONAL
STOCKS The Portfolios are not managed according to traditional
methods of "active" investment management, which
involve the buying and selling of securities based upon
economic, financial and market analysis and investment
judgment. Instead, the Portfolios, utilizing a
"passive" or indexing investment approach, attempt to
approximate the investment performance of their
respective indexes by holding a portfolio of stocks
selected through statistical procedures. The Portfolios
are managed without regard to tax ramifications.
The European Portfolio invests in a statistically
selected sample of the approximately 600 stocks
included in the MSCI -- Europe Index, an index of
equity securities of companies located in fourteen
European countries. Three countries, the United
Kingdom, Germany and France, dominate MSCI -- Europe,
with 34%, 14%, and 12% of the market capitalization of
the Index, respectively, as of December 31, 1996. The
8
<PAGE> 12
11 other countries are individually much less
significant to the Index and, consequently, the
Portfolio.
The Pacific Portfolio invests in a statistically
selected sample of the more than 500 stocks included in
the MSCI -- Pacific (Free) Index, an index of equity
securities of Pacific Basin companies. The MSCI --
Pacific (Free) Index is dominated by the Japanese stock
market, which represented 74% of the market
capitalization of the Index as of December 31, 1996.
The "Free" Index includes only shares that U.S.
investors are "free" to purchase.
The Emerging Markets Portfolio invests in a
statistically selected sample of the approximately 500
stocks included in the MSCI -- Select Emerging Markets
Free Index, an index of equity securities of companies
located in the countries of 14 emerging markets. Four
countries, Malaysia, South Africa, Hong Kong and
Brazil, represent a majority of the MSCI -- Select
Emerging Markets Free Index, with 19%, 12%, 14% and 14%
of the market capitalization of the Index,
respectively, as of December 31, 1996. The fourteen
countries of the Index and their percentage weightings
as of December 31, 1996, were:
<TABLE>
<S> <C> <C> <C>
Greece................. 1.3% Hong Kong.............. 13.6%
Portugal............... 2.2% Indonesia.............. 6.1%
Turkey................. 1.5% Malaysia............... 18.6%
EUROPE................. 5.0% Philippines (Free)..... 3.8%
Singapore.............. 6.4%
Argentina.............. 3.8% Thailand............... 5.4%
Brazil................. 13.8% Israel................. 2.3%
Mexico (Free).......... 9.0% ASIA................... 56.2%
LATIN AMERICA.......... 26.6% South Africa........... 12.2%
</TABLE>
The Index includes only shares that U.S. investors are
"free,"
or allowed by law, to purchase and sell and that have
sufficient
trading liquidity.
The Pacific, European and Emerging Markets Portfolios
are each expected to invest in approximately 400 stocks
or more. Stocks are selected for inclusion in each
Portfolio based on country, market capitalization,
industry weightings, and fundamental characteristics
such as return variability, earnings valuation, and
yield. Each Portfolio is constructed to have aggregate
investment characteristics similar to those of its
respective index. In order to parallel the performance
of its respective index, each Portfolio will invest in
each country in approximately the same percentage as
the country's weight in the index. The correlation
between the performance of each Portfolio and its
respective index is expected to be at least 0.95. (A
correlation of 1.00 would be perfect correlation).
The Total International Portfolio allocates its assets
among the European, Pacific and Emerging Markets
Portfolios based on each market segment's contribution
to the market capitalization of the MSCI -- EAFE + EMF
Index. As of December 31, 1996, the European and
Pacific markets contributed approximately 49% and 38%,
and the Emerging Markets contributed 13% to the Index's
market capitalization.
9
<PAGE> 13
The policy of the Pacific, European and Emerging
Markets Portfolios is to remain fully invested in
common stocks. At least 80% of the assets of each
Portfolio will be invested in stocks that are included
in its respective index. Since the Total International
Portfolio will invest primarily in shares of the
underlying Portfolios, at least 80% of its equity
exposure will be to stocks that are included in the
MSCI -- EAFE + Select EMF Index. Each Portfolio may
invest in certain short-term fixed income securities
such as cash reserves, although cash or cash
equivalents are normally expected to represent less
than 1% of each Portfolio's assets. Each Portfolio may
also invest up to 50% of its assets in stock futures
contracts, options, warrants, convertible securities,
and swap agreements in order to invest uncommitted cash
balances, maintain liquidity to meet shareholder
redemptions, or minimize trading costs. Any investment
in futures contracts, options, warrants, convertible
securities or swap agreements over 20% of each
Portfolio's assets would be made only in emergency
situations, for short-term purposes.
These Portfolios will not invest in cash reserves,
futures contracts, options or warrants as part of a
temporary defensive strategy, such as lowering a
Portfolio's investment in common stocks, to protect
against potential stock market declines. The Portfolios
intend to remain fully invested, to the extent
practicable, in a pool of securities which will
approximate the investment characteristics of their
respective indexes. The Portfolios may also enter into
forward foreign currency exchange contracts in order to
maintain the same currency exposure as their respective
indexes, but not as part of a defensive strategy to
protect against fluctuations in exchange rates. See
"Implementation of
Policies" for a description of these and other
investment practices
of the Portfolios.
The investment objective and policies of the Funds are
not fundamental and so may be changed by the Board of
Directors or Board of Trustees without shareholder
approval. However, shareholders would be notified prior
to a material change in either.
- --------------------------------------------------------------------------------
INVESTMENT
RISKS As mutual funds investing in common stocks, the
Portfolios are subject to MARKET RISK -- i.e., the
possibility that stock prices will decline over short
or even extended periods. Both U.S. and foreign stock
markets tend to be cyclical, with periods when stock
prices generally rise and periods when stock prices
generally decline.
INTERNATIONAL STOCKS
MAY EXHIBIT GREATER
VOLATILITY THAN
U.S. STOCKS Investments in foreign stock markets can be as volatile
as, if not more volatile than, investments in U.S.
markets. To illustrate the volatility of foreign stock
market returns for the U.S. dollar-based investor, the
table below sets forth the extremes of foreign stock
market returns, as well as average annual returns, for
the period from 1969 to 1996, as measured by the
MSCI -- Europe, Australasia, and Far East Index and as
calculated for a U.S. dollar investor.
10
<PAGE> 14
<TABLE>
<CAPTION>
AVERAGE INTERNATIONAL STOCK MARKET RETURNS
(1969-1996)
------------------------------------------
MSCI --
EAFE 1 YEAR 5 YEARS 10 YEARS
------ ------- --------
<S> <C> <C> <C>
Best +69.9% +36.5% +22.8%
Worst -23.2 + 1.5 + 7.0
Average +15.0 +13.9 +15.8
</TABLE>
As shown, the MSCI -- EAFE Index has provided annual
total returns, averaging +15.8% for all 10-year periods
from 1969-1996. Note, however, that the period from
1969 to 1996 was a very favorable one for foreign stock
market investing. The figures on total return and stock
market volatility are provided here only as a guide to
potential market risk, and may not be useful for
forecasting future returns in any particular period.
This table on international stock market returns should
not be viewed as a representation of future returns for
international stocks or the Portfolios of the Fund, as
historical performance may be a poor guide to future
returns, and the Indexes shown do not reflect "real
world" transaction costs and other expenses.
THE JAPANESE STOCK
MARKET IS A MAJOR
COMPONENT OF THE
PACIFIC (FREE) INDEX Investors should realize that Japanese securities
comprised 74% of the MSCI -- Pacific (Free) Index as of
December 31, 1996. Therefore stocks of Japanese
companies will represent a correspondingly large
component of the Pacific Portfolio's investment assets.
Such a large investment in the Japanese stock market
may entail a higher degree of risk than with more
diversified international portfolios, especially
considering that by fundamental measures of corporate
valuation, such as its high price-earnings ratios and
low dividend yields, the Japanese market as a whole may
appear expensive relative to other world stock markets.
STOCKS FROM THREE
COUNTRIES DOMINATE
THE EUROPE INDEX Stocks from the United Kingdom, Germany and France
comprised 34%, 14% and 12% of the MSCI -- Europe Index,
respectively, as of December 31, 1996. The remaining 11
countries in the MSCI -- Europe Index have much less
significant capitalization weightings in the Index and
will therefore have much less impact on the total
return of the Index and the European Portfolio.
EMERGING MARKETS
MAY EXHIBIT GREATER
VOLATILITY THAN
DEVELOPED MARKETS Investors should be aware that emerging markets can be
substantially more volatile than both U.S. and more
developed foreign markets. For example, from 1989-1996,
the average positive monthly return for the Wilshire
5000 Index, a broad measure of the U.S. equity market,
was +3.1%. The average negative monthly return for the
Wilshire 5000 Index was -2.6%. In contrast, from
1989-1996, the average positive monthly return of the
Morgan Stanley Capital International Emerging Markets
Free Index, a widely quoted emerging market benchmark,
was +4.5%; while the average negative monthly return
was -4.3%.
INVESTMENT ILLIQUIDITY
RISK Volatility in emerging markets may be exacerbated by
illiquidity. Average daily trading volume in all of the
emerging markets combined is a small fraction of the
average daily volume of the U.S. market. Small trading
volumes may result in investors being forced to
purchase
11
<PAGE> 15
securities at substantially higher prices than the
current market, or sell securities at much lower prices
than the current market.
INTERNATIONAL STOCKS
ALSO EXPOSE INVESTORS
TO CURRENCY AND
OTHER RISKS For U.S. investors, the returns of foreign investments,
such as those held by the Portfolios, are influenced by
not only the returns on foreign common stocks
themselves, but also by the returns on the currencies
in which the stocks are denominated. Currency risk is
the risk that changes in foreign exchange rates will
affect, favorably or unfavorably, the value of foreign
securities held by a Portfolio. In a period when the
U.S. dollar generally rises against foreign currencies,
the returns on foreign stocks for a U.S. investor will
be diminished. By contrast, in a period when the U.S.
dollar generally declines, the returns on foreign
stocks will be enhanced.
Other risks and considerations of international
investing include: differences in accounting, auditing
and financial reporting standards; generally higher
transaction costs on foreign portfolio transactions;
small trading volumes and generally lower liquidity of
foreign stock markets, which may result in greater
price volatility; foreign withholding taxes payable on
a Portfolio's foreign securities, which may reduce
dividend income payable to shareholders; the
possibility of expropriation or confiscatory taxation;
adverse change in investment or exchange control
regulations; difficulty in obtaining a judgment from a
foreign court; political instability which could
affect U.S. investment in foreign countries; and
potential restriction on the flow of international
capital.
- --------------------------------------------------------------------------------
WHO SHOULD
INVEST
LONG-TERM INVESTORS
SEEKING TO INVEST
IN INTERNATIONAL
COMMON STOCKS The Portfolios are designed for investors who seek a
low-cost "passive" approach for investing in a broadly
diversified portfolio of international common stocks.
Unlike other equity mutual funds, which generally seek
to "beat" market averages with often unpredictable
results, the Portfolios of the Fund seek to "match"
their respective indexes and thus are expected to
provide returns that parallel those of their respective
benchmarks.
The share prices of the Portfolios are expected to be
volatile, and investors should be able to tolerate
sudden, sometimes substantial fluctuations in the value
of their investment. No assurance can be given that a
Portfolio will achieve its stated objective or that
shareholders will be protected from the risks inherent
in equity investing. Investors may wish to minimize the
timing risk of investing in a Portfolio by purchasing
shares on a periodic basis (dollar-cost averaging)
rather than investing in one lump sum.
Because of the risks associated with international
common stock investments, the Fund is intended to be a
long-term investment vehicle and is not designed to
provide investors with a means of speculating on
short-term market movements. Investors who engage in
excessive account activity generate additional costs
which are borne by all of the Portfolio's shareholders.
In order to minimize such costs the Portfolios have
adopted the following policies. The Portfolios reserve
the right to reject any purchase request (including
exchange purchases from other Vanguard portfolios) that
is reasonably deemed to be disruptive to
12
<PAGE> 16
efficient portfolio management, either because of the
timing of the investment or previous excessive trading
by the investor. Additionally, the Portfolios have
adopted exchange privilege limitations as described in
the section "Exchange Privilege Limitations." Finally,
the Portfolios reserve the right to suspend the
offering of their shares. Investors should not consider
the Portfolios a complete investment program, but
should maintain holdings of securities with different
risk characteristics -- including U.S. common stocks,
bonds and money market instruments.
- --------------------------------------------------------------------------------
IMPLEMENTATION
OF POLICIES
THE PORTFOLIOS INVEST
IN INTERNATIONAL
COMMON STOCKS USING
SAMPLING TECHNIQUES The Portfolios utilize a number of investment practices
in an effort to parallel the investment performance of
their respective indexes.
The MSCI -- Europe Index consists of approximately 600
equity securities from Europe, the MSCI -- Pacific
(Free) Index consists of more than 500 equity
securities from Australia and the Far East, and the
MSCI -- Select Emerging Markets (Free) Index consists
of some 500 stocks from Asia, Latin America, Africa and
Europe. The stocks included in each index are chosen by
Morgan Stanley Capital International on a statistical
basis. Each stock in the MSCI -- Europe,
MSCI -- Pacific (Free), and MSCI -- Select Emerging
Markets (Free) Indexes is weighted according to its
market value as a percentage of the total market value
of all stocks in the respective index. (A stock's
market value equals the number of shares outstanding
times the most recent price of the security.) The
inclusion of a stock in the index in no way implies
that Morgan Stanley Capital International believes the
stock to be an attractive investment.
The European, Pacific, and Emerging Markets Portfolios
will be unable to hold all of the issues that comprise
their respective indexes because of the costs involved
and the illiquidity of many of the securities. Instead,
each Portfolio will attempt to hold a representative
sample of approximately 500 or more of the securities
in its respective Index, which will be selected
utilizing a mathematical technique known as "portfolio
optimization." Under this technique, each stock is
considered for inclusion in the Portfolio based on its
contribution to certain country, capitalization,
industry, and fundamental investment characteristics.
Each Portfolio is constructed so that, in the
aggregate, each Portfolio's country, capitalization,
industry, and fundamental investment characteristics
resemble those of its respective Index. Over time,
portfolio composition is altered (or "rebalanced") to
reflect changes in the characteristics of the Indexes.
Due to the use of this sampling or "portfolio
optimization" technique, the Portfolios are not
expected to track their benchmark indexes with the same
degree of accuracy as large capitalization domestic
index funds. Over time, the correlation between the
performance of each Portfolio and its respective index
is expected to be greater than 0.95. A correlation of
1.00 would indicate perfect correlation, which would be
achieved when the net asset value of each Portfolio,
including the value of its dividend and capital gains
distributions, increases or decreases in exact
proportion to changes in its respective index.
13
<PAGE> 17
EACH PORTFOLIO MAY
INVEST IN SHORT-TERM
FIXED INCOME
SECURITIES Although each Portfolio's policy is to remain
substantially fully invested in common stocks, the
Portfolios may invest temporarily in certain short-term
fixed income securities. Such securities may be used to
invest uncommitted cash balances or to maintain
liquidity to meet shareholder redemptions. These
securities include: obligations of the United States
Government and its agencies or instrumentalities;
commercial paper (rated Prime-1 by Moody's Investors
Services, Inc. or A-1 by Standard & Poor's
Corporation), bank certificates of deposit and bankers'
acceptances; and repurchase agreements collateralized
by these securities.
EACH PORTFOLIO MAY
INVEST IN DERIVATIVE
SECURITIES The Portfolios may utilize stock futures contracts,
options, warrants, convertible securities and swap
agreements to a limited extent. Such instruments are
commonly referred to as "derivatives," because their
value is based on (or "derived" from) a traditional
security or a market index. Specifically, each
Portfolio may enter into futures contracts and options
provided that not more than 5% of its assets is
required as a margin deposit for futures contracts or
options. Additionally, the Fund's investment in
warrants will not exceed more than 5% of its assets (2%
with respect to warrants not listed on the New York or
American Stock Exchanges). Futures contracts, options,
warrants, convertible securities and swap agreements
may be used for several reasons: to simulate full
investment in the underlying Index while retaining a
cash balance for fund management purposes, to
facilitate trading, to reduce transaction costs or to
seek higher investment returns when a futures contract,
option, warrant, convertible security or swap agreement
is priced more attractively than the underlying equity
security or index. While each of these securities can
be used as leveraged investments, the Portfolios may
not use them to leverage its net assets.
FUTURES CONTRACTS,
OPTIONS, WARRANTS,
CONVERTIBLE SECURITIES
AND SWAP AGREEMENTS
POSE CERTAIN RISKS The risk of loss associated with futures contracts in
some strategies can be substantial due to the leverage
associated with low margin deposits. As a result, a
relatively small price movement in a futures contract
may result in an immediate and substantial loss or
gain. However, the Portfolios will not use futures
contracts, options, warrants, convertible securities
and swap agreements for speculative purposes or to
leverage their net assets. Accordingly, the primary
risks associated with the use of futures contracts,
options, warrants, convertible securities and swap
agreements by the Portfolios are: (i) imperfect
correlation between the change in market value of the
stocks held by a Portfolio and the prices of futures
contracts, options, warrants, convertible securities
and swap agreements; and (ii) possible lack of a liquid
secondary market for a futures contract and the
resulting inability to close a futures position prior
to its maturity date. The risk of imperfect correlation
will be minimized by investing only in those contracts
whose behavior is expected to resemble that of a
Portfolio's underlying securities. The risk that a
Portfolio will be unable to close out a futures
position will be minimized by entering into such
transactions on an exchange with an active and liquid
secondary market. However options, warrants,
convertible securities and swap agreements purchased or
sold over-the-counter may be less liquid than
14
<PAGE> 18
exchange traded securities. Illiquid securities, in
general, including swap agreements, may not represent
more than 15% of the net assets of a Portfolio.
Since there are no futures traded on the MSCI indexes,
it will be necessary for the Portfolios to utilize a
composite of other futures contracts to simulate the
performance of the Indexes. This process may magnify
the "tracking error" of a Portfolio's performance
compared to that of its Index, due to lower correlation
of the selected futures with its Index. The investment
adviser will attempt to reduce this tracking error by
investing in futures contracts whose behavior is
expected to resemble that of the underlying securities,
although there can be no assurance that these selected
futures will perfectly correlate with the performance
of any Index.
Swap agreements are contracts between parties in which
one party agrees to make payments to the other party
based on the change in market value of a specified
index or asset. In return, the other party agrees to
make payments to the first party based on the return of
a different specified index or asset. Although swap
agreements entail
the risk that a party will default on its payment
obligations thereunder, the Portfolios will minimize
this risk by entering into agreements that mark to
market no less frequently than quarterly. Swap agree-
ments also bear the risk that the Portfolios will not
be able to meet their obligation to the counterparty.
This risk will be mitigated by investing the
Portfolios in the specific asset for which it is
obligated to pay a return.
ALL FOUR PORTFOLIOS MAY
ENTER INTO FORWARD
CURRENCY CONTRACTS Each Portfolio may enter into foreign currency forward
and foreign currency futures contracts in order to
maintain the same currency exposure as its respective
index. A Portfolio may not enter into such contracts
for speculative purposes, or as a way of protecting
against anticipated adverse changes in exchange rates
between foreign currencies and the U.S. dollar. A
foreign currency forward contract is an obligation to
purchase or sell a specific currency at a future date,
which may be any fixed number of days from the date of
the contract agreed upon by the parties, at a price set
at the time of the contract.
THREE PORTFOLIOS MAY
LEND THEIR SECURITIES The European, Pacific and Emerging Markets Portfolios
may lend their investment securities to qualified
institutional investors for either short-term or
long-term purposes of realizing additional income.
Loans of securities by the Portfolios will be
collateralized by cash, letters of credit, or
securities issued or guaranteed by the U.S. Government
or its agencies. The collateral will equal at least
100% of the current market value of the loaned
securities.
PORTFOLIO TURNOVER
IS EXPECTED TO BE LOW Although the Portfolios generally seek to invest for
the long term, the Portfolios retain the right to sell
securities irrespective of how long they have been
held. However, because of the "passive" investment
management approach of the Portfolios, the portfolio
turnover rate for each Portfolio is expected to be
under 50%, a generally lower turnover rate than for
most other investment companies. A portfolio turnover
rate of 50% would occur if one half of a Portfolio's
securities were sold within one year. Ordinarily,
securities will be sold from a Portfolio only to
15
<PAGE> 19
reflect certain administrative changes in an index
(including mergers or changes in the composition of an
index) or to accommodate cash flows out of the
Portfolio while maintaining the similarity of the
Portfolio to its benchmark index.
EACH PORTFOLIO MAY
BORROW MONEY Each Portfolio may borrow money from a bank up to a
limit of 15% of the market value of its assets, but
only for temporary or emergency purposes. A Portfolio
may borrow money only to meet redemption requests prior
to the settlement of securities already sold or in the
process of being sold
by the Portfolio. To the extent that a Portfolio
borrows money prior to
selling securities, the Portfolio may be leveraged; at
such times, the
Portfolio may appreciate or depreciate in value more
rapidly than its
benchmark index. Each Portfolio will repay any money
borrowed in
excess of 5% of the market value of its total assets
prior to purchasing
additional portfolio securities.
- --------------------------------------------------------------------------------
INVESTMENT
LIMITATIONS
THE FUND HAS ADOPTED
CERTAIN FUNDAMENTAL
LIMITATIONS Each Portfolio has adopted certain limitations on its
investment practices. Specifically, each Portfolio will
not:
(a) with respect to 75% of its assets, purchase
securities of any issuer (except obligations of the
U.S. Government and its instrumentalities) if, as a
result, more than 5% of the value of the
Portfolio's assets would be invested in the
securities of such issuer, except for the Total
International Portfolio, which will normally invest
100% of its assets in the underlying Portfolios of
the International Equity Index Fund.
(b) with respect to 75% of its assets, purchase more
than 10% of the voting securities of any issuer;
(c) invest more than 25% of its assets in any one
industry, except for the Total International
Portfolio which may invest more than 25% of its
assets in investment companies which are the
underlying Portfolios of the Fund; and
(d) borrow money except from banks for temporary or
emergency purposes and in no event in excess of 15%
of the market value of its total assets.
These investment limitations are considered at the time
investment securities are purchased. The limitations
described here and in the Statement of Additional
Information for each Fund may be changed only with the
approval of a majority of a Funds' shareholders.
- --------------------------------------------------------------------------------
MANAGEMENT OF
THE FUND
VANGUARD ADMINISTERS
AND DISTRIBUTES
THE PORTFOLIOS Vanguard International Equity Index Fund is a member of
The
Vanguard Group of Investment Companies, a family of
more than
30 investment companies with more than 90 distinct
investment port-
folios and total assets in excess of $250 billion.
Through their jointly-owned subsidiary, The Vanguard
Group, Inc. ("Vanguard"), the Fund and the other funds
in the Group obtain at cost virtually all of their
corporate management, administrative and distribution
services.
Vanguard also provides investment advisory services on
an at-cost basis to certain Vanguard funds. As a result
of Vanguard's unique corporate structure, the Vanguard
funds have costs substantially lower than those of most
competing mutual funds. In 1996, the average expense
ratio (annual costs including advisory fees divided by
total net assets) for the Vanguard funds amounted to
approximately
16
<PAGE> 20
.29% compared to an average of 1.22% for the mutual
fund industry (data provided by Lipper Analytical
Services, Inc.).
Vanguard Total International Portfolio is an
independent series of Vanguard STAR Fund. The Portfolio
operates under a separate service agreement and, to the
extent that its assets are composed of shares of other
Vanguard funds, it will bear no direct expenses.
The Officers of the Funds manage their day-to-day
operations and are responsible to the Funds' Board of
Directors (Trustees). The Directors (Trustees) set
broad policies for the Funds and choose the Officers. A
list of the Directors (Trustees) and Officers of the
Funds and a statement of their present positions and
principal occupations during the past five years can be
found in the Statement of Additional Information.
Vanguard employs a supporting staff of management and
administrative personnel to provide the requisite
services to the funds and also furnishes the funds with
necessary office space, furnishings and equipment. Each
Fund pays its share of Vanguard's net expenses, which
are allocated among the funds under methods approved by
the Board of Directors (Trustees) of each Fund. In
addition, each Fund bears its own direct expenses, such
as legal, auditing and custodian fees.
Vanguard provides distribution and marketing services
to the Funds. The Funds are available on a no-load
basis (i.e., there are no sales commissions or 12b-1
fees). However, each Fund bears its own share of the
Group's distribution costs.
- --------------------------------------------------------------------------------
INVESTMENT
ADVISER
VANGUARD MANAGES
THE FUNDS ON AN
AT-COST BASIS The Vanguard International Equity Index Fund receives
all investment advisory services on an at-cost basis
from Vanguard's Core Management Group, which also
provides investment advisory services to Vanguard Index
Trust, the equity portion of Vanguard Balanced Index
Fund, Vanguard Institutional Index Fund, a portion of
the assets of Vanguard/Windsor II and Vanguard/Morgan
Growth Fund, the Equity Index Portfolio of Vanguard
Variable Insurance Fund, Vanguard Tax-Managed Fund, the
REIT Index Portfolio of Vanguard Specialized
Portfolios, the Total International Portfolio of
Vanguard STAR Fund, the Aggressive Growth Portfolio of
Vanguard Horizon Fund, and several indexed separate
accounts. Total indexed assets under management as of
December 31, 1996, were $57 billion. The Portfolios of
Vanguard International Equity Index Fund are not
actively managed, but are instead administered by the
Core Management Group using computerized, quantitative
techniques. The Group is supervised by the Officers of
the Funds.
In placing portfolio transactions, Vanguard's Core
Management Group uses its best judgment to choose the
broker most capable of providing the brokerage services
necessary to obtain the best available price and most
favorable execution at the lowest commission rate. The
full range and quality of brokerage services available
are considered in making these determinations. In those
instances where it is reasonably determined that more
than one broker can offer the services needed to obtain
the best available price and most favorable execution,
consideration may be given to those brokers which
supply statistical informa-
17
<PAGE> 21
tion and provide other services in addition to
execution services to the Fund. However, the Core
Management Group will not pay higher commissions
specifically for the purpose of obtaining research
services. The Fund may direct the Core Management Group
to use a particular broker for certain transactions in
exchange for commission rebates or research services
provided to the Fund.
The Total International Portfolio does not employ an
investment adviser.
- --------------------------------------------------------------------------------
DIVIDENDS,
CAPITAL GAINS
AND TAXES
DIVIDENDS AND ANY
CAPITAL GAINS WILL BE
PAID ANNUALLY Each Portfolio intends to distribute substantially all
of its ordinary income in the form of dividends. The
Portfolios pay annual dividends. Capital gains
distributions, if any, are also made annually.
Each Portfolio's dividend and capital gains
distributions may be reinvested in additional shares or
received in cash. See "Choosing a Distribution Option"
for a description of these distribution methods.
In order to satisfy certain distribution requirements
of the Tax Reform Act of 1986, each Portfolio may
declare special year-end dividend and capital gains
distributions during December. Such distributions, if
received by shareholders by January 31, are deemed to
have been paid by each Portfolio and received by
shareholders on December 31 of the prior year.
EACH PORTFOLIO WILL
CHARGE A $10 ACCOUNT
MAINTENANCE FEE Each Portfolio will automatically deduct a $10 annual
account maintenance fee from the dividend income of
each Portfolio account on an annual basis. If the
dividend to be paid to an account is less than the fee
to be deducted, sufficient shares will be redeemed from
an account to make up the difference. The Board of
Directors (Trustees) reserves the right to change the
annual account maintenance fee to reflect the actual
cost of maintaining smaller shareholder accounts. For
federal tax purposes, the account maintenance fee does
not reduce dividend income and may be treated as an
investment expense by each shareholder (subject to
limitations). This fee will be waived for shareholders
with an account balance of $10,000 or more.
Each Portfolio intends to continue to qualify for
taxation as a "regulated investment company" under the
Internal Revenue Code so that it will not be subject to
federal income tax to the extent its income is
distributed to shareholders. Dividends paid by each
Portfolio from net investment income and net short-term
capital gains, whether received in cash or reinvested
in additional shares, will be taxable to shareholders
as ordinary income. For corporate investors, dividends
from net investment income will not generally qualify
for the intercorporate dividends-received deduction.
Distributions paid by a Portfolio from long-term
capital gains, whether received in cash or reinvested
in additional shares, are taxable as long-term capital
gains, regardless of the length of time you have owned
shares in a Portfolio. Capital gains distributions are
made when a Portfolio realizes net capital gains on
sales of portfolio securities during the year or when a
Portfolio receives distributions of long-term capital
gains from investments in other regulated investment
companies. A Portfolio does not seek to realize any
particular amount of
18
<PAGE> 22
capital gains during a year; rather, realized gains are
a by-product of portfolio management activities.
Consequently, capital gains distributions may be
expected to vary considerably from year to year; there
will be no capital gains distributions in years when a
Portfolio realizes net capital losses.
Note that if you elect to receive capital gains
distributions in cash, instead of reinvesting them in
additional shares, you are in effect reducing the
capital at work for you in a Portfolio. Also, keep in
mind that if you purchase shares in a Portfolio shortly
before the record date for a dividend or capital gains
distribution, a portion of your investment will be
returned to you as a taxable distribution, regardless
of whether you are reinvesting your distributions or
receiving them in cash.
The Funds will notify you annually as to the tax status
of dividend and capital gains distributions paid by
each Portfolio.
THREE PORTFOLIOS MAY
"PASS THROUGH"
FOREIGN TAXES The European, Pacific, and Emerging Markets Portfolios
may elect to "pass through" to their shareholders the
amount of foreign income taxes paid by a Portfolio. The
Portfolios will make such an election only if it is
deemed to be in the best interests of the shareholders.
If this election is made, shareholders of a Portfolio
will be required to include in their gross income their
pro rata share of foreign taxes paid by the Portfolio.
However, shareholders will be able to treat their pro
rata share of foreign taxes as either an itemized
deduction or a foreign tax credit against U.S. income
taxes (but not both) on their federal income tax
return.
ANY FOREIGN TAX CREDITS
WOULD NOT "PASS
THROUGH" TO TOTAL
INTERNATIONAL PORTFOLIO
SHAREHOLDERS If the European, Pacific or Emerging Markets Portfolios
elect to pass through foreign taxes to their
shareholders, the foreign tax credit would not pass
through to Total International Portfolio shareholders.
Since the Total International Portfolio holds shares of
the European, Pacific and Emerging Markets Portfolios,
which are U.S. corporations, and does not hold shares
of foreign securities, it cannot pass through the
foreign tax credit to its investors. However, the Total
International Portfolio would claim a deduction for
foreign taxes paid by the underlying funds.
A CAPITAL GAIN OR LOSS
MAY BE REALIZED
UPON EXCHANGE OR
REDEMPTION A sale of shares of a Portfolio is a taxable event, and
may result in a capital gain or loss. A capital gain or
loss may be realized from an ordinary redemption of
shares or an exchange of shares between two mutual
funds (or two portfolios of a mutual fund). You are
responsible for calculating any capital gains or losses
realized upon redemption or exchange of a Portfolio's
shares.
Dividend distributions, capital gains distributions,
and capital gains or losses from redemptions and
exchanges may be subject to state and local taxes.
Each Portfolio is required to withhold 31% of taxable
dividends, capital gains distributions, and redemptions
paid to shareholders who have not complied with IRS
taxpayer identification regulations. You may avoid this
withholding requirement by certifying on your Account
Registration Form your proper Social Security or
Employer Identifica-
19
<PAGE> 23
tion number and by certifying that you are not subject
to backup withholding.
Vanguard International Equity Index Fund has obtained a
certificate of authority to do business as a foreign
corporation in Pennsylvania and does business and
maintains an office in that state. In the opinion of
counsel, shares of the Fund will be exempt from
Pennsylvania personal property taxes.
Vanguard Total International Portfolio is part of a
Pennsylvania business trust and, in the opinion of
counsel, is not liable for any income or franchise tax
in the Commonwealth of Pennsylvania. The Portfolio will
be subject to Pennsylvania county personal property tax
in the county which is the site of its principal
office. In the opinion of counsel, shareholders who are
Pennsylvania residents will not be subject to county
personal property taxes, with the exception of non-
exempt holders who are residents of the City and School
District of Pittsburgh.
The tax discussion set forth above is included for
general information only. Prospective investors should
consult their own tax advisers concerning the tax
consequences of an investment in the Fund.
- --------------------------------------------------------------------------------
THE SHARE PRICE OF
EACH PORTFOLIO Each Portfolio's share price or "net asset value" per
share is calculated by dividing the total assets of the
Portfolio, less all liabilities, by the total number of
shares outstanding. The net asset value is determined
as of the close of the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on each day that the
Exchange is open for trading. Portfolio securities are
valued at the last quoted sales price available,
according to the broadest and most representative
market, at the time the Portfolio's assets are valued.
Price information on listed securities is taken from
the exchange where the security is primarily traded.
Securities regularly traded in the over-the-counter
market are valued at the latest quoted bid price. Other
assets and securities for which no quotations are
readily available are valued at fair value as
determined in good faith by the Directors (Trustees).
Securities may be valued on the basis of prices
provided by a pricing service when such prices are
believed to reflect the fair market value of such
securities. The prices provided by a pricing service
may be determined without regard to bid or last sale
prices of each security but take into account
institutional-size transactions in similar groups of
securities as well as any developments related to
specific securities. All assets and liabilities
initially expressed in foreign currencies will be
converted into U.S. dollars using the officially quoted
daily exchange rates determined by Morgan Stanley
Capital International (MSCI) in the calculation of its
Europe, Australasia and Far East Index. This officially
quoted daily exchange rate may be determined by MSCI
prior to or after the close of a particular foreign
securities market. If such quotations are not
available, the rate of exchange will be determined in
accordance with policies established by the Board of
Directors (Trustees).
- --------------------------------------------------------------------------------
20
<PAGE> 24
GENERAL
INFORMATION Vanguard International Equity Index Fund is organized
as a Maryland corporation. The Articles of
Incorporation permit the Directors to issue
1,500,000,000 shares of common stock with a $.001 par
value. The Board of Directors has the power to
designate one or more classes ("series") of shares of
common stock and to classify or reclassify any unissued
shares with respect to such series. Currently the Fund
is offering shares of three series.
The shares of each series are fully paid and
non-assessable; have no preference as to conversion,
exchange, dividends, retirement or other features; and
have no pre-emptive rights. Such shares have non-
cumulative voting rights, meaning that the holders of
more than 50% of the shares voting for the election of
Directors (Trustees) can elect 100% of the Directors
(Trustees) if they so choose. Annual meetings of
shareholders will not be held except as required by the
Investment Company Act of 1940 and other applicable
law. An annual meeting will be held to vote on the
removal of a Director (Trustee) or Directors (Trustees)
of the Fund if requested in writing by the holders of
not less than 10% of the outstanding shares of the
Fund.
The Total International Portfolio is an independent
series of Vanguard STAR Fund, a Pennsylvania business
trust.
All securities and cash for the European, Pacific and
Emerging Markets Portfolios are held by Morgan Stanley
Trust Company. CoreStates Bank, N.A., holds the daily
cash balances that are used by these three Portfolios
to invest in repurchase agreements or securities
acquired in these transactions. Securities and cash for
the Total International Portfolio are held by
CoreStates. The Vanguard Group, Inc., Valley Forge, PA,
serves as the Fund's Transfer and Dividend Disbursing
Agent. Price Waterhouse LLP, serves as independent
accountant for the Fund and will audit its financial
statements annually. The Fund is not involved in any
litigation.
- --------------------------------------------------------------------------------
21
<PAGE> 25
SHAREHOLDER GUIDE
OPENING AN
ACCOUNT AND
PURCHASING
SHARES You may open a regular (non-retirement) account, either
by mail or wire. Simply complete and return an Account
Registration Form and any required legal documentation,
indicating the amount you wish to invest. Your purchase
must be equal to or greater than the $3,000 minimum
initial investment requirement for each Portfolio
($1,000 for Uniform Gifts/Transfers to Minors Act
accounts). To open a new account by wire, you must call
Client Services before initiating the wire transfer.
You must open a new Individual Retirement Account by
mail (IRAs may not be opened by wire) using a Vanguard
IRA Adoption Agreement. Your purchase must be equal to
or greater than the $1,000 minimum initial investment
requirement, but no more than $2,000 if you are making
a regular IRA contribution. Rollover contributions are
generally limited to the amount withdrawn within the
past 60 days from an IRA or other qualified retirement
plan. If you need assistance with the forms or have any
questions about the Fund, please call our Investor
Information Department (1-800-662-7447). NOTE: For
other types of account registrations (e.g.,
corporations, associations, other organizations, trusts
or powers of attorney), please call us to determine
which additional forms you may need.
The shares of each Portfolio are purchased at the
next-determined net asset value after your investment
has been received. The Portfolios are offered on a
no-load basis (i.e., there are no sales commissions or
12b-1 fees).
PURCHASE
RESTRICTIONS 1) Because of the risks associated with common stock
investments, the Portfolios are intended to be
long-term investment vehicles and are not designed
to provide investors with a means of speculating on
short-term market movements. Consequently, the
Portfolios reserve the right to reject any specific
purchase (and exchange purchase) request. The
Portfolios also reserve the right to suspend the
offering of shares for a period of time.
2) Vanguard will not accept third-party checks to
purchase shares of the Portfolios. Please be sure
your purchase check is made payable to The Vanguard
Group.
IMPORTANT NOTE
ON EXPENSES The Emerging Markets Portfolio assesses a 1%
transaction fee on redemptions. Each Portfolio assesses
a transaction fee on purchases (1.5% for the Emerging
Markets Portfolio, 1% for the European Portfolio, 0.5%
for the Pacific Portfolio, and 0.75% for the Total
International Portfolio, as well as a $10 annual
account maintenance fee. The $10 annual account
maintenance fee will be waived for shareholders with an
account balance of $10,000 or more. See "Portfolio
Expenses."
ADDITIONAL
INVESTMENTS Subsequent investments to regular accounts may be made
by mail ($100 minimum), wire ($1,000 minimum), written
exchange from another Vanguard Fund account ($100
minimum), or Vanguard Fund Express. Subsequent
investments to Individual Retirement Accounts may be
made by mail ($100 minimum) or exchange from another
Vanguard Fund account. In some instances, contributions
may be made
22
<PAGE> 26
by wire or Vanguard Fund Express. Please call us for
more information on these options.
-----------------------------------------------------------------------------
<TABLE>
<S> <C>
ADDITIONAL INVESTMENTS
NEW ACCOUNT TO EXISTING ACCOUNTS
PURCHASING BY MAIL Please include the amount Additional investments
of your initial investment should include the
Complete and sign the on the registration form, Invest-by-Mail remittance
enclosed Account make your check payable to form attached to your Fund
Registration Form The Vanguard confirmation statements.
Group-(Portfolio Number), Please make your check
see below for appropriate payable to The Vanguard
Portfolio number, and mail Group-(Portfolio Number),
to: see below for the
appropriate Portfolio
VANGUARD FINANCIAL CENTER number, write your account
P.O. BOX 2600 number on your check and,
VALLEY FORGE, PA 19482-2600 using the return envelope
provided, mail to the
address indicated on the
Invest-by-Mail Form.
For express or VANGUARD FINANCIAL CENTER All written requests should
registered mail, 455 DEVON PARK DRIVE be mailed to one of the
send to: WAYNE, PA 19087-1815 addresses indicated for new
accounts. Do not send
registered or express mail
to the post office box
address.
European Portfolio -- 79
Emerging Markets Portfolio -- 533
Pacific Portfolio -- 72
Total International Portfolio -- 113
---------------------------
CORESTATES BANK, N.A.
PURCHASING BY WIRE ABA 031000011
CORESTATES NO 01019897
Money should be ATTN VANGUARD
wired to: VANGUARD INTERNATIONAL EQUITY
INDEX FUND
BEFORE Wiring NAME OF PORTFOLIO
ACCOUNT NUMBER (or temporary reference
Please contact number
Client Services for new accounts)
(1-800-662-2739) ACCOUNT REGISTRATION
</TABLE>
You should notify our Client Services Department of
your intended wire purchase by 12:00 noon (Eastern
time). To assure proper receipt, please be sure your
bank includes the Portfolio name, the account number
Vanguard has assigned to you and the eight-digit
CoreStates number. If you are opening a new account,
please complete the Account Registration Form and mail
it to the "New Account" address above after completing
your wire arrangement. Note: Federal Funds wire
purchase orders will be accepted only when the Fund and
Custodian Bank are open for business. Funds must be
received at the Federal Reserve Bank by 4:00 p.m.
Eastern time in order to receive that day's trade date.
-----------------------------------------------------------------------------
PURCHASING BY
EXCHANGE (from a
Vanguard account) Telephone exchanges are not accepted for the Fund. You
may, however, open an account by exchange by providing
the appropriate information on the Account Registration
Form. The new account will have the same
23
<PAGE> 27
registration as the existing account. The Fund reserves
the right to refuse any exchange purchase request.
-----------------------------------------------------------------------------
PURCHASING BY
FUND EXPRESS
Automatic Investment The Fund Express Automatic Investment option lets you
move money automatically from your bank account to your
Vanguard account on the schedule (monthly, bimonthly
[every other month], quarterly, semiannually, or
annually) you select. To establish this option, please
provide the appropriate information on the Account
Registration Form. We will send you a confirmation of
your Fund Express enrollment; please wait two weeks
before using the service.
- --------------------------------------------------------------------------------
CHOOSING A
DISTRIBUTION
OPTION You must select one of three distribution options:
1. AUTOMATIC REINVESTMENT OPTION -- Both dividends and
capital gains distributions will be reinvested in
additional shares. This option will be selected for
you automatically unless you specify one of the
other options.
2. CASH DIVIDEND OPTION -- Your dividends will be paid
in cash and your capital gains will be reinvested in
additional shares.
3. ALL CASH OPTION -- Both dividend and capital gains
distributions will be paid in cash.
You may change your option by calling our Client
Services Department (1-800-662-2739).
In addition, an option to invest your cash dividends
and/or capital gains distributions in another Vanguard
Fund account is available. Please call our Client
Services Department (1-800-662-2739) for information.
You may also elect Vanguard Dividend Express which
allows you to transfer your cash dividends and/or
capital gains distributions automatically to your bank
account. Please see "Other Vanguard Services" for more
information.
- --------------------------------------------------------------------------------
TAX CAUTION
INVESTORS SHOULD ASK
ABOUT THE TIMING OF
CAPITAL GAINS AND
DIVIDEND DISTRIBUTIONS
BEFORE INVESTING Under Federal tax laws, each Portfolio is required to
distribute net capital gains and dividend income to
Portfolio shareholders. These distributions are made to
all shareholders who own Portfolio shares as of the
distribution's record date, regardless of how long the
shares have been owned. Purchasing shares just prior to
the record date could have a significant impact on your
tax liability for the year. For example, if you
purchase shares immediately prior to the record date of
a sizable capital gain or income dividend distribution,
you will be assessed taxes on the amount of the capital
gain and/or dividend distribution later paid even
though you owned the Portfolio shares for just a short
period of time. (Taxes are due on the distributions
even if the dividend or gain is reinvested in
additional Portfolio shares.) While the total value of
your investment will be the same after the distribution
(assuming there is no market change) -- the amount of
the distribution will offset the drop in the net asset
value of the shares -- you should be aware of the tax
implications the timing of your purchase may have.
Prospective investors should, therefore, inquire about
potential distributions before investing. The
Portfolio's annual dividend and capital gains
distributions normally occur in December. For
additional infor-
24
<PAGE> 28
mation on distributions and taxes, see the section
titled "Dividends, Capital Gains and Taxes."
- --------------------------------------------------------------------------------
IMPORTANT
INFORMATION
ESTABLISHING OPTIONAL
SERVICES The easiest way to establish optional Vanguard services
on your account is to select the options you desire
when you complete your Account Registration Form. IF
YOU WISH TO ADD OPTIONS LATER, YOU MAY NEED TO PROVIDE
VANGUARD WITH ADDITIONAL INFORMATION AND A SIGNATURE
GUARANTEE. PLEASE CALL OUR CLIENT SERVICES DEPARTMENT
(1-800-662-2739) FOR FURTHER ASSISTANCE.
SIGNATURE
GUARANTEES For our mutual protection, we may require a signature
guarantee on certain written transaction requests. A
signature guarantee verifies the authenticity of your
signature and may be obtained from banks, brokers and
any other guarantor that Vanguard deems acceptable. A
SIGNATURE GUARANTEE CANNOT BE PROVIDED BY A NOTARY
PUBLIC.
CERTIFICATES Share certificates for the European and Pacific
Portfolios (but not for the Emerging Markets and Total
International Portfolios) will be issued upon request.
If a certificate is lost, you may incur an expense to
replace it.
BROKER-DEALER
PURCHASES If you purchase shares in Vanguard Funds through a
registered broker-dealer or investment adviser, the
broker-dealer or adviser may charge a service fee.
CANCELLING TRADES The Portfolios will not cancel any trade (e.g.,
purchase, exchange or redemption) believed to be
authentic, received in writing or by telephone, once
the trade request has been received.
ELECTRONIC
PROSPECTUS
DELIVERY You may receive a prospectus for the Portfolios or any
of the Vanguard Funds in an electronic format. Please
call 1-800-231-7870 for additional information or see
"Other Vanguard Services -- Computer Access." You may
also receive a paper copy of the prospectus, by calling
1-800-662-7447.
- --------------------------------------------------------------------------------
WHEN YOUR
ACCOUNT WILL
BE CREDITED Your trade date is the date on which your account is
credited. If your purchase is made by check, Federal
Funds wire or exchange, and is received by the close of
the New York Stock Exchange (generally 4:00 p.m.
Eastern time), your trade date is the day of receipt.
If your purchase is received after the close of the
Exchange, your trade date is the next business day. All
four Portfolios charge a transaction fee on purchases
(1.5% for the Emerging Markets Portfolio, 1% for the
European Portfolio, 0.5% for the Pacific Portfolio, and
0.75% for the Total International Portfolio). See
"Portfolio Expenses."
In order to prevent lengthy processing delays caused by
the clearing of foreign checks, Vanguard will only
accept a foreign check which has been drawn in U.S.
dollars and has been issued by a foreign bank with a
U.S. correspondent bank. The name of the U.S.
correspondent bank must be printed on the face of the
foreign check.
- --------------------------------------------------------------------------------
SELLING YOUR
SHARES You may withdraw any portion of the funds in your
account by redeeming shares at any time. You generally
may initiate a request by writing or by telephoning.
Your redemption proceeds are normally
25
<PAGE> 29
mailed within two business days after the receipt of
the request in Good Order.
-----------------------------------------------------------------------------
SELLING BY MAIL Requests should be mailed to VANGUARD FINANCIAL CENTER,
VANGUARD INTERNATIONAL INDEX PORTFOLIOS, P.O. BOX 1120,
VALLEY FORGE, PA 19482. (For express or registered
mail, send your request to Vanguard Financial Center,
Vanguard International Index Portfolios, 455 Devon Park
Drive, Wayne, PA 19087.)
The Emerging Markets Portfolio charges a 1% transaction
fee on all redemptions (including the sale of shares).
The redemption price of shares will be the Portfolio's
net asset value next determined after Vanguard has
received all required documents in Good Order.
-----------------------------------------------------------------------------
DEFINITION OF
GOOD ORDER GOOD ORDER means that the request includes the
following:
1. The account number and Portfolio name.
2. The amount of the transaction (specified in dollars
or shares).
3. The signatures of all owners EXACTLY as they are
registered on the account.
4. Any required signature guarantees.
5. Other supporting legal documentation that might be
required in the case of estates, corporations,
trusts and certain other accounts.
6. Any certificates that you are holding for the
account.
IF YOU HAVE QUESTIONS ABOUT THIS DEFINITION AS IT
PERTAINS TO YOUR REQUEST, PLEASE CALL OUR CLIENT
SERVICES DEPARTMENT (1-800-662-2739).
-----------------------------------------------------------------------------
SELLING BY TELEPHONE To sell shares by telephone, you or your pre-authorized
representative may call our Client Services Department
at 1-800-662-2739. The proceeds will be sent to you by
mail. PLEASE NOTE: As a protection against fraud, your
telephone mail redemption privilege will be suspended
for 15 calendar days following any expedited address
change to your account. An expedited address change is
one that is made by telephone, by Vanguard Online, or,
in writing, without the signatures of all account
owners. Please see "Important Information About
Telephone Transactions."
-----------------------------------------------------------------------------
SELLING BY FUND
EXPRESS
Automatic
Withdrawal With the Fund Express Automatic Withdrawal option,
money will be automatically moved from your Vanguard
Fund account to your bank account according to the
schedule you have selected. You may elect Fund Express
on the Account Registration Form or call our Investor
Information Department (1-800-662-7447) for a Fund
Express Application.
-----------------------------------------------------------------------------
SELLING BY EXCHANGE You may sell shares by making an exchange to another
Vanguard Fund account. Exchanges to or from the
Portfolios may be made only by mail. Please see
"Exchanging Your Shares" for details.
-----------------------------------------------------------------------------
26
<PAGE> 30
IMPORTANT
REDEMPTION
INFORMATION Shares purchased by check or Fund Express may be
redeemed at any time. However, your redemption proceeds
will not be paid until payment for the purchase is
collected, which may take up to ten calendar days.
-----------------------------------------------------------------------------
DELIVERY OF
REDEMPTION
PROCEEDS Redemption requests received by telephone prior to the
close of the New York Stock Exchange (generally 4:00
p.m. Eastern time) are processed on the day of receipt
and the redemption proceeds are normally sent on the
following business day.
Redemption requests received by telephone after the
close of the Exchange are processed on the business day
following receipt and the proceeds are normally sent on
the second business day following receipt.
Redemption proceeds must be sent to you within seven
days of receipt of your request in Good Order, except
as described in "Important Redemption Information."
If you experience difficulty in making a telephone
redemption during periods of drastic economic or market
changes, your redemption request may be made by regular
or express mail. It will be implemented at the net
asset value next determined after your request has been
received by Vanguard in Good Order. The Fund reserves
the right to revise or terminate the telephone
redemption privilege at any time.
Each Portfolio may suspend the redemption right or
postpone payment at times when the New York Stock
Exchange is closed or under any emergency circumstances
as determined by the United States Securities and
Exchange Commission.
If the Board of Directors determines that it would be
detrimental to the best interests of a Portfolio's
remaining shareholders to make payment in cash, a
Portfolio may pay redemption proceeds in whole or in
part by a distribution in kind of readily marketable
securities.
-----------------------------------------------------------------------------
VANGUARD'S AVERAGE
COST STATEMENT If you make a redemption from a qualifying account,
Vanguard will send you an Average Cost Statement which
provides you with the tax basis of the shares you
redeemed. Please see "Statements and Reports" for
additional information.
-----------------------------------------------------------------------------
LOW BALANCE FEE AND
MINIMUM ACCOUNT
BALANCE REQUIREMENT Due to the relatively high cost of maintaining smaller
accounts, each Portfolio will automatically deduct a
$10 annual fee from non-retirement accounts with
balances falling below $2,500 ($500 for Uniform
Gifts/Transfers to Minors Act accounts). The fee
generally will be waived for investors whose aggregate
Vanguard assets exceed $50,000.
In addition, each Portfolio reserves the right to
liquidate any non-retirement account that is below the
minimum initial investment amount of $3,000. If at any
time your total investment does not have a value of at
least $3,000, you may be notified that your account is
below the Fund's minimum account balance requirement.
You would then be allowed
27
<PAGE> 31
60 days to make an additional investment before the
account is liquidated. Proceeds would be promptly paid
to the registered shareholder.
Vanguard will not liquidate your account if it has
fallen below $3,000 solely as a result of declining
markets (i.e., a decline in a Portfolio's net asset
value).
- --------------------------------------------------------------------------------
EXCHANGING YOUR
SHARES Should your investment goals change, you may exchange
your shares of a Portfolio for those of other available
Vanguard Funds. Exchanges to or from a Portfolio may be
made only by mail. TELEPHONE EXCHANGES BETWEEN
NON-RETIREMENT ACCOUNTS ARE NOT ACCEPTED FOR THE FUND.
Note, too, that the Emerging Markets Portfolio charges
a 1% transaction fee on all redemptions (including the
exchange of shares).
-----------------------------------------------------------------------------
EXCHANGING BY MAIL Please be sure to include on your exchange request the
name and account number of your current Portfolio, the
name of the Fund you wish to exchange into, the amount
you wish to exchange, and the signatures of all
registered account holders. Send your request to
VANGUARD FINANCIAL CENTER, VANGUARD INTERNATIONAL INDEX
PORTFOLIOS, P.O. BOX 1120, VALLEY FORGE, PA 19482. (For
express or registered mail, send your request to
Vanguard Financial Center, Vanguard International
Equity Index Fund, 455 Devon Park Drive, Wayne, PA
19087.)
-----------------------------------------------------------------------------
IMPORTANT EXCHANGE
INFORMATION Before you make an exchange, you should consider the
following:
- Please read the Fund's prospectus before making an
exchange. For an additional copy and for answers to
any questions you may have, call our Investor
Information Department (1-800-662-7447).
- An exchange is treated as a redemption and a
purchase. Therefore, you could realize a taxable gain
or loss on the transaction.
- Exchanges are accepted only if the registrations and
the taxpayer identification numbers of the two
accounts are identical.
- The shares to be exchanged must be on deposit and not
held in certificate form.
- New accounts are not currently accepted in
Vanguard/Windsor Fund.
- The redemption price of shares redeemed by exchange
is the net asset value next determined after Vanguard
has received all required documentation in Good
Order.
- When opening a new account by exchange, you must meet
the minimum investment requirement of the new Fund.
Every effort will be made to maintain the exchange
privilege. However, the Fund reserves the right to
revise or terminate its provisions, limit the amount of
or reject any exchange as deemed necessary, at any
time.
- --------------------------------------------------------------------------------
28
<PAGE> 32
EXCHANGE
PRIVILEGE
LIMITATIONS The Fund's exchange privilege is not intended to afford
shareholders a way to speculate on short-term movements
in the market. Accordingly, in order to prevent
excessive use of the exchange privilege that may
potentially disrupt the management of the Fund and
increase transaction costs, the Fund has established a
policy of limiting excessive exchange activity.
Exchange activity generally will not be deemed
excessive if limited to TWO SUBSTANTIVE EXCHANGE
REDEMPTIONS (AT LEAST 30 DAYS APART) from a Portfolio
during any twelve-month period. Notwithstanding these
limitations, the Fund reserves the right to reject any
purchase request (including exchange purchases from
other Vanguard port-folios) that is reasonably deemed
to be disruptive to efficient portfolio management.
- --------------------------------------------------------------------------------
IMPORTANT
INFORMATION
ABOUT TELEPHONE
TRANSACTIONS The ability to initiate redemptions (except wire
redemptions) by telephone is automatically established
on your account unless you request in writing that
telephone transactions on your account not be
permitted.
To protect your account from losses resulting from
unauthorized or fraudulent telephone instructions,
Vanguard adheres to the following security procedures:
1. SECURITY CHECK. To request a transaction by
telephone, the caller must know (i) the name of the
Portfolio; (ii) the 10-digit account number; (iii)
the exact name and address used in the registration;
and (iv) the Social Security or employer
identification number listed on the account.
2. PAYMENT POLICY. The proceeds of any telephone
redemption by mail will be made payable to the
registered shareowner and mailed to the address of
record, only.
Neither the Fund nor Vanguard will be responsible for
the authenticity of transaction instructions received
by telephone, provided that reasonable security
procedures have been followed. Vanguard believes that
the security procedures described above are reasonable,
and that if such procedures are followed, you will bear
the risk of any losses resulting from unauthorized or
fraudulent telephone transactions on your account.
- --------------------------------------------------------------------------------
TRANSFERRING
REGISTRATION You may transfer the registration of any of your Fund
shares to another person by completing a transfer form
and sending it to: VANGUARD FINANCIAL CENTER, P.O. BOX
1110, VALLEY FORGE, PA 19482 ATTENTION: TRANSFER
DEPARTMENT. The request must be in Good Order. To
obtain a transfer form and full instructions, please
call our Client Services Department (1-800-662-2739).
- --------------------------------------------------------------------------------
STATEMENTS AND
REPORTS Vanguard will send you a confirmation statement each
time you initiate a transaction in your account except
for checkwriting redemptions from Vanguard money market
accounts. You will also receive a comprehensive account
statement at the end of each calendar quarter.
29
<PAGE> 33
The fourth-quarter statement will be a year-end
statement, listing all transaction activity for the
entire calendar year.
Vanguard's Average Cost Statement provides you with the
average cost of shares redeemed from your account
during the calendar year, using the average cost single
category method. This service is available for most
taxable accounts opened since January 1, 1986. In
general, investors who redeemed shares from a
qualifying Vanguard account during the most recent
quarter may expect to receive an Average Cost Statement
along with their quarterly Portfolio Summary State-
ment. Please call our Client Services Department
(1-800-662-2739) for information.
Financial reports on the Fund will be mailed to you
semiannually, according to the Fund's fiscal year-end.
- --------------------------------------------------------------------------------
OTHER VANGUARD
SERVICES For more information about any of these services,
please call our Investor Information Department at
1-800-662-7447.
VANGUARD DIRECT
DEPOSIT SERVICE With Vanguard Direct Deposit Service, most U.S.
Government checks (including Social Security and
military pension checks) and private payroll checks may
be automatically deposited into your Vanguard Fund
account. Separate brochures and forms are available for
direct deposit of U.S. Government and private payroll
checks.
VANGUARD AUTOMATIC
EXCHANGE SERVICE Vanguard Automatic Exchange Service allows you to move
money automatically among your Vanguard Fund accounts.
For instance, the service can be used to "dollar-cost
average" from a money market portfolio into a stock or
bond fund or to contribute to an IRA or other
retirement plan. Please contact our Client Services
Department at 1-800-662-2739 for additional
information.
VANGUARD FUND
EXPRESS Vanguard Fund Express allows you to transfer money
between your Fund account and your account at a bank,
savings and loan association, or a credit union that is
a member of the Automated Clearing House (ACH) system.
You may elect this service on the Account Registration
Form or call our Investor Information Department
(1-800-662-7447) for a Fund Express application.
Special rules govern how your Fund Express purchases or
redemptions are credited to your account. In addition,
some services of Fund Express cannot be used with
specific Vanguard Funds. For more information, please
refer to the Vanguard Fund Express brochure.
VANGUARD DIVIDEND
EXPRESS Vanguard Dividend Express allows you to transfer your
dividends and/or capital gains distributions
automatically from your Fund account, one business day
after the Fund's payable date, to your account at a
bank, savings and loan association, or a credit union
that is a member of the Automated Clearing House (ACH)
system. You may elect this service on the Account
Registration Form or call our Investor Information
Department (1-800-662-7447) for a Vanguard Dividend
Express application.
30
<PAGE> 34
VANGUARD
TELE-ACCOUNT Vanguard Tele-Account is a convenient, automated
service that provides share price, price change and
yield quotations on Vanguard Funds through any
TouchToneTM telephone. This service also lets you
obtain information about your account balance, your
last transaction, and your most recent dividend or
capital gains payment. In addition, you may perform
investment exchanges of Vanguard Fund shares and
redemptions by check using Tele-Account. To contact
Vanguard Tele-Account service, dial 1-800-ON-BOARD
(1-800-662-6273). A brochure offering detailed
operating instructions is available from our Investor
Information Department (1-800-662-7447).
COMPUTER ACCESS
VANGUARD ONLINE
KEYWORD: vanguard Vanguard Online allows you to obtain information via
your personal computer on Fund share price, yield, and
total return. Vanguard Online is offered through
America Online (AOL). To establish an AOL account, call
1-800-238-6336.
VANGUARD ON THE
WORLD WIDE WEB
http://www.vanguard.com Vanguard sponsors an education-oriented website
offering news and information about Vanguard Funds and
services, as well as interactive, easy-to-use
investment planning tools.
- --------------------------------------------------------------------------------
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<PAGE> 38
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<PAGE> 39
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
THE VANGUARD GROUP
Vanguard Financial Center
P.O. Box 2600
Valley Forge, PA 19482
INVESTOR INFORMATION
DEPARTMENT:
1-800-662-7447 (SHIP)
CLIENT SERVICES
DEPARTMENT:
1-800-662-2739 (CREW)
TELE-ACCOUNT FOR
24-HOUR ACCESS:
1-800-662-6273 (ON-BOARD)
TELECOMMUNICATION SERVICE
FOR THE HEARING-IMPAIRED:
1-800-662-2738
TRANSFER AGENT:
The Vanguard Group, Inc.
Vanguard Financial Center
Valley Forge, PA 19482
P072
</TABLE>
- --------------------------------------------------------------------------------
<PAGE> 40
PART B
VANGUARD INTERNATIONAL EQUITY INDEX FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
MARCH 28, 1997
This Statement is not a prospectus, but should be read in conjunction with
the Fund's current Prospectus (dated March 28, 1997). To obtain the Prospectus
please call:
VANGUARD INVESTOR INFORMATION CENTER
1-800-662-7447
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies......................................................... B-1
Investment Limitations.................................................................... B-5
Purchase of Shares........................................................................ B-6
Redemption of Shares...................................................................... B-6
The Vanguard Group........................................................................ B-6
Directors and Officers.................................................................... B-9
Portfolio Transactions.................................................................... B-10
Performance Measures...................................................................... B-10
Foreign Investments....................................................................... B-11
Total Return.............................................................................. B-12
Financial Statements...................................................................... B-12
</TABLE>
INVESTMENT OBJECTIVE AND POLICIES
REPURCHASE AGREEMENTS Each Portfolio along with the other members of The
Vanguard Group, may invest in repurchase agreements with commercial banks,
brokers or dealers to generate income from its excess cash balances. A
repurchase agreement is an agreement under which a Portfolio acquires a money
market instrument (generally a security issued by the U.S. Government or an
agency thereof, a banker's acceptance or a certificate of deposit) from a
seller, subject to resale to the seller at an agreed upon price and date
(normally, the next business day). A repurchase agreement may be considered a
loan collateralized by securities. The resale price reflects an agreed upon
interest rate effective for the period the instrument is held by a Portfolio and
is unrelated to the interest rate on the underlying instrument. In these
transactions, the securities acquired by a Portfolio (including accrued interest
earned thereon) must have a total value in excess of the value of the repurchase
agreement and are held by a custodian bank until repurchased. In addition, the
Fund's Board of Directors will monitor the Fund's repurchase agreement
transactions generally and will establish guidelines and standards for review of
the creditworthiness of any bank, broker or dealer party to a repurchase
agreement with a Portfolio. No more than an aggregate of 15% of the Portfolio's
assets, at the time of investment, will be invested in repurchase agreements
having maturities longer than seven days and securities subject to legal or
contractual restrictions on resale for which there are no readily available
market quotations. From time to time, the Fund's Board of Directors may
determine that certain restricted securities known as Rule 144A securities are
liquid and not subject to the 15% limitation described above. A Portfolio will
enter into repurchase agreements only with Federal Reserve member banks with
minimum assets of at least $2 billion or registered securities dealers.
The use of repurchase agreements involves certain risks. For example, if
the other party to the agreement defaults on its obligation to repurchase the
underlying security at a time when the value of the security has declined, the
Fund may incur a loss upon disposition of the security. If the other party to
the agreement becomes insolvent and subject to liquidation or reorganization
under the Bankruptcy Code or other laws, a court may determine that the
underlying security is collateral for a loan by a Portfolio not within the
control of
B-1
<PAGE> 41
the Portfolio and therefore the Portfolio may not be able to substantiate its
interest in the underlying security and may be deemed an unsecured creditor of
the other party to the agreement. While the Fund's management acknowledges these
risks, it is expected that they can be controlled through careful monitoring
procedures.
LENDING OF SECURITIES Each Portfolio may lend its securities to qualified
institutional investors who need to borrow securities in order to complete
certain transactions, such as covering short sales, avoiding failures to deliver
securities or completing arbitrage operations. By lending its portfolio
securities, a Portfolio attempts to increase its net investment income through
the receipt of interest on the loan. Any gain or loss in the market price of the
securities loaned that might occur during the term of the loan would be for the
account of the Portfolio. A Portfolio may lend its portfolio securities to
qualified brokers, dealers, banks or other financial institutions, so long as
the terms, the structure and the aggregate amount of such loans are not
inconsistent with the Investment Company Act of 1940, or the Rules and
Regulations or interpretations of the Securities and Exchange Commission (the
"Commission") thereunder, which currently require that (a) the borrower pledge
and maintain with the Fund collateral consisting of cash, a letter of credit
issued by a domestic U.S. bank, or securities issued or guaranteed by the United
States Government having at all times not less than 100% of the value of the
securities loaned, (b) the borrower add to such collateral whenever the price of
the securities loaned rises (i.e. the borrower "marks to the market" on a daily
basis), (c) the loan be made subject to termination by a Portfolio at any time
and (d) the Portfolio receive reasonable interest on the loan (which may include
the Portfolio's investing any cash collateral in interest bearing short-term
investments), any distribution on the loaned securities and any increase in
their market value. Loan arrangements made by a Portfolio will comply with all
other applicable regulatory requirements, including the rules of the New York
Stock Exchange, which rules presently require the borrower, after notice, to
redeliver the securities within the normal settlement time of three business
days. All relevant facts and circumstances, including the creditworthiness of
the broker, dealer or institution, will be considered in making decisions with
respect to the lending of securities, subject to review by the Fund's Board of
Directors.
FUTURES CONTRACTS, OPTIONS ON FUTURES CONTRACTS, WARRANTS, CONVERTIBLE
SECURITIES AND SWAP AGREEMENTS Each Portfolio may enter into futures contracts,
warrants, options on futures contracts, convertible securities and swap
agreements for the purpose of remaining fully invested and reducing transaction
costs. Futures contracts provide for the future sale by one party and purchase
by another party of a specified amount of a specific security at a specified
future time and at a specified price. Futures contracts which are standardized
as to maturity date and underlying financial instrument are traded on national
futures exchanges. The Fund's trading of futures contracts and options is
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission ("CFTC"), a U.S. Government Agency. Assets committed to futures
contracts will be segregated at the Fund's custodian bank to the extent required
by law.
The Fund will "under normal circumstances" invest at least 80% of each
Portfolio's assets in stocks represented in its respective index. However, the
Fund has given itself the flexibility to invest up to 50% in futures and options
under other than normal circumstances. Any investment in futures and options
over 20% of a Portfolio's assets would be made in emergency situations, for
short-term purposes. Each Portfolio would normally remain 80% invested in stocks
that represent its respective index.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery. Closing
out an open futures position is done by taking an opposite position ("buying" a
contract which has previously been "sold", or "selling" a contract previously
"purchased") in an identical contract to terminate the position. Brokerage
commissions are incurred when a futures contract is closed.
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements which are higher than the exchange
minimums. Futures contracts are customarily purchased and sold on margin
deposits which may range upward from less than 5% of the value of the contract
being traded.
B-2
<PAGE> 42
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent that
the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The Fund
expects to earn interest income on its margin deposits.
Each Portfolio will use futures contracts and options to simulate full
investment in the underlying index while retaining a cash balance for Fund
management purposes.
Regulations of the CFTC applicable to the Fund require that all of its
futures transactions constitute bona fide hedging transactions. Each Portfolio
will only sell futures contracts to protect securities it owns against price
declines or purchase contracts to protect against an increase in the price of
securities it intends to purchase. As evidence of this hedging interest, the
Fund expects that approximately 75% of its futures contract purchases will be
"completed," that is, equivalent amounts of related securities will have been
purchased or are being purchased by a Portfolio upon sale of open futures
contracts.
Although techniques other than the sale and purchase of futures contracts
could be used to control a Portfolio's exposure to market fluctuations, the use
of futures contracts may be a more effective means of hedging this exposure.
While each Portfolio will incur commission expenses in closing out futures
positions, these costs are lower than transaction costs incurred in the purchase
and sale of the underlying securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS A Portfolio will not enter
into futures contract transactions to the extent that, immediately thereafter,
the sum of its initial margin deposits on open contracts exceeds 5% of the
market value of a Portfolio's total assets. Assets committed to futures or
options will be held in a segregated account at the Fund's custodial bank.
RISK FACTORS IN FUTURES TRANSACTIONS Positions in futures contracts may be
closed out only on an exchange which provides a secondary market for such
futures. However, there can be no assurance that a liquid secondary market will
exist for any particular futures contract at any specific time. Thus, it may not
be possible to close a futures position. In the event of adverse price
movements, a Portfolio would continue to be required to make daily cash payments
to maintain its required margin. In such situations, if a Portfolio has
insufficient cash, it may have to sell portfolio securities to meet daily margin
requirements at a time when it may be disadvantageous to do so. In addition, a
Portfolio may be required to make delivery of the instruments
underlying futures contracts it holds. The inability to close options and
futures positions also could have an adverse impact on the ability to
effectively hedge the Portfolio.
A Portfolio will minimize the risk that it will be unable to close out a
futures contract by only entering into futures which are traded on national
futures exchanges and for which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit if the contract were closed
out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the amount invested in the contract. However, because the futures
strategies of each Portfolio are engaged in only for hedging purposes, the
adviser does not believe that a Portfolio is subject to the risks of loss
frequently associated with futures transactions. A Portfolio would presumably
have sustained comparable losses if, instead of the futures contracts, it had
invested in the underlying financial instrument and sold it after the decline.
Utilization of futures transactions by each Portfolio does involve the risk
of imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is also
possible that a Portfolio could both lose money on futures contracts and also
experience a
B-3
<PAGE> 43
decline in value of its portfolio securities. There is also the risk of loss by
the Fund of margin deposits in the event of bankruptcy of a broker with whom a
Portfolio has an open position in a futures contract or related option.
Additionally, investments in futures and options involve the risk that the
investment adviser will incorrectly predict stock market and interest rate
trends.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular type of contract, no trades may
be made on that day at a price beyond that limit. The daily limit governs only
price movement during a particular trading day and therefore does not limit
potential losses, because the limit may prevent the liquidation of unfavorable
positions. Futures contract prices have occasionally moved to the daily limit
for several consecutive trading days with little or no trading, thereby
preventing prompt liquidation of futures positions and subjecting some futures
traders to substantial losses.
SWAP AGREEMENTS Swap agreements are contracts between parties in which one
party agrees to make payments to the other party based on the change in market
value of a specified index or asset. In return, the other party agrees to make
payments to the first party based on the return of a different specified index
or asset. Although swap agreements entail the risk that a party will default on
its payment obligations thereunder, the Portfolio will minimize this risk by
entering into agreements that mark to market no less frequently than quarterly.
Swap agreements also bear the risk that the Portfolio will not be able to meet
its obligation to the counterparty. This risk will be mitigated by investing the
Portfolio in the specific asset for which it is obligated to pay a return.
FEDERAL TAX TREATMENT OF FUTURES CONTRACTS Each Portfolio is required for
federal income tax purposes to recognize as income for each taxable year its net
unrealized gains and losses on certain futures contracts as of the end of the
year as well as those actually realized during the year. In most cases, any gain
or loss recognized with respect to a futures contract is considered to be 60%
long-term capital gain or loss and 40% short-term capital gain or loss, without
regard to the holding period of the contract. Furthermore, sales of futures
contracts which are intended to hedge against a change in the value of
securities held by a Portfolio may affect the holding period of such securities
and, consequently, the nature of the gain or loss on such securities upon
disposition. A Portfolio may be required to defer the recognition of losses on
futures contracts to the extent of any unrecognized gains on related positions
held by the Portfolio.
In order for a Portfolio to continue to qualify for Federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest, income derived from loans of securities, gains from the sale of
securities or of foreign currencies or other income derived with respect to the
Portfolio's business of investing in securities. In addition, gains realized on
the sale or other disposition of securities held for less than three months must
be limited to less than 30% of the Portfolio's annual gross income. It is
anticipated that any net gain realized from the closing out of futures contracts
will be considered gain from the sale of securities and therefore be qualifying
income for purposes of the 90% requirement. In order to avoid realizing
excessive gains on securities held less than three months, a Portfolio may be
required to defer the closing out of futures contracts beyond the time when it
would otherwise be advantageous to do so. It is anticipated that unrealized
gains on futures contracts, which have been open for less than three months as
of the end of the Portfolio's fiscal year and which are recognized for tax
purposes, will not be considered gains on sales of securities held less than
three months for the purpose of the 30% test.
Each Portfolio will distribute to shareholders annually any net capital
gains which have been recognized for federal income tax purposes (including
unrealized gains at the end of the Portfolio's fiscal year) on futures
transactions. Such distributions will be combined with distributions of capital
gains realized on the Portfolio's other investments and shareholders will be
advised on the nature of the distributions.
B-4
<PAGE> 44
INVESTMENT LIMITATIONS
The following restrictions and fundamental policies cannot be changed
without approval of the holders of a majority of the outstanding shares of each
Portfolio (as defined in the Investment Company Act of 1940). A Portfolio may
not:
1) invest in commodities or purchase real estate, although it may purchase
securities of companies which deal in real estate or interests therein,
and it may invest in stock index futures contracts, stock futures
contracts, foreign currency futures contracts and options and warrants
thereon to the extent that not more than 5% of its assets are required
as deposit to secure obligations under such futures contracts;
2) purchase securities on margin or sell securities short (the deposit or
payment by the Fund of initial or variation margin in order to engage
in an interest-rate futures contract is not considered the purchase of
a security on margin);
3) purchase more than 10% of the outstanding voting securities of any
issuer, except to the extent that the Total International Equity
Portfolio may purchase more than 10% of any underlying Vanguard
Portfolio as described in the prospectus;
4) with respect to 75% of its assets invest more than 5% of the value of
its total assets in the securities of any single issuer except
obligations of the U.S. Government and its instrumentalities except for
the Total International Portfolio, which will normally invest 100% of
its assets in the underlying Portfolios of the Fund;
5) borrow money, except from a bank and only as a temporary or emergency
measure and in no event in excess of 15% of total assets taken at the
lower of their value or cost;
6) pledge, mortgage, or hypothecate any of its assets to an extent greater
than 5% of the value of its total assets;
7) issue senior securities (collateral arrangements with regard to initial
and variation margin on futures contracts shall not be considered
issuance of a senior security);
8) engage in the business of underwriting securities issued by other
persons, except to the extent that the Fund may technically be deemed
to be an underwriter under the Securities Act of 1933, as amended, in
disposing of portfolio securities;
9) purchase or otherwise acquire any security if, as a result, more than
15% of its net assets would be invested in securities that are illiquid
(including any investment in the Vanguard Group, Inc.);
10) invest for the purpose of controlling management of any company;
11) invest in securities of other investment companies, except as may be
acquired as a part of a merger, consolidation or acquisition of assets
approved by the Fund's shareholders or otherwise to the extent
permitted by Section 12 of the Investment Company Act of 1940. The
Portfolios will invest only in investment companies which have
investment objectives and investment policies consistent with those of
the Fund. Additionally the Total International Equity Portfolio is
expected to invest 100% of its assets in other investment company
members of The Vanguard Group as described in the prospectus;
12) have dealings on behalf of the Fund with Officers and Directors of the
Fund, except for the purchase or sale of securities on an agency or
commission basis;
13) make loans to any Officers, Directors or employees of the Fund;
14) invest in assessable securities or securities involving unlimited
liability on the part of the holders thereof;
15) make loans except (i) by purchasing bonds, debentures or similar
obligations (including repurchase agreements, which are either publicly
distributed or customarily purchased by institutional investors) and
(ii) by lending its securities to banks, brokers, or dealers and other
financial institutions so long as such loans are not inconsistent with
the Investment Company Act or the Rules and Regulations or
interpretations of the Securities and Exchange Commission thereunder;
16) invest directly in oil, gas or other mineral exploration or development
programs.
These limitations are considered at the time investment securities are
purchased.
B-5
<PAGE> 45
Although not fundamental policies subject to shareholder vote, as long as a
Portfolio's shares are registered for sale in certain states, it will not (i)
invest more than 5% of the assets of a Portfolio, at the time of investment, in
the securities of any issuers which have (with predecessors) a record of less
than three years' continuous operation, and (ii) purchase or retain any security
if one or more officers, trustees or partners of a Portfolio or its investment
adviser individually own or would own, directly or beneficially, more than 1/2
of 1 per cent of the securities of such issuer, and in the aggregate such
persons own or would own more than 5% of such securities. Notwithstanding these
limitations, a Portfolio may own all or any portion of the securities of, or
make loans to, or contribute to the costs or other financial requirements of any
company which will be wholly owned by the Fund and one or more other investment
companies and is primarily engaged in the business of providing, at-cost,
management, administrative, distribution or related services to the Fund and
other investment companies. See "The Vanguard Group."
PURCHASE OF SHARES
The Fund reserves the right in its sole discretion (i) to suspend the
offerings of its shares, (ii) to reject purchase orders when in the judgment of
management such rejection is in the best interests of the Fund, and (iii) to
reduce or waive the minimum investment for or any other restrictions on initial
and subsequent investments as well as redemption fees for certain fiduciary
accounts or under circumstances where certain economies can be achieved in sales
of the Fund's shares.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment
(i) during any period that the New York Stock Exchange is closed, or trading on
the Exchange is restricted as determined by the Securities and Exchange
Commission (the "Commission"), (ii) during any period when an emergency exists
as defined by the rules of the Commission as a result of which it is not
reasonably practicable for the Fund to dispose of securities owned by it, or
fairly to determine the value of its assets, and (iii) for such other periods as
the Commission may permit.
The Fund has made an election with the Commission to pay in cash all
redemptions requested by any shareholder of record limited in amount during any
90-day period to the lesser of $250,000 or 1% of the net assets of the Fund at
the beginning of such period. Such commitment is irrevocable without the prior
approval of the Commission. Redemptions in excess of the above limits may be
paid, in whole or in part, in investment securities or in cash, as the Directors
may deem advisable; however, payment will be made wholly in cash unless the
Directors believe that economic or market conditions exist which would make such
a practice detrimental to the best interests of the Fund. If redemptions are
paid in investment securities, such securities will be valued as set forth in
the Prospectus under "The Share Price of Each Portfolio" and a redeeming
shareholder would normally incur brokerage expenses if he converted these
securities to cash.
No charge is made by the Fund for redemptions from the European and Pacific
Portfolios. There is a 1% redemption transaction fee charged for redemptions
from the Emerging Market Portfolio. The redemption transaction fee is paid to
the Portfolio to reimburse the Portfolio for transaction costs it incurs while
liquidating securities in order to fund redemptions. Any redemption may be more
or less than the shareholder's cost depending on the market value of the
securities held by a Portfolio of the Fund.
THE VANGUARD GROUP
The Fund is a member of The Vanguard Group of Investment Companies, which
consists of over 30 investment companies.
B-6
<PAGE> 46
Through their jointly-owned subsidiary, The Vanguard Group, Inc.
("Vanguard"), the Fund and the other Funds in the Group obtain at cost virtually
all of their corporate management, administrative and distribution services.
Vanguard also provides investment advisory services on an at-cost basis to
certain Vanguard Funds.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the Funds and also
furnishes the Funds with necessary office space, furnishings and equipment. Each
Fund pays its share of Vanguard's net expenses, which are allocated among the
Funds under methods approved by the Board of Directors (Trustees) of each Fund.
In addition, each Fund bears its own direct expenses, such as legal, auditing
and custodian fees.
The Fund's Officers are also Officers and employees of Vanguard. No Officer
or employee owns, or is permitted to own, any securities of any external adviser
for the Funds.
The Vanguard Group adheres to a Code of Ethics established pursuant to Rule
17j-1 under the Investment Company Act of 1940. The Code is designed to prevent
unlawful practices in connection with the purchase or sale of securities by
persons associated with Vanguard. Under Vanguard's Code of Ethics certain
Officers and employees of Vanguard who are considered access persons are
permitted to engage in personal securities transactions. However, such
transactions are subject to procedures and guidelines substantially similar to
those recommended by the mutual fund industry and approved by the U.S.
Securities and Exchange Commission.
The Vanguard Group was established and operates under a Funds' Service
Agreement which was approved by the shareholders of each of the Funds. The
amounts which each of the Funds has invested are adjusted from time to time in
order to maintain the proportionate relationship between each Fund's relative
net assets and its contribution to Vanguard's capital. The Fund's Service
Agreement provides as follows: (a) each Vanguard Fund may invest up to 0.40% of
its current net assets in Vanguard and (b) there is no other limitation on the
amount that each Vanguard Fund may contribute to Vanguard's capitalization. At
December 31, 1996, the Fund had contributed capital of $281,000 to Vanguard,
representing 1.4% of Vanguard's capitalization.
MANAGEMENT Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the Funds by third parties. The Fund's
share of Vanguard's actual net costs of operation relating to management and
administrative services (including transfer agency) for the year ended December
31, 1996 totaled approximately $6,732,000.
DISTRIBUTION Vanguard provides all distribution and marketing activities
for the Funds in the Group. Vanguard Marketing Corporation, a wholly-owned
subsidiary of The Vanguard Group, Inc., acts as Sales Agent for the shares of
the Funds in connection with any sales made directly to investors in the states
of Florida, Missouri, New York, Ohio, Texas and such other states as it may be
required.
The principal distribution expenses are for advertising, promotional
materials and marketing personnel. Distribution services may also include
organizing and offering to the public, from time to time, one or more new
investment companies which will become members of the Group. The Directors and
Officers of Vanguard determine the amount to be spent annually on distribution
activities, the manner and amount to be spent on each Fund, and whether to
organize new investment companies.
One half of the distribution expenses of a marketing and promotional nature
is allocated among the Funds based upon relative net assets. The remaining one
half of those expenses is allocated among the Funds based upon each Fund's sales
for the preceding 24 months relative to the total sales of the Funds as a Group;
provided, however, that no Fund's aggregate quarterly rate of contribution for
distribution expenses of a marketing and promotional nature shall exceed 125% of
average distribution expense rate for the Group, and that no Fund shall incur
annual distribution expenses in excess of 20/100 of 1% of its average month-end
net assets. During the fiscal year ended December 31, 1996, the Fund paid
approximately $643,000 of the Group's distribution and marketing expenses, which
represented an effective annual rate of .02 of 1% of its average month-end net
assets.
B-7
<PAGE> 47
INVESTMENT ADVISORY SERVICES Vanguard's Core Management Group provides
investment advisory services to the Fund and also to the following Funds:
Vanguard Index Trust, Vanguard Balanced Index Fund, the Growth and Income and
Capital Appreciation Portfolios and the equity portion of the Balanced Portfolio
of the Vanguard Tax-Managed Fund, the REIT Index Portfolio of Vanguard
Specialized Portfolios, the Total International Portfolio of Vanguard STAR Fund,
the Aggressive Growth Portfolio of Vanguard Horizon Fund, Vanguard Institutional
Index Fund, Vanguary Treasury Fund, a portion of the assets of Vanguard/Windsor
II, the Equity Index Portfolio of the Vanguard Variable Insurance Fund, a
portion of Vanguard/Morgan Growth Fund and several indexed separate accounts.
Vanguard's Fixed Income Group also provides investment advisory services to
the following Funds: Vanguard Municipal Bond Fund; Vanguard Money Market
Reserves; several Portfolios of Vanguard Fixed Income Securities Fund; Vanguard
California Tax-Free Fund; Vanguard Ohio Tax-Free Fund; Vanguard New York Insured
Tax-Free Fund; Vanguard New Jersey Tax-Free Fund; Vanguard Pennsylvania Tax-Free
Fund; Vanguard Florida Insured Tax-Free Fund; Vanguard Balanced Index Fund;
Vanguard Bond Index Fund; Vanguard Admiral Funds; the Money Market and
High-Grade Bond Portfolios of the Vanguard Variable Insurance Fund; and the
municipal securities portion of the Balanced Portfolio of Vanguard Tax-Managed
Fund. These services are provided on an at-cost basis by the Fixed Income Group.
The compensation and other expenses of this staff are paid by the Funds
utilizing these services. During the fiscal year ended December 31, 1996, the
Fund paid approximately $66,000 of Vanguard's expenses relating to investment
advisory services.
REMUNERATION OF DIRECTORS AND OFFICERS The Fund pays each Director, who is
not also an Officer, an annual fee plus travel and other expenses incurred in
attending Board meetings. The Fund's Officers and employees are paid by Vanguard
which, in turn, is reimbursed by the Fund and each other Fund in the Group, for
its proportionate share of Officers' and employees' salaries and retirement
benefits. The Fund's proportionate share of remuneration paid to Officers for
the year ended December 31, 1996 was $82,858.
Under its retirement plan, Vanguard contributes annually an amount equal to
10% of each Officer's annual compensation plus 5.7% of that part of the
Officer's compensation during the year, if any, that exceeds the Social Security
Taxable Wage Base then in effect. Directors who are not officers are paid an
annual fee upon retirement equal to $1,000 for each year of service on the Board
up to a maximum of 15 years. The Fund's proportionate share of retirement
contributions for its Officers for the year ended December 31, 1996 was
approximately $2,100.
The following table provides detailed information with respect to the
amounts paid or accrued for the Directors for the fiscal year ended December 31,
1996.
VANGUARD INTERNATIONAL EQUITY INDEX FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
AGGREGATE PENSION OR RETIREMENT ESTIMATED TOTAL COMPENSATION
COMPENSATION BENEFITS ACCRUED AS ANNUAL BENEFITS FROM ALL VANGUARD FUNDS
NAMES OF DIRECTORS FROM FUND PART OF FUND EXPENSES UPON RETIREMENT PAID TO DIRECTORS(2)
- --------------------------- ------------ ---------------------- --------------- -----------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) -- -- -- --
John J. Brennan(1) -- -- -- --
Barbara Barnes Hauptfuhrer $ 920 $143 $15,000 $65,000
Robert E. Cawthorn $ 920 $119 $13,000 $65,000
Bruce K. MacLaury $1,001 $141 $12,000 $60,000
Burton G. Malkiel $ 920 $ 95 $15,000 $65,000
Alfred M. Rankin, Jr. $ 920 $ 75 $15,000 $65,000
John C. Sawhill $ 920 $ 89 $15,000 $65,000
James O. Welch, Jr. $ 920 $110 $15,000 $65,000
J. Lawrence Wilson $ 920 $ 79 $15,000 $65,000
</TABLE>
(1) As "Interested Directors," Messrs. Bogle and Brennan receive no compensation
for their service as Directors.
(2) The amounts reported in this column reflect the total compensation paid to
each Director for their service as Director or Trustee of 34 Vanguard Funds
(33 in the case of Mr. Malkiel; 27 in the case of Mr. MacLaury).
B-8
<PAGE> 48
DIRECTORS AND OFFICERS
The Officers of the Fund manage its day-to-day operations and are
responsible to the Fund's Board of Directors. The Directors set broad policies
for the Fund and choose its Officers. The following is a list of the Directors
and Officers of the Fund and a statement of their present positions and
principal occupations during the past five years. The mailing address of the
Directors and Officers of the Fund is: Post Office Box 876, Valley Forge, PA
19482.
JOHN C. BOGLE, Chairman and Director*
Chairman and Director of The Vanguard Group, Inc., and of each of the
investment companies in The Vanguard Group; Director of The Mead
Corporation, General Accident Insurance, and Chris-Craft Industries, Inc.
JOHN J. BRENNAN, President, Chief Executive
Officer & Director*
President, Chief Executive Officer and Director of The Vanguard Group,
Inc., and of each of the other investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, Director
Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.; Director of
Sun Company, Inc. and Westinghouse Electric Corporation.
BARBARA BARNES HAUPTFUHRER, Director
Director of The Great Atlantic and Pacific Tea Company, ALCO Standard
Corp., Raytheon Company, Knight-Ridder, Inc. and Massachusetts Mutual Life
Insurance Co. and Trustee Emerita of Wellesley College.
BRUCE K. MACLAURY, Director
President Emeritus of The Brookings Institution; Director of American
Express Bank, Ltd., The St. Paul Companies, Inc., and National Steel
Corporation.
BURTON G. MALKIEL, Director
Chemical Bank Chairman's Professor of Economics, Princeton University;
Director of Prudential Insurance Co. of America, Amdahl Corporation, Baker
Fentress & Co., The Jeffrey Co., and Southern New England Communications
Company.
ALFRED M. RANKIN, JR., Director
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of The BFGoodrich Company and The Standard Products Company.
JOHN C. SAWHILL, Director
President and Chief Executive Officer, The Nature Conservancy; formerly,
Director and Senior Partner, McKinsey & Co., President, New York
University; Director of Pacific Gas and Electric Company, Procter & Gamble
Company and NACCO Industries.
JAMES O. WELCH, JR., Director
Retired Chairman of Nabisco Brands, Inc. and retired Vice Chairman and
Director of RJR Nabisco; Director of TECO Energy, Inc. and Kmart
Corporation.
J. LAWRENCE WILSON, Director
Chairman and Chief Executive Officer of Rohm & Haas Company; Director of
Cummins Engine Company; and Trustee of Vanderbilt University.
RAYMOND J. KLAPINSKY, Secretary*
Senior Vice President and Secretary of The Vanguard Group, Inc.; Secretary
of each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND, Treasurer*
Treasurer of The Vanguard Group, Inc. and 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.
- ---------------
* Officers of the Fund are "interested persons" as defined in the Investment
Company Act of 1940.
B-9
<PAGE> 49
PORTFOLIO TRANSACTIONS
In placing portfolio transactions, the Fund uses its best judgment to
choose the broker most capable of providing the brokerage services necessary to
obtain best available price and most favorable execution. The full range and
quality of brokerage services available are considered in making these
determinations. In those instances where it is reasonably determined that more
than one broker can offer the brokerage services needed to obtain the best
available price and most favorable execution, consideration will be given to
those brokers which supply statistical information and provide other services in
addition to execution services to the Fund.
Since the Fund does not market its shares through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be made through such
firms. However, the Fund may place portfolio orders with qualified
broker-dealers who recommend the Fund to clients, and may, when a number of
brokers and dealers can provide best price and execution on a particular
transaction, consider the sale of Fund shares by a broker or dealer in selecting
among broker-dealers. For the years ended December 31, 1994, 1995 and 1996 the
Fund paid approximately $1,559,349, $1,697,441 and $4,174,360 in brokerage
commissions, respectively.
PERFORMANCE MEASURES
Vanguard may use reprinted material discussing The Vanguard Group, Inc. or
any of the member funds of The Vanguard Group of Investment Companies.
The Fund may use one or more of the following unmanaged indexes for
comparative performance purposes:
MORGAN STANLEY CAPITAL INTERNATIONAL -- SELECT EMERGING MARKETS INDEX -- is an
unpublished index which includes common stocks of companies located in the
countries 12 emerging markets.
MORGAN STANLEY CAPITAL INTERNATIONAL -- EAFE (FREE) INDEX -- is an arithmetic,
market value-weighted average of the performance of over 1,000 securities listed
on the stock exchanges of countries in Europe, Australasia and the Far East.
MSCI EMF INDEX -- an arithmetic, market value-weighted average of the
performance of securities listed on the stock exchanges of twenty-two developing
countries.
MSCI EAFE + SELECT EMF INDEX -- an arithmetic, market value-weighted average of
the performance of securities listed on the stock markets of Europe, Australia,
the Far East and fourteen developing countries.
FT-ACTUARIES WORLD INDEX -- includes approximately 2,400 securities from 24
countries including the U.S.
FT-ACTUARIES EURO-PACIFIC INDEX -- a subset of the FT Actuaries World Index,
which excludes companies in the U.S., Canada, Mexico and South Africa.
SALOMON-RUSSELL PRIMARY MARKET INDEX -- consists of the approximately 700
largest stocks within 23 countries.
SALOMON-RUSSELL EXTENDED MARKET INDEX -- consists of approximately 1,000 medium
and small capitalization stocks from 23 countries.
SALOMON-RUSSELL BROAD MARKET INDEX -- consists of all of the stocks within the
Primary Market Index and the Extended Market Index.
RUSSELL UNIVERSE OF NON-U.S. EQUITY PORTFOLIOS -- a universe of separate
accounts and pooled funds available to U.S. investors, which invest in
international equities.
RUSSELL UNIVERSE OF WORLD EQUITY PORTFOLIOS -- a universe of equity-oriented
global portfolios.
LIPPER INTERNATIONAL UNIVERSE -- a universe of mutual funds that invest in
international equities.
LIPPER DIVERSIFIED INTERNATIONAL UNIVERSE -- a universe of mutual funds that
invest in international equities from more than one country.
B-10
<PAGE> 50
LIPPER INTERNATIONAL AVERAGE -- the average return of the portfolios included in
the Lipper International Universe.
LIPPER DIVERSIFIED INTERNATIONAL AVERAGE -- the average return of the portfolios
included in the Lipper Diversified International Universe.
STANDARD AND POOR'S 500 COMPOSITE STOCK PRICE INDEX -- is a well diversified
list of 500 companies representing the U.S. stock market.
WILSHIRE 5000 EQUITY INDEX -- consists of more than 7,000 common equity
securities, covering all stocks in the U.S. for which daily pricing is
available.
WILSHIRE 4500 EQUITY INDEX -- consists of all stocks in the Wilshire 5000 except
for the 500 stocks in the Standard and Poor's 500 Index.
SALOMON BROTHERS HIGH-GRADE CORPORATE BOND INDEX -- consists of publicly issued,
non-convertible corporate bonds rated Aa or Aaa. It is a value-weighted, total
return index, including approximately 800 issues with maturities of 12 years or
greater.
BARING EMERGING MARKETS INDEX -- a diversified index of approximately 250
relatively liquid stocks from 13 emerging market countries.
SALOMON BROTHERS BROAD INVESTMENT-GRADE BOND INDEX -- is a market-weighted index
that contains approximately 4,700 individually priced investment-grade corporate
bonds rated BBB or better, U.S. Treasury and agency issues and mortgage
pass-through securities.
SHEARSON LEHMAN LONG-TERM TREASURY BOND INDEX -- is composed of all bonds
covered by the Shearson Lehman Hutton Treasury Bond Index with maturities of 10
years or greater.
NASDAQ INDUSTRIAL INDEX -- is composed of more than 3,000 industrial issues. It
is a value-weighted index calculated on price change only and does not include
income.
COMPOSITE INDEX -- 65% Standard & Poor's 500 Index and 35% Lehman Long-Term
Corporate AA or Better Bond Index.
COMPOSITE INDEX -- 65% Lehman Long-Term Corporate AA or Better Bond Index and a
35% weighting in a blended equity composite (75% Standard & Poor's/BARRA Value
Index and 25% Standard & Poor's Utilities Index).
LEHMAN LONG-TERM CORPORATE AA OR BETTER BOND INDEX -- consists of all publicly
issued, fixed rate, nonconvertible investment grade, dollar-denominated,
SEC-registered corporate debt rated AA or AAA.
FOREIGN INVESTMENTS
FOREIGN INVESTMENTS Investors should recognize that investing in foreign
companies involves certain special considerations which are not typically
associated with investing in U.S. companies. Since the stocks of foreign
companies are frequently denominated in foreign currencies, and since the Fund
may temporarily hold uninvested reserves in bank deposits in foreign currencies,
it will be affected favorably or unfavorably by changes in currency rates and in
exchange control regulations, and may incur costs in connection with conversions
between various currencies. The investment policies of the Fund permit it to
enter into forward foreign currency exchange contracts in order to hedge its
holdings and commitments against changes in the level of future currency rates.
Such contracts involve an obligation to purchase or sell a specific currency at
a future date at a price set at the time of the contract.
As foreign companies are not generally subject to uniform accounting,
auditing and financial reporting standards and practices comparable to those
applicable to domestic companies, there may be less publicly available
information about certain foreign companies than about domestic companies.
Securities of some foreign companies are generally less liquid and more volatile
than securities of comparable domestic companies. There is generally less
government supervision and regulation of stock exchanges, brokers and listed
B-11
<PAGE> 51
companies than in the U.S. In addition, with respect to certain foreign
countries, there is the possibility of expropriation or confiscatory taxation,
political or social instability, or diplomatic developments which could affect
U.S. investments in those countries.
Although the Fund will endeavor to achieve most favorable execution costs
in its portfolio transactions, fixed commissions on many foreign stock exchanges
are generally higher than negotiated commissions on U.S. exchanges. In addition,
it is expected that the expenses for custodian arrangements of the Fund's
foreign securities will be somewhat greater than the expenses for a Fund that
invests primarily in domestic securities.
Certain foreign governments levy withholding taxes against dividend and
interest income. Although in some countries a portion of these taxes are
recoverable, the non-recovered portion of foreign withholding taxes will reduce
the income received from the companies comprising the Fund's Portfolio.
Over the last decade the growth in the international stock markets has
considerably outpriced that of the U.S. Stock Market. Almost two-thirds of the
world's equity market capitalization now lies outside the United States.
As of December 31, 1996 the total market capitalization of the Morgan
Stanley Capital International World Stock Market Index was $10.5 trillion. The
major countries and regions comprising the Index are as follows:
<TABLE>
<CAPTION>
PERCENT OF WORLD
INDEX
CAPITALIZATION
-------------------
<S> <C> <C>
United States.......................................................... 43%
Canada................................................................. 3
Japan.................................................................. 17
Other Pacific Basin.................................................. 7
------
Total Pacific Basin.................................................... 24
Europe................................................................. 30
======
100%
</TABLE>
TOTAL RETURN
The average annual total return for the European Portfolio* for one- and
five-year periods ended December 31, 1996 and since its inception on June 18,
1990 was +21.26%, +13.53% and +10.90%, respectively. The average annual return
for the Pacific Portfolio* for the same periods was -7.82%, +3.48% and +1.88%,
respectively. The average annual total return for the Emerging Markets
Portfolio** for one-year period ended December 31, 1996 and since its inception
on May 4, 1994 was +15.83% and +9.69%.
*Performance figures are not adjusted for a 1% transaction fee on purchases
and the annual account maintenance fee of $10.
**Performance figures are not adjusted for the 2% portfolio transaction fee
on purchases, the 1% portfolio transaction fee on redemptions, and the annual
account maintenance fee of $10.
NOTE: Effective January 1, 1997, the 2% transaction fee on purchases of
the Emerging Markets Portfolio was reduced to 1.5% and the 1% transaction fee
deducted from purchases of the Pacific Portfolio was reduced to 0.5%. The 1%
transaction fee for the European Portfolio remained unchanged.
FINANCIAL STATEMENTS
The Fund's Financial Statements for the year ended December 31, 1996,
including the financial highlights, appearing in the Fund's 1996 Annual Report
to Shareholders, and the report thereon of Price Waterhouse LLP, independent
accountants, also appearing therein, are incorporated by reference in this
Statement of Additional Information. The Fund's 1996 Annual Report to
Shareholders is enclosed with this Statement of Additional Information.
B-12
