-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: keymaster@town.hall.org Originator-Key-Asymmetric: MFkwCgYEVQgBAQICAgADSwAwSAJBALeWW4xDV4i7+b6+UyPn5RtObb1cJ7VkACDq pKb9/DClgTKIm08lCfoilvi9Wl4SODbR1+1waHhiGmeZO8OdgLUCAwEAAQ== MIC-Info: RSA-MD5,RSA, NuwnG1QtzZQgi1SFI+x1GecLvhJTWHYSrEzW6cLaheQrjczVM4hDcpdaEOqdNei3 Bzs0S+lUOWMsge57PutaxA== 0000893220-95-000089.txt : 19950301 0000893220-95-000089.hdr.sgml : 19950301 ACCESSION NUMBER: 0000893220-95-000089 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19941231 FILED AS OF DATE: 19950227 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: VANGUARD/WELLESLEY INCOME FUND INC CENTRAL INDEX KEY: 0000105544 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 231711688 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: N-30D SEC ACT: 1940 Act SEC FILE NUMBER: 811-01766 FILM NUMBER: 95515516 BUSINESS ADDRESS: STREET 1: PO BOX 2600 STREET 2: VM #V34 CITY: VALLEY FORGE STATE: PA ZIP: 19482 BUSINESS PHONE: 610-669-6289 MAIL ADDRESS: ZIP: 19482 FORMER COMPANY: FORMER CONFORMED NAME: WELLESLEY INCOME FUND INC DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: RICHWILL INCOME FUND DATE OF NAME CHANGE: 19700608 N-30D 1 VANGUARD WELLESLEY INCOME FUND 1994 ANNUAL REPORT 1 VANGUARD WELLESLEY INCOME FUND ANNUAL REPORT 1994 THE VANGUARD VOYAGE . . . STAYING THE COURSE 2 THE VANGUARD VOYAGE. . . STAYING THE COURSE WE ARE PRESENTLY OBSERVING TWO MILESTONES IN OUR HISTORY: (1) THE 20TH ANNIVERSARY OF THE VANGUARD GROUP; AND (2) THE 65TH ANNIVERSARY YEAR OF WELLINGTON FUND, THE OLDEST MUTUAL FUND ASSOCIATED WITH VANGUARD. WE CELEBRATE THESE TWO EVENTS SINCE THEY HAVE INDELIBLY ALTERED THE MUTUAL FUND INDUSTRY--IN OUR VIEW, FOR THE BETTER. Wellington Fund--a pioneer in the mutual fund industry-began operations on June 30, 1929. Its first fifteen years were a struggle for survival in an industry that was shaken to its roots by the Great Crash of 1929-1933. From an initial base of $100,000, Wellington's assets had grown to but $27 million by the end of World War II. The Vanguard Group was founded on September 24, 1974. Soon thereafter, we assumed responsibility for the management of Wellington Fund and ten associated funds, with assets aggregating $1.4 billion. The years that followed the founding of The Vanguard Group were marked by exceptional growth. Today, Wellington Fund, with assets of nearly $9 billion, remains one of the largest mutual funds in the nation. And Vanguard, now managing 85 mutual fund portfolios, is entrusted with assets of $134 billion, and ranks as the second largest fund complex in the world. Our durability in an era of change--and our longevity in an era of challenge--didn't "just happen." What brought us to where we are today is what we were when we began. Put another way, we set our original investment course based on sound principles, and our corporate course based on a single focus: serving solely the interests of our Fund shareholders. FOUNDING INVESTMENT PRINCIPLES The founding investment principles of Wellington Fund were, above all, conservative. The Fund provided a broadly diversified portfolio at a time when holding individual securities was the conventional strategy. It incurred no debt in an era of high leverage that would soon come back to haunt less cautious investors. And it was a "balanced" fund--in fact, Wellington is America's oldest balanced fund--with holdings from each of the three basic financial asset classes: cash reserves, bonds, and common stocks. In short, Wellington Fund was a staid investment in an era of stock speculation that was to become, almost within moments, an era of conservatism. For Vanguard, these investment principles endure. "Balance" is still our watchword, because the three basic financial asset classes have different--and usually countervailing--investment characteristics. When it began, Wellington Fund provided a balanced program in a single investment; in 1994, such a balance is often achieved by a combination of Vanguard money market, bond, and stock funds. "Conservatism," too, remains our standard. Over the years, we have tried to maintain the discipline to eschew offering funds that lack sound financial principles, often based on marketplace fads that could not--and did not--endure. Our conservatism applies not only to the funds we offer, but to the instruments in which they invest. For example, we have steered clear of exotic derivative securities with unpredictable investment characteristics. Too many fund managers have been taken in by these highly risky instruments, and their shareholders have paid a heavy price--except in cases where the manager has "made the fund whole," when to do otherwise would have shocked investors and impaired their confidence in the fund complex. Speculation, it seems, comes and goes, albeit in different guises. But the investment principles to which we have adhered since Wellington Fund began in 1929 remain firm: * We offer Funds with sound and durable investment objectives, designed for long-term investors. (please turn to inside back cover) VANGUARD/WELLESLEY INCOME FUND SEEKS TO PROVIDE AS MUCH CURRENT INCOME AS IS CONSISTENT WITH REASONABLE RISK, WHILE ALSO OFFERING THE POTENTIAL FOR MODERATE CAPITAL GROWTH. NORMALLY, ABOUT 60% OF THE FUND'S ASSETS ARE INVESTED IN FIXED-INCOME SECURITIES AND 40% IN COMMON STOCKS. 3 CHAIRMAN'S LETTER FELLOW SHAREHOLDER: The year ended December 31, 1994, was a tough period for income funds. The bond market took something of a drubbing, and the stock market barely held its own. The results achieved by Wellesley Income Fund were, of course, affected by these trends, and we closed the year with a return of -4.4%, only our second negative return in the past twenty years. This table compares the Fund's total return (capital change plus income) with those of the two unmanaged indexes of the markets in which we invest: for stocks, the Standard & Poor's 500 Composite Stock Price Index; and for bonds, the Lehman Long-Term Corporate Bond Index. A hypothetical portfolio composed of the two Indexes--reflecting the Fund's typical balance of 65% bonds and 35% stocks--would have earned a total return of -3.3%, a bit better than the return of the Fund.
- ---------------------------------------------------------- Total Return ----------------- Year Ended December 31, 1994 - ---------------------------------------------------------- WELLESLEY INCOME FUND -4.4% - ---------------------------------------------------------- LEHMAN LONG-TERM CORPORATE BOND INDEX -5.8% STANDARD & POOR'S 500 STOCK INDEX +1.3 - ----------------------------------------------------------
The Fund's total return is based on net asset values of $19.24 per share on December 31, 1993, and $17.05 on December 31, 1994, with the latter figure adjusted to take into account the reinvestment of our four quarterly dividends totaling $1.11 per share from net investment income and distributions totaling $.24 per share from net realized capital gains. Wellesley's dividend yield at year end was 7.1%. THE FINANCIAL MARKETS IN 1994 Following a twelve-year bull market in bonds--including eight years of "double-digit" gains--bonds faltered during 1994. The total return on the Lehman Corporate Bond Index was -5.8% (-13.2% decline in price, partly offset by interest income of +7.4%), as yields on long-term corporates rose from 7.3% to 8.6%. Yields on short-term and intermediate-term bonds also rose sharply; however, because of their shorter maturities, price declines were much smaller. The stock market treated investors more kindly during 1994, although the rising rate environment was a major factor in dampening stock returns. Equities encountered significant volatility during the year, but, on balance, the Standard & Poor's 500 Index eased just a notch lower--from 466 at the outset to 459 at the year's conclusion, a decline of -1.5%. The inclusion of dividend income of $13 brought the Index's total return into positive territory (+1.3%). Despite this modest gain in the overall stock market, the returns on higher-yielding stocks (as distinct from, say, growth stocks) were generally negative, since their yields must compete directly with the yields available on bonds. A primary cause of the year's steep interest rate rise was investor fears about a resurgence of inflation. So far, at least, the U.S. Consumer Price Index gives little evidence of it. The CPI has risen just 2.7% over the past twelve months, although more sensitive indicators--such as commodity prices and producer prices--have been rising at higher rates. In an effort to quell inflationary fears, the Federal Reserve acted to "tighten" the money supply [FIGURE 1] 4 [FIGURE 2] in order to slow economic growth and rein in potential future inflation. Fully six rate increases--in February, March, April, May, August, and again in November--combined to raise the Federal funds rate (at which banks borrow from one another) from 3.00% to 5.50%. Still, the specter of inflation remains, and further rate increases may well lie in prospect. To add some perspective to the financial market cross-currents in 1994, we present the chart above showing the cumulative returns on stocks and bonds during the past five years--the first half (believe it or not!) of the decade of the 1990s. Particularly striking is that the average annual total return on bonds (+8.6%) was virtually identical to the return on stocks (+8.7%). As a result, despite the "slings and arrows" of 1994, bond-oriented income funds such as Wellesley gave a good account of themselves in terms of total return during the five-year period, all the while assuming a lower-risk profile than an all-stock portfolio. As 1994 has now made obvious, there are times when bonds carry higher risks than stocks. Nonetheless, there is some tendency for the two securities markets to fluctuate independently (1990 was another good example). And it is this tendency that continues to commend an income fund such as Wellesley as a particularly suitable investment for long-term investors seeking a combination of generous current income and the potential for modest capital growth with reasonable risk. WELLESLEY INCOME FUND IN 1994 Our total return of -4.4% was, as noted at the outset, a bit less than the return of -3.3% for our corporate bond/stock index. The biggest factor in shaping the Fund's return in 1994 was our exposure to interest rate risk. While this risk exposure was marginally reduced late in 1993 by a selective shortening of bond maturities, this more conservative position was simply overwhelmed by the bond market's pervasive decline, and the returns on our bonds were essentially the same as those on the bond index. On the other hand, our equity position--designed to produce above-average yields--was heavily invested in some of the most yield-sensitive securities of the equity market. These stocks suffered equally with--and in some cases even more than--the bond market. The best example of this dichotomy can be seen by looking at the returns achieved by two distinctive market sectors: the utility group, which experienced a negative total return of -10% for the year, and the technology group, which enjoyed a positive return of +20%. Utility stocks, of course, provide very high yields; technology stocks, low yields. Given the Fund's income objective, it had fully 28% of its equity portfolio in the former group and no representation in the latter. These two differences alone accounted for 3.5 percentage points of the 3.6 point shortfall of our equity position relative to the Standard & Poor's 500 Stock Index. (Our equity return of -2.3% compared with +1.3% for the Index.) The Fund's total return also fell a bit behind the -2.9% return of the average income-oriented mutual fund, a shortfall of 1.5 percentage points. However, as we noted last year--when we achieved a positive margin of +2.5 percentage points over our competitors--portfolios of income-oriented funds are a sort of "mixed bag," and are difficult to evaluate relative to our "plain vanilla" bond-stock strategy. 2 5 [FIGURE 3]
Average Annual Total Returns--Periods Ended December 31, 1994 - ------------------------------------------------------------- 1 Year 5 Years 10 Years - ------------------------------------------------------------- WELLESLEY INCOME FUND -4.44% +8.47% +11.80% AVERAGE INCOME FUND -2.92 +7.49 + 9.88 COMPOSITE INDEX* -3.29 +8.65 +12.52 LEHMAN BOND INDEX -5.76 +8.57 +11.47
*Composite Index is 65% Lehman Corporate Bond Index and 35% Standard & Poor's 500 Index. Note: Past performance is not predictive of future performance. While other income funds, on average, maintain a bond position similar to ours (64% and 61% of net assets, respectively), the quality of their bonds is distinctly lower. We hold no bonds rated below "investment-grade," while the average income fund holds fully 44% of its bond portfolio in lower-rated or unrated bonds. Also, other income funds are more inclined to fill out the equity portion of their portfolios with foreign and smaller capitalization stocks and convertible bonds. The strategies of most income funds, then, entail higher risks in bond quality than we are willing to assume. As a result, it is not surprising that their portfolios generate higher levels of gross income. Indeed, the average income fund earns a gross yield of 7.9%, compared with 7.5% for Wellesley. However, these funds are also much more expensive to hold--average annual operating expense ratio of 1.06% versus 0.34% for our Fund--giving us a 0.72% "natural" yield advantage, other factors held equal. As a result, Wellesley's net yield of 7.1% for 1994 surpassed the competitors' average net yield of 6.9%. When an investor can obtain a higher net yield on a higher quality portfolio, it is a proposition worth carefully considering. I should mention that I have already received letters from shareholders asking why Wellesley Income Fund didn't simply replace its long-term bonds with those of the short-term variety, and replace its utility stocks with technology stocks. The answers are really two: 1) such a strategy would have been inconsistent with the Fund's stated policies and objectives and, what is more, would have reduced the Fund's dividend income by something like 40%; and 2) hindsight, it is said, is "always 20/20," and forecasting the events of 1994 accurately and in advance is, in truth, beyond the ability of experienced and amateur investors alike. There is no "bell" that rings to signal a coming deterioration in the short-term market climate, nor, for that matter, is there a bell that signals a coming improvement. (continued) 3 6 A TEN-YEAR REVIEW It seems to me that investors should give only limited weight to a mutual fund's results in any single year. And I would regard the modest shortfall in Wellesley Income Fund's performance in 1994 as merely a "blip" in our remarkable long-term record of success. Relative to competitive funds, the record of Wellesley Income Fund is clearly a superior one, as shown by the cumulative returns presented in the chart on page 3. To summarize, during the past decade, our average annual total return was +11.8%, compared with +9.9% for the average income fund. If that annual margin sounds small, I assure you that, compounded over a decade, it is anything but! This summary table compares the ten-year results assuming an investment of $10,000 on December 31, 1984, in both Wellesley Income Fund and the average income fund, with all dividends and capital gains reinvested. On December 31, 1994, the investor in Wellesley Income Fund would have accumulated $30,520; the investor in the average income fund, $25,650. This $4,870 of extra performance is equivalent to 49%(!) of the initial $10,000 investment.
- ------------------------------------------------------------------- Total Return ------------------------------------ Ten Years Ended December 31, 1994 ------------------------------------ Annual Rate Final Value of Initial of Return Investment of $10,000 - ------------------------------------------------------------------- WELLESLEY INCOME FUND +11.8% $30,520 AVERAGE INCOME FUND + 9.9 25,650 - ------------------------------------------------------------------- WELLESLEY ADVANTAGE + 1.9% $ 4,870 - -------------------------------------------------------------------
It should go without saying that the returns reflected in the table are merely history. The Fund's future returns--both on an absolute basis and relative to our peer group--are unpredictable, and may be better or worse than those illustrated. I acknowledge that the chart on page 3 also reflects the shortfall (averaging -0.7% annually) that Wellesley Income Fund has experienced relative to our "composite index," comprising 65% bonds and 35% stocks. The most important reason for this differential is that the Standard & Poor's 500 Index includes both growth stocks and income stocks. However, given our basic objectives, the Fund's equity position is limited to income stocks. Since the returns on growth stocks were well above those earned on income-oriented stocks during the past decade, we were distinctly disadvantaged relative to the Index. I should also add that the bond and stock market indexes represent very tough "bogeys" for all mutual funds to match. Market indexes are theoretical constructs, operating in a "paper world" and completely free of the "real world" expenses of fund operations, advisory fees, portfolio transaction costs, and the "drag" of cash reserves. Of course, Wellesley's costs are remarkably low, in part because we have negotiated sensibly low advisory fees (about 0.07% of assets in 1994) with Wellington Management Company, and in part because of the "at-cost" structure under which The Vanguard Group operates. Given these low costs, our objective remains to outpace a similarly constructed composite index over the long term. IN SUMMARY In my Chairman's letter one year ago, I called your special attention to the fact that "all income funds . . . entail exposure to interest rate risk. That is to say, both higher-yielding stocks and longer-term bonds have significant price sensitivity to changes in interest rates. This sensitivity `paid off' for Wellesley Income Fund in 1993, as rates fell sharply; but you should not ignore the possibility--even, perhaps, the likelihood--of some retracement in interest rates, and the commensurately negative impact on the Fund." That situation, of course, is precisely what came to pass during 1994. While it simply is not possible--for anyone--to accurately forecast the future course of interest rates, I believe that with rates having risen so sharply over the past year, the probabilities now favor better total returns for bonds in the coming year. (There are no guarantees!) Whatever the case may be, the Fund's return in 1994 should not unduly disturb the shareholder who is holding Wellesley Income Fund for the long haul. If our record since we began operations in 1970 proves anything, it surely proves that the Fund has been a reliable and productive investment for long-term investors who can (as they inevitably must) take short-term disappointments in stride. 4 7 So, we suggest that the best strategy for shareholders is to "stay the course," come what may in the financial markets. For our part, we assure you that we, too, will stay the course, holding fast to the conservative investment principles and income orientation that have served our shareholders so well over nearly a quarter century. Sincerely, /s/ JOHN C. BOGLE - ----------------- John C. Bogle Chairman of the Board January 16, 1995 AVERAGE ANNUAL TOTAL RETURNS--THE CURRENT YIELD QUOTED IN THE CHAIRMAN'S LETTER IS CALCULATED IN ACCORDANCE WITH SEC GUIDELINES. THE AVERAGE ANNUAL TOTAL RETURNS FOR THE FUND (PERIODS ENDED DECEMBER 31, 1994) ARE AS FOLLOWS:
10 YEARS ----------------------------- INCEPTION TOTAL INCOME CAPITAL DATE 1 YEAR 5 YEARS RETURN RETURN RETURN --------- ------ ------- ------ -------- ------- WELLESLEY INCOME FUND 7/1/70 -4.44% +8.47% +11.80% +7.98% +3.82%
ALL OF THESE DATA REPRESENT PAST PERFORMANCE. THE INVESTMENT RETURN AND PRINCIPAL VALUE OF AN INVESTMENT WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. 5 8 TOTAL INVESTMENT RETURN TABLE The following table illustrates the results of a single share investment in VANGUARD/WELLESLEY INCOME FUND since inception through December 31, 1994. During the period illustrated, stock and bond prices fluctuated widely; these results should not be considered a representation of the dividend income or capital gain or loss that may be realized from an investment made in the Fund today.
- ------------------------------------------------------------------------------------------------------------------------------------ PERIOD PER SHARE DATA TOTAL INVESTMENT RETURN* - ------------------------------------------------------------------------------------------------------------------------------------ Wellesley Income Fund Composite Value With Income ----------------------------- Stock/Bond Year Ended Net Asset Capital Gains Income Dividends & Capital Capital Income Total Index** December 31 Value Distributions Dividends Gains Reinvested Return Return Return Total Return - ------------------------------------------------------------------------------------------------------------------------------------ INITIAL (7/70) $11.66 -- -- $ 11.66 -- -- -- -- - ------------------------------------------------------------------------------------------------------------------------------------ 1970 12.03 -- $ .46 12.49 + 3.2% + 3.9% + 7.1% +10.6% - ------------------------------------------------------------------------------------------------------------------------------------ 1971 12.56 $.38 .85 14.37 + 7.6 + 7.4 +15.0 +12.1 - ------------------------------------------------------------------------------------------------------------------------------------ 1972 12.66 .26 .82 15.77 + 2.9 + 6.8 + 9.7 +11.4 - ------------------------------------------------------------------------------------------------------------------------------------ 1973 11.40 -- .83 15.22 -10.0 + 6.5 - 3.5 - 4.4 - ------------------------------------------------------------------------------------------------------------------------------------ 1974 9.84 -- .82 14.24 -13.7 + 7.3 - 6.4 -14.2 - ------------------------------------------------------------------------------------------------------------------------------------ 1975 10.69 -- .82 16.73 + 8.6 + 8.9 +17.5 +24.4 - ------------------------------------------------------------------------------------------------------------------------------------ 1976 12.23 -- .88 20.62 +14.4 + 8.9 +23.3 +22.0 - ------------------------------------------------------------------------------------------------------------------------------------ 1977 11.81 -- .93 21.50 - 3.4 + 7.7 + 4.3 - 0.8 - ------------------------------------------------------------------------------------------------------------------------------------ 1978 11.27 -- .96 22.28 - 4.6 + 8.2 + 3.6 + 2.2 - ------------------------------------------------------------------------------------------------------------------------------------ 1979 10.98 -- 1.00 23.66 - 2.6 + 8.8 + 6.2 + 3.8 - ------------------------------------------------------------------------------------------------------------------------------------ 1980 11.08 -- 1.14 26.47 + 0.9 +11.0 +11.9 + 9.7 - ------------------------------------------------------------------------------------------------------------------------------------ 1981 10.74 -- 1.25 28.76 - 3.1 +11.8 + 8.7 - 1.8 - ------------------------------------------------------------------------------------------------------------------------------------ 1982 11.82 -- 1.26 35.46 +10.1 +13.2 +23.3 +36.5 - ------------------------------------------------------------------------------------------------------------------------------------ 1983 12.66 -- 1.31 42.06 + 7.1 +11.5 +18.6 +13.3 - ------------------------------------------------------------------------------------------------------------------------------------ 1984 13.28 -- 1.37 49.06 + 4.9 +11.7 +16.6 +13.6 - ------------------------------------------------------------------------------------------------------------------------------------ 1985 15.31 .10 1.38 62.51 +16.0 +11.4 +27.4 +29.3 - ------------------------------------------------------------------------------------------------------------------------------------ 1986 16.27 .47 1.33 73.97 + 9.2 + 9.1 +18.3 +18.7 - ------------------------------------------------------------------------------------------------------------------------------------ 1987 14.57 .38 1.04 72.55 - 8.1 + 6.2 - 1.9 + 2.8 - ------------------------------------------------------------------------------------------------------------------------------------ 1988 15.26 -- 1.23 82.42 + 4.7 + 8.9 +13.6 +12.6 - ------------------------------------------------------------------------------------------------------------------------------------ 1989 16.82 .24 1.31 99.67 +11.8 + 9.1 +20.9 +21.0 - ------------------------------------------------------------------------------------------------------------------------------------ 1990 16.02 .08 1.30 103.42 - 4.3 + 8.1 + 3.8 + 3.1 - ------------------------------------------------------------------------------------------------------------------------------------ 1991 18.08 -- 1.27 125.73 +12.9 + 8.7 +21.6 +24.3 - ------------------------------------------------------------------------------------------------------------------------------------ 1992 18.16 .21 1.21 136.63 + 1.6 + 7.1 + 8.7 + 8.7 - ------------------------------------------------------------------------------------------------------------------------------------ 1993 19.24 .40 1.14 156.65 + 8.2 + 6.4 +14.6 +12.4 - ------------------------------------------------------------------------------------------------------------------------------------ 1994 17.05 .24 1.11 149.69 -10.2 + 5.8 - 4.4 - 3.3 - ------------------------------------------------------------------------------------------------------------------------------------ LIFETIME +1,184.1% +1,014.4% - ------------------------------------------------------------------------------------------------------------------------------------ AVERAGE ANNUAL TOTAL RETURN +11.0% +10.3% - ------------------------------------------------------------------------------------------------------------------------------------
*Adjusted to include reinvestment of income dividends and any capital gains distributions for both the Fund and the Index. **Composite index shown for comparative purposes is comprised of the Standard & Poor's 500 Stock Index (35%) and Salomon Brothers High-Grade Bond Index (65%) from June 30, 1970, through December 31, 1972, and Standard & Poor's 500 Stock Index (35%) and Lehman Long-Term Corporate Bond Index (65%) thereafter. Note: No adjustment has been made for income taxes payable by shareholders on reinvested income dividends and capital gains distributions. 6 9 REPORT FROM THE INVESTMENT ADVISER In 1994, the Federal Reserve Board raised short-term interest rates six times beginning in early February. One-year Treasury bill rates rose by more than 3.5 percentage points, while thirty-year Treasury bond yields increased by 1.5 percentage points. Because of this large increase in interest rates, Wellesley Income Fund's total return (reflecting both the change in net asset value and the distributions to shareholders) was negative for the calendar year, marking only the second time in twenty years that this has occurred. The performance of Wellesley Income Fund remains extremely sensitive to the general direction of long-term interest rates. This is due largely to the long average maturity of the Fund's bonds combined with our meaningful weighting in high-yielding, interest- rate-sensitive stocks. Both the bond and stock segments of the Wellesley portfolio had negative returns in 1994. During 1994, the Fund maintained its traditional posture of 60% to 65% of assets invested in longer-term bonds of investment-grade quality, and 35% to 40% of assets invested in dividend-paying equities. We do not anticipate a change in that strategy going forward. INVESTMENT OUTLOOK FOR 1995 The U.S. economy is still strong enough that we expect the Federal Reserve to continue to raise short-term rates. We expect some moderation in economic growth in 1995; however, we do expect inflation to rise moderately, as is typical in the year following a peak in economic activity. We are forecasting that both GDP growth and inflation will be above 3% for 1995. Federal Reserve monetary policy and government fiscal policy are mapping a course which is maintaining a balance between sustainable economic growth and fairly stable prices, both of which we are currently experiencing. The markets must be convinced that the Fed is committed to controlling inflation before long-term interest rates will stabilize. We believe this will happen; thus, we expect that long-term interest rates will remain in a trading range around the current level of 8%. We are cautious about the prospects for the stock market in 1995. The stock market is in a race between higher earnings and higher interest rates. Higher corporate earnings are currently supporting stock market valuations; however, the rise in short-term interest rates threatens earnings growth, and, at some level of short-term rates, stock prices will become vulnerable. STRATEGY IN 1995 Our strategy remains consistent with that of previous years, despite the performance decline we have experienced. The dominant theme guiding the investment strategy for Wellesley Income Fund is our ongoing obligation to shareholders to achieve an attractive absolute level of income with high-quality securities. Our long-term goal is to achieve increases in Wellesley's dividend by purchasing stocks of strong companies that are able to pass onto shareholders higher dividends generated from rising earnings spurred by successful business strategies. Since we wrote to you six months ago, the equity portfolio has had 19 companies announce dividend increases. We avoid investments in bonds rated below investment-grade and in stocks with ultra-high dividends which may not be sustainable over the longer term. After experiencing a "correction" that endured for five quarters, utility stocks, many of which have declined in value by more than 30% from their peaks in September 1993, are now modestly attractive on a relative valuation basis. Based on this cautiously optimistic view of utility stocks, we were net buyers of utilities for the first time in over two years. Wellesley's utility holdings increased to 28% of total fund equities from 27% at the end of June 1994. Another sector that we added to significantly was the energy sector. This sector has come under pressure as short-term commodity price weakness has masked an improving long-term fundamental picture. Rising global economic growth is causing an increase in demand for both oil and gas. While there are enough uncertainties in the near term (e.g., Iraq's inevitable return to the world markets) to keep us from quickly building our overweighting, we will continue to add to our positions on further market weakness. The majority of Wellesley's stocks are New York Stock Exchange-listed issues and generally have above-average yields. The average yield on our stocks 7 10 is currently 80% higher than the yield on the average stock in the marketplace. Our primary focus is securities of U.S.-based companies, so we are pleased that, given the devaluation of the peso, we did not own stocks or bonds of any Mexican companies. The Fund's bond portfolio will continue to have a long average maturity and excellent call protection, which should lend sustainability to the Fund's income stream, even though these bonds are subject to price fluctuations in the short-term. Our bond holdings currently have an average maturity of 16 years, an average coupon of 7.3%, and an average quality rating of "Aa." Eighty-eight percent of the bond portfolio's assets are rated "A" or better. Over the long term, we believe that high-quality, long-term bonds with call protection will provide reasonably attractive real returns. SUMMARY Following the large increase in rates last year (and thus the Fund's negative total return), we believe that 1995 will be more positive for shareholders primarily because we expect long-term interest rates to stabilize in coming months. The same investment disciplines utilized for Wellesley Income Fund over the past two decades will continue to be followed in 1995. We have the utmost confidence in the Fund's consistent investment approach, which stresses securities of high-quality companies with attractive yields. Over the long term, shareholders should achieve satisfactory rewards as long as inflation is reasonably contained and long-term interest rates do not rise sharply. Respectfully, Earl E. McEvoy Senior Vice President John R. Ryan Senior Vice President Wellington Management Company January 11, 1995 8 11 FINANCIAL STATEMENTS December 31, 1994 STATEMENT OF NET ASSETS
Face Market Amount Value (000) (000)+ - ------------------------------------------------------ CORPORATE BONDS (39.9%) - ------------------------------------------------------ ASSET-BACKED SECURITIES (2.0%) American Express Trust 7.15%, 8/15/99 $25,000 $ 24,051 Discover Card 6.25%, 8/16/00 20,000 18,900 6.80%, 6/16/00 25,000 24,078 General Motors Acceptance Corp. 6.30%, 6/15/99 31,316 30,591 NationsBank Corp. 6.00%, 12/15/05 20,000 17,187 --------- GROUP TOTAL 114,807 --------- - ------------------------------------------------------ BANKS & FINANCE (9.0%) Allstate Corp. 7.50%, 6/15/13 20,000 17,293 BankAmerica Corp. 7.50%, 10/15/02 10,000 9,347 Bank of Boston 6.625%, 12/1/05 15,000 12,645 6.875%, 7/15/03 15,000 13,340 Bank of New York 7.875%, 11/15/02 15,000 14,329 Boatmen's Banchares, Inc. 7.625%, 10/1/04 10,000 9,367 British Telecom Finance 9.625%, 2/15/19 5,000 5,270 Chase Manhattan Corp. 6.50%, 8/1/05 15,000 12,662 Chemical Bank 8.625%, 5/1/02 20,000 19,986 Comerica, Inc. 7.125%, 12/1/13 15,000 12,779 8.375%, 7/15/24 5,000 4,646 CoreStates Capital 6.625%, 3/15/05 20,000 17,081 First Bank System 6.625%, 5/15/03 10,000 8,853 First Chicago Corp. 6.375%, 1/30/09 5,000 4,007 7.625%, 1/15/03 15,000 14,117 First Union Corp. 6.00%, 10/30/08 15,000 11,513 Fleet Financial Group 6.875%, 3/1/03 30,000 26,808 7.625%, 12/1/99 15,000 14,494 Ford Motor Credit Corp. 5.625%, 12/15/98 20,000 18,109 General Motors Acceptance Corp. 7.00%, 9/15/02 30,000 26,841 International Bank for Reconstruction & Development 8.25%, 9/1/16 15,000 14,851 8.625%, 10/15/16 20,000 20,405 J. P. Morgan & Co., Inc. 5.75%, 10/15/08 20,000 15,416 6.25%, 1/15/09 20,000 16,390 Morgan Guaranty Trust 7.375%, 2/1/02 20,000 18,888 NBD Bank 6.25%, 8/15/03 20,000 17,264 National City Cleveland Bank 6.50%, 5/1/03 10,000 8,810 NationsBank Corp. 7.75%, 8/15/04 15,000 14,088 Norwest Corp. 6.00%, 3/15/00 15,000 13,534 6.65%, 10/15/23 10,000 7,861 Norwest Financial Corp. 7.95%, 5/15/02 10,000 9,737 Republic New York Corp. 5.875%, 10/15/08 15,000 11,611 State Street Bank & Trust Co. 5.95%, 9/15/03 5,000 4,221 Suntrust Banks 6.125%, 2/15/04 20,000 17,059 7.375%, 7/1/02 16,000 15,086 Wachovia Corp. 6.375%, 4/15/03 20,000 17,500 Wells Fargo & Co. 6.125%, 11/1/03 15,000 12,716 --------- GROUP TOTAL 508,924 --------- - ------------------------------------------------------ INDUSTRIAL (13.0%) Alcan Aluminium Ltd. 9.625%, 7/15/19 7,000 7,139 Aluminum Co. of America 5.75%, 2/1/01 20,000 17,617 Amoco Canada Petroleum Co. 6.75%, 9/1/23 25,000 20,171 Archer-Daniels-Midland 8.375%, 4/15/17 5,000 4,962 Bristol-Meyers Squibb Co. 7.15%, 6/15/23 25,000 21,813 British Petroleum Co. 7.875%, 5/15/02 20,000 19,552 Burlington Resources 7.15%, 5/1/99 10,000 9,567 Chevron Corp. 9.375%, 6/1/16 10,000 10,328
9 12 STATEMENT OF NET ASSETS (continued)
Face Market Amount Value (000) (000)+ - ------------------------------------------------------- Coastal Corp. 8.125%, 9/15/02 $10,000 $ 9,457 9.75%, 8/1/03 11,275 11,700 10.00%, 2/1/01 27,000 27,998 Coca-Cola Co. 6.00%, 7/15/03 10,000 8,657 Coca-Cola Enterprises, Inc. 7.875%, 2/1/02 10,000 9,732 Crown Cork & Seal Co., Inc. 8.00%, 4/15/23 15,000 13,513 E.I. du Pont de Nemours & Co. 8.125%, 3/15/04 9,900 9,835 8.25%, 1/15/22 30,000 28,848 Eastman Chemical 7.25%, 1/15/24 25,000 20,761 Eaton Corp. 7.625%, 4/1/24 10,000 8,895 Enron Corp. 7.00%, 8/15/23 10,000 7,982 Ford Motor Co. 8.875%, 1/15/22 10,000 10,099 General Motors Corp. 9.40%, 7/15/21 20,000 20,764 Georgia Pacific Corp. 9.50%, 5/15/22 10,000 10,028 Gillette Co. 5.75%, 10/15/05 20,000 16,632 6.25%, 8/15/03 10,000 8,771 International Paper Co. 7.625%, 1/15/07 15,000 13,997 Johnson & Johnson 6.73%, 11/15/23 20,000 16,450 Johnson Controls 8.20%, 6/15/24 6,000 5,624 Knight-Ridder, Inc. 8.50%, 9/1/01 10,000 9,979 Lockheed Corp. 6.75%, 3/15/03 7,000 6,202 McDonalds Corp. 7.375%, 7/15/33 7,500 6,474 Mobil Corp. 8.625%, 8/15/21 20,000 20,326 9.17%, 2/29/00 7,353 7,515 Monsanto Co. 6.00%, 7/1/00 18,750 16,646 8.13%, 12/15/06 5,000 4,843 Northrop-Grumman 9.375%, 10/15/24 15,000 14,859 PPG Industries, Inc. 9.00%, 5/1/21 10,000 10,339 J.C. Penney Co., Inc. 9.75%, 6/15/21 20,000 21,569 Philips Electronics 7.75%, 4/15/04 10,000 9,429 Phillips Petroleum Co. 9.375%, 2/15/11 10,000 10,428 Praxair Inc. 6.75%, 3/1/03 25,000 22,254 Procter & Gamble Co. 9.36%, 1/1/21 30,000 32,364 Rohm & Haas Co. 9.80%, 4/15/20 10,000 11,128 Shell Oil Co. 6.625%, 7/1/99 15,000 14,178 Tele-Communications, Inc. 9.25%, 1/15/23 20,000 18,136 Tenneco, Inc. 7.875%, 10/1/02 20,000 19,007 Texaco, Inc. 8.625%, 4/1/32 30,000 29,817 United Parcel Service 8.375%, 4/1/20 10,000 10,025 Unocal Corp. 8.75%, 8/15/01 10,000 10,104 WMX Technologies 6.375%, 12/1/03 20,000 17,423 Wal-Mart Stores Inc. 5.875%, 10/15/05 25,000 20,542 6.50%, 6/1/03 10,000 8,862 Whirlpool Corp. 9.00%, 3/1/03 10,000 10,283 Witco Chemical Corp. 6.60%, 4/1/03 5,000 4,479 --------- GROUP TOTAL 738,103 --------- - ------------------------------------------------------- TRANSPORTATION (.3%) AMR Corp. Cvt. 6.125%, 11/1/24 8,200 6,560 Hertz Corp. 6.00%, 2/1/01 15,000 13,245 --------- GROUP TOTAL 19,805 --------- - ------------------------------------------------------- UTILITY (15.6%) AT&T Corp. 6.75%, 4/1/04 10,000 9,022 7.125%, 1/15/02 33,750 31,846 8.625%, 12/1/31 40,000 39,111 Arizona Public Service Co. 6.625%, 3/1/04 10,000 8,729 9.50%, 4/15/21 10,000 10,191 Baltimore Gas & Electric Co. 7.25%, 7/1/02 15,000 14,037 8.375%, 8/15/01 10,000 10,024
10 13
Face Market Amount Value (000) (000)+ - ------------------------------------------------------- BellSouth Telecommunications 6.25%, 5/15/03 $12,000 $10,587 8.25%, 7/1/32 35,000 32,940 Carolina Power & Light Co. 6.875%, 8/15/23 10,000 8,025 Carolina Telephone & Telegraph Co. 5.75%, 8/15/00 5,000 4,426 Central Illinois Public Service 6.375%, 4/1/03 4,000 3,559 Chesapeake & Potomac Telephone Co., MD 7.15%, 5/1/23 20,000 17,180 Chesapeake & Potomac Telephone Co., VA 7.875%, 1/15/22 15,000 14,488 Commonwealth Edison Co. 7.00%, 7/1/05 10,000 8,689 7.375%, 9/15/02 15,000 13,782 Consolidated Edison Co. 6.375%, 4/1/03 20,000 17,653 Duke Power Co. 5.875%, 6/1/01 16,900 14,852 7.00%, 7/1/33 10,000 8,195 Florida Power & Light Co. 5.375%, 4/1/00 12,500 11,008 GTE Florida Inc. 6.31%, 12/15/02 20,000 17,725 Houston Lighting & Power Co. 7.50%, 7/1/23 20,000 17,319 Illinois Bell Telephone Co. 6.625%, 2/1/25 10,000 8,021 7.25%, 3/15/24 20,000 16,962 Illinois Power Co. 5.625%, 4/15/00 10,000 8,776 6.50%, 8/1/03 10,000 8,759 7.50%, 7/15/25 10,000 8,330 Iowa-Illinois Gas & Electric Co. 6.95%, 10/15/25 5,000 4,063 Kansas Gas & Electric Co. 6.50%, 8/1/05 6,500 5,595 Kentucky Utilities 7.92%, 5/15/07 5,000 4,789 MCI Communications Corp. 7.125%, 1/20/00 15,000 14,282 7.50%, 8/20/04 15,000 14,209 Michigan Bell Telephone Co. 7.50%, 2/15/23 35,000 31,575 Michigan Consolidated Gas 8.25%, 5/1/14 3,200 3,134 Mountain States Telephone Co. 9.50%, 5/1/00 1,500 1,572 New England Telephone Co. 6.875%, 10/1/23 15,000 12,271 9.00%, 8/1/31 10,000 10,130 New Jersey Bell Telephone Co. 8.00%, 6/1/22 35,000 33,366 New York Telephone Co. 6.50%, 3/1/05 30,000 26,036 Niagara Mohawk Power Co. 6.875%, 3/1/01 8,500 7,529 6.875%, 4/1/03 8,000 6,869 Northern States Power Co. 6.375%, 4/1/03 8,000 7,105 Ohio Bell Telephone Co. 6.125%, 5/15/03 15,000 13,180 Pacific Bell Telephone Co. 7.00%, 7/15/04 5,000 4,577 7.125%, 3/15/26 25,000 20,851 7.25%, 7/1/02 10,000 9,413 Pacific Gas & Electric Co. 8.25%, 11/1/22 25,000 23,483 8.875%, 7/1/24 10,000 9,945 PECO Energy Corp. 6.50%, 5/1/03 30,000 26,349 Pennsylvania Power & Light Co. 6.50%, 4/1/05 15,000 12,952 6.75%, 10/1/23 9,000 7,133 Public Service Co. of Colorado 7.25%, 1/1/24 10,000 8,446 Southern California Edison Co. 6.25%, 6/15/03 6,050 5,300 8.875%, 6/1/24 10,000 9,701 Southern California Gas Co. 6.875%, 11/1/25 15,000 12,121 Southwestern Bell Telephone Co. 7.25%, 7/15/25 15,000 12,729 Southwestern Public Service Co. 7.25%, 7/15/04 10,000 9,272 8.20%, 12/1/22 10,000 9,487 Texas Utilities Co. 6.75%, 7/1/05 10,000 8,755 8.00%, 6/1/02 10,000 9,558 9.75%, 5/1/21 10,000 10,385 Union Electric Co. 6.75%, 10/15/99 7,250 6,798 6.875%, 8/1/04 10,000 9,118 U.S. West Communications 7.50%, 6/15/23 45,000 39,087 Virginia Electric & Power Co. 5.875%, 4/1/00 13,000 11,684 6.00%, 8/1/02 10,000 8,702 6.75%, 10/1/23 20,000 16,169
11 14 STATEMENT OF NET ASSETS (continued)
Face Market Amount Value (000) (000)+ - ------------------------------------------------------- Wisconsin Gas Co. 6.60%, 9/15/13 $ 2,500 $ 2,094 Wisconsin Public Service Co. 7.30%, 10/1/02 5,000 4,698 8.80%, 9/1/21 5,000 5,000 ----------- GROUP TOTAL 883,748 ----------- - ------------------------------------------------------- TOTAL CORPORATE BONDS (Cost $2,480,708) 2,265,387 - ------------------------------------------------------- U.S. GOVERNMENT & AGENCY OBLIGATIONS (20.9%) - ------------------------------------------------------- Federal Home Loan Mortgage Corp. 8.14%, 9/29/04 25,000 24,306 Federal National Mortgage Assn. 6.00%, 9/1/01 1,306 1,255 6.625%, 4/10/03 25,000 22,516 7.00%, 12/1/07-1/1/08 22,868 21,654 7.50%, 6/1/19-1/1/23 7,662 7,233 8.50%, 12/1/97-3/1/98 1,554 1,558 Government National Mortgage Assn. 6.50%, 6/15/08-12/15/24 392,326 341,765 7.00%, 4/15/17-5/15/24 129,492 117,028 7.50%, 5/15/16-8/15/22 61,777 58,057 8.00%, 3/15/02-6/15/22 29,693 28,875 Tennessee Valley Authority 6.125%, 7/15/03 16,400 14,319 7.75%, 12/15/22 25,000 23,252 8.625%, 11/15/29 40,000 39,691 U.S. Treasury Bonds 7.125%, 2/15/23 100,000 91,000 7.25%, 5/15/16 225,000 208,055 8.125%, 8/15/19 100,000 101,328 U.S. Treasury Note 5.75%, 8/15/03 100,000 86,906 - ------------------------------------------------------- TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS (Cost $1,260,004) 1,188,798 - ------------------------------------------------------- Market Value Shares (000)+ - ------------------------------------------------------- COMMON STOCKS (36.3%) - ------------------------------------------------------- CONSUMER (1.6%) Flowers Industries, Inc. 1,639,400 $ 29,714 Kimberly-Clark Corp. 730,000 36,865 Universal Corp. 1,159,600 23,047 --------- GROUP TOTAL 89,626 --------- - ------------------------------------------------------- ENERGY (6.8%) Atlantic Richfield Co. 518,000 52,707 Chevron Corp. 600,000 26,775 Dresser Industries, Inc. 683,200 12,895 Exxon Corp. 467,700 28,413 Mobil Corp. 886,900 74,721 Royal Dutch Petroleum Co. 659,500 70,896 Sun Co., Inc. 504,100 14,493 Texaco, Inc. 1,404,200 84,076 USX-Marathon Group 1,429,000 23,400 --------- GROUP TOTAL 388,376 --------- - ------------------------------------------------------- FINANCE (7.6%) Aetna Life & Casualty Co. 139,500 6,574 Banc One Corp. 600,000 15,225 BankAmerica 1,540,000 60,830 Bankers Trust New York Corp. 1,026,500 56,842 Boatmen's Bancshares, Inc. 1,454,000 39,440 Comerica, Inc. 489,000 11,919 CoreStates Financial Corp. 3,208,600 83,424 First Security Corp. 267,000 6,074 First Union Corp. 486,200 20,116 Keycorp 2,029,050 50,726 J.P. Morgan & Co., Inc. 819,644 45,900 PNC Bank Corp. 1,656,800 35,000 --------- GROUP TOTAL 432,070 --------- - ------------------------------------------------------- HEALTHCARE (1.6%) Baxter International, Inc. 845,200 23,877 Bristol-Myers Squibb Co. 877,000 50,756 Upjohn Co. 553,000 17,005 --------- GROUP TOTAL 91,638 --------- - ------------------------------------------------------- INDUSTRIAL (4.2%) Dow Chemical Co. 347,000 23,336 E.I. du Pont de Nemours & Co. 1,004,400 56,498 Eastman Kodak Co. 604,800 28,879 Ford Motor Co. 200,000 5,600 Minnesota Mining & Manufacturing Co. 536,400 28,630 Tenneco, Inc. 450,000 19,125 Union Camp Corp. 972,900 45,848 Witco Chemical Corp. 1,234,600 30,402 --------- GROUP TOTAL 238,318 --------- - -------------------------------------------------------
12 15
Market Value Shares (000)+ - --------------------------------------------------------- REAL ESTATE INVESTMENT TRUSTS (2.7%) Bay Apartment Communities, Inc. 316,200 $ 6,364 CBL & Associates Properties, Inc. 805,500 16,613 Colonial Properties 415,000 9,338 Duke Realty Investments 519,700 14,682 Equity Residential Properties Trust 308,200 9,246 General Growth Properties 486,800 11,014 (1)Home Properties of New York 425,000 8,341 JP Realty Inc. 110,500 2,321 Paragon Group, Inc. 390,000 7,410 Post Properties, Inc. 382,800 12,058 Roc Communities, Inc. 407,600 8,560 Simon Property Group 314,200 7,619 Spieker Properties 507,400 10,338 (1)Town & Country Trust 947,000 13,495 Urban Shopping Centers 532,800 10,589 Wellsford Residential Property Trust 265,200 5,569 ---------- GROUP TOTAL 153,557 ---------- - --------------------------------------------------------- RETAIL (.9%) Kmart Corp. 450,000 5,850 J.C. Penney Co., Inc. 1,020,000 45,518 ---------- GROUP TOTAL 51,368 ---------- - --------------------------------------------------------- TRANSPORTATION (.5%) Union Pacific Corp. 650,000 29,656 ---------- - --------------------------------------------------------- UTILITY (10.4%) BCE, Inc. 1,286,200 41,319 Cinergy Corp. 887,972 20,756 Consolidated Edison Co. of New York 527,400 13,581 DQE Inc. 804,700 23,839 Detroit Edison Co. 1,238,200 32,348 Entergy Corp. 524,000 11,463 Equitable Resources, Inc. 106,400 2,886 GTE Corp. 1,021,800 31,037 General Public Utilities Corp. 717,400 18,832 Houston Industries, Inc. 249,700 8,896 * Metrogas ADS 665,000 6,733 Montana Power Co. 516,100 11,870 National Fuel & Gas Co. 283,700 7,234 Niagara Mohawk Power Corp. 912,500 13,003 NICOR, Inc. 862,100 19,613 Nova Scotia Power 595,000 4,720 NYNEX Corp. 1,431,772 52,618 Pacific Enterprises 485,000 10,306 Pacific Gas & Electric Co. 1,930,200 47,049 Pacific Telesis Group 490,000 13,965 Pacificorp 256,800 4,655 PECO Energy Corp. 387,200 9,486 Pennsylvania Power & Light Co. 563,000 10,697 Public Service Co. of Colorado 349,900 10,278 Questar Corp. 212,100 5,833 Rochester Gas & Electric Corp. 531,600 11,097 Royal PTT 577,600 19,422 SCE Corp. 1,398,000 20,446 Sierra Pacific Resources 744,300 14,049 Southern Co. 1,476,000 29,520 Texas Utilities Co. 378,857 12,123 Unicom Corp. 1,067,207 25,613 US West Corp. 655,249 23,343 ---------- GROUP TOTAL 588,630 ---------- - --------------------------------------------------------- TOTAL COMMON STOCKS (Cost $2,080,921) 2,063,239 - --------------------------------------------------------- CONVERTIBLE PREFERRED STOCKS (1.1%) - --------------------------------------------------------- H.F. Ahmanson 6.0% 516,000 20,511 Boise Cascade $1.58 169,700 3,988 Reynolds Metals $3.31 267,600 12,945 Santa Fe Energy 8.25% 1,041,300 8,851 Sears, Roebuck & Co. PERCS $3.75 147,400 8,181 Storage Technology $3.50 78,300 5,128 - --------------------------------------------------------- TOTAL CONVERTIBLE PREFERRED STOCKS (Cost $62,583) 59,604 - --------------------------------------------------------- TEMPORARY CASH INVESTMENT - --------------------------------------------------------- Face Amount (000) ------ REPURCHASE AGREEMENT Collateralized by U.S. Government Obligations in a Pooled Cash Account 5.90%, 1/3/95 (Cost $90) $90 90 - --------------------------------------------------------- TOTAL INVESTMENTS (98.2%) (Cost $5,884,306) 5,577,118 - --------------------------------------------------------- OTHER ASSETS AND LIABILITIES (1.8%) - --------------------------------------------------------- Other Assets--Notes C and F 175,176 Liabilities--Note F (71,667) ---------- 103,509 - ---------------------------------------------------------
13 16 STATEMENT OF NET ASSETS (continued)
Market Value (000)+ - --------------------------------------------------------- NET ASSETS (100%) - --------------------------------------------------------- Applicable to 333,156,619 outstanding $.10 par value shares (authorized 400,000,000 shares) $5,680,627 - --------------------------------------------------------- NET ASSET VALUE PER SHARE $17.05 =========================================================
+ See Note A to Financial Statements. * Non-Income Producing Security. (1)Considered an affiliated company as the Fund owns more than 5% of the outstanding voting securities of the company.
- --------------------------------------------------------- AT DECEMBER 31, 1994, NET ASSETS CONSISTED OF: - --------------------------------------------------------- Amount Per (000) Share ---------- ------- Paid in Capital $5,989,939 $17.98 Undistributed Net Investment Income 13,070 .04 Accumulated Net Realized Losses--Note E (15,194) (.05) Unrealized Depreciation of Investments--Note D (307,188) (.92) - --------------------------------------------------------- NET ASSETS $5,680,627 $17.05 - ---------------------------------------------------------
14 17 STATEMENT OF OPERATIONS
Year Ended December 31, 1994 (000) - -------------------------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends................................................ $ 116,710 Interest................................................. 273,776 - -------------------------------------------------------------------------------------------------- Total Income...................................... 390,486 - -------------------------------------------------------------------------------------------------- EXPENSES Investment Advisory Fee--Note B.......................... 4,457 The Vanguard Group--Note C Management and Administrative......................... $13,437 Marketing and Distribution............................ 1,283 14,720 ------- ---------- Taxes (other than income taxes).......................... 476 Custodian's Fees......................................... 220 Auditing Fees............................................ 20 Shareholders' Reports.................................... 232 Annual Meeting and Proxy Costs........................... 129 Directors' Fees and Expenses............................. 33 - -------------------------------------------------------------------------------------------------- Total Expenses.................................... 20,287 - -------------------------------------------------------------------------------------------------- Net Investment Income.......................... 370,199 - -------------------------------------------------------------------------------------------------- REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD ........................................... 46,034 - -------------------------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES ................... (696,906) - -------------------------------------------------------------------------------------------------- Net Decrease in Net Assets Resulting from Operations .................................. $(280,673) ==================================================================================================
15 18 STATEMENT OF CHANGES IN NET ASSETS
YEAR ENDED Year Ended DECEMBER 31, 1994 December 31, 1993 (000) (000) - -------------------------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income.................................... $ 370,199 $ 271,526 Realized Net Gain ....................................... 46,034 134,114 Change in Unrealized Appreciation (Depreciation) ........ (696,906) 158,024 - -------------------------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations......................... (280,673) 563,664 - -------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1) Net Investment Income.................................... (368,591) (287,169) Realized Net Gain........................................ (78,686) (118,442) - -------------------------------------------------------------------------------------------------- Total Distributions................................. (447,277) (405,611) - -------------------------------------------------------------------------------------------------- NET EQUALIZATION CREDITS--Note A............................ 617 18,650 - -------------------------------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS (2) Issued --Regular........................................ 1,065,849 1,962,428 --In Lieu of Cash Distributions.................. 379,611 347,422 --Exchange....................................... 497,331 1,047,944 Redeemed--Regular........................................ (732,681) (317,119) --Exchange....................................... (813,628) (383,596) - -------------------------------------------------------------------------------------------------- Net Increase from Capital Share Transactions........ 396,482 2,657,079 - -------------------------------------------------------------------------------------------------- Total Increase (Decrease)........................... (330,851) 2,833,782 - -------------------------------------------------------------------------------------------------- NET ASSETS Beginning of Year........................................ 6,011,478 3,177,696 - -------------------------------------------------------------------------------------------------- End of Year (3).......................................... $5,680,627 $6,011,478 ================================================================================================== (1) Distributions Per Share Net Investment Income................................. $1.11 $1.14 Realized Net Gain..................................... $ .24 $ .40 - -------------------------------------------------------------------------------------------------- (2) Shares Issued and Redeemed Issued................................................ 85,297 155,647 Issued in Lieu of Cash Distributions.................. 21,438 18,033 Redeemed.............................................. (86,104) (36,146) - -------------------------------------------------------------------------------------------------- 20,631 137,534 - -------------------------------------------------------------------------------------------------- (3) Undistributed Net Investment Income .................. $ 13,070 $ 10,845 - --------------------------------------------------------------------------------------------------
16 19 FINANCIAL HIGHLIGHTS
Year Ended December 31, ------------------------------------------ For a Share Outstanding Throughout Each Year 1994 1993 1992 1991 1990 - -------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF YEAR ........ $19.24 $18.16 $18.08 $16.02 $16.82 INVESTMENT OPERATIONS Net Investment Income ................... 1.11 1.14 1.21 1.27 1.30 Net Realized and Unrealized Gain (Loss) on Investments......................... (1.95) 1.48 .29 2.06 (.72) TOTAL FROM INVESTMENT OPERATIONS ... (.84) 2.62 1.50 3.33 .58 - -------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income..... (1.11) (1.14) (1.21) (1.27) (1.30) Distributions from Realized Capital Gains (.24) (.40) (.21) -- (.08) TOTAL DISTRIBUTIONS ................ (1.35) (1.54) (1.42) (1.27) (1.38) - -------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF YEAR .............. $17.05 $19.24 $18.16 $18.08 $16.02 ================================================================================================== TOTAL RETURN ............................... -4.44% +14.65% +8.67% +21.57% +3.76% - -------------------------------------------------------------------------------------------------- RATIOS/SUPPLEMENTAL DATA - ------------------------ Net Assets, End of Year (Millions).......... $5,681 $6,011 $3,178 $1,934 $1,022 Ratio of Expenses to Average Net Assets..... .34% .33% .35% .40% .45% Ratio of Net Investment Income to Average Net Assets....................... 6.16% 5.79% 6.50% 7.08% 7.77% Portfolio Turnover Rates: Common Stocks............................ 32% 26% 16% 19% 12% Bonds.................................... 31% 18% 24% 34% 23% - --------------------------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS Vanguard/Wellesley Income Fund is registered under the Investment Company Act of 1940 as a diversified open-end investment company. Certain of the Fund's investments are in long-term corporate debt instruments; the issuers' abilities to meet these obligations may be affected by economic developments in their respective industries. A. The following significant accounting policies are in conformity with generally accepted accounting principles for investment companies. Such policies are consistently followed by the Fund in the preparation of financial statements. 1. SECURITY VALUATION: Common stocks listed on an exchange are valued at the latest quoted sales prices as of the close of the New York Stock Exchange (generally 4:00 PM) on the valuation date; such securities not traded are valued at the mean of the latest quoted bid and asked prices; those securities not listed are valued at the latest quoted bid prices. Bonds are valued utilizing the latest bid prices and on the basis of a matrix system (which considers such factors as security prices, yields, maturities and ratings), both as furnished by independent pricing services. Temporary cash investments are valued at cost which approximates market value. 2. FEDERAL INCOME TAXES: The Fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Accordingly, no provision for Federal income taxes is required in the financial statements. 17 20 NOTES TO FINANCIAL STATEMENTS (continued) 3. EQUALIZATION: The Fund follows the accounting practice known as "equalization," under which a portion of the price of capital shares issued and redeemed, equivalent to undistributed net investment income per share on the date of the transaction, is credited or charged to undistributed income. As a result, undistributed income per share is unaffected by Fund share sales or redemptions. 4. REPURCHASE AGREEMENTS: The Fund, along with other members of The Vanguard Group of Investment Companies, transfers uninvested cash balances into a Pooled Cash Account, the daily aggregate of which is invested in repurchase agreements secured by U.S. Government obligations. Securities pledged as collateral for repurchase agreements are held by the Fund's custodian bank until maturity of each repurchase agreement. Provisions of each agreement ensure that the market value of this collateral is sufficient in the event of default; however, in the event of default or bankruptcy by the other party to the agreement, realization and/or retention of the collateral may be subject to legal proceedings. 5. OTHER: Security transactions are accounted for on the date the securities are purchased or sold. Costs used in determining realized gains and losses on the sale of investment securities are those of specific securities sold. Dividend income and distributions to shareholders are recorded on the ex-dividend date. Discounts and premiums on debt securities purchased are amortized to interest income over the lives of the respective securities. B. Under the terms of a contract expiring April 30, 1995, the Fund pays Wellington Management Company an investment advisory fee calculated at an annual percentage rate of average net assets of the fund. For the year ended December 31, 1994, the investment advisory fee represents an effective annual rate of .07 of 1% of average net assets. C. The Vanguard Group, Inc. furnishes at cost corporate management, administrative, marketing and distribution services. The costs of such services are allocated to the Fund under methods approved by the Board of Directors. At December 31, 1994, the Fund had contributed capital of $890,000 to Vanguard (included in Other Assets), representing 4.4% of Vanguard's capitalization. The Fund's directors and officers are also directors and officers of Vanguard. Vanguard has requested the Fund's investment adviser to direct certain portfolio trades, subject to obtaining the best price and execution, to brokers who have agreed to rebate or credit to the Fund a portion of the commissions generated. Such rebates or credits are used solely to reduce the Fund's administrative expenses. For the year ended December 31, 1994, directed brokerage arrangements reduced the Fund's expenses by $574,000 (.01 of 1% of average net assets). D. During the year ended December 31, 1994, the Fund made purchases of $1,451,642,000 and sales of $1,229,638,000 of investment securities other than U.S. Government securities and temporary cash investments. Purchases and sales of U.S. Government obligations were $882,929,000 and $685,180,000, respectively. At December 31, 1994, unrealized depreciation for financial reporting and Federal income tax purposes aggregated $307,188,000, of which $134,634,000 related to appreciated securities and $441,822,000 related to depreciated securities. E. Capital gain distributions are determined on a tax basis and may differ from realized capital gains for financial reporting purposes depending on the timing of the realization of gains. For Federal tax purposes, capital gains required to be distributed in December 1994 included net gains realized through October 31, 1994. Subsequently the Fund realized capital losses of $16,810,000 which are available to offset future net capital gains. F. The market value of securities on loan to broker/dealers at December 31, 1994, was $112,518,000, for which the Fund had received as collateral cash of $24,387,000 and U.S. Treasury securities with a market value of $90,871,000. 18 21 REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders and Board of Directors Vanguard/Wellesley Income Fund In our opinion, the accompanying statement of net assets and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Vanguard/Wellesley Income Fund (the "Fund") at December 31, 1994, the results of its operations, the changes in its net assets and the financial highlights for each of the respective periods presented, in conformity with generally accepted accounting principles. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities by correspondence with the custodian and brokers and the application of alternative auditing procedures where confirmations from brokers were not received, provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP Thirty South Seventeenth Street Philadelphia, Pennsylvania 19103 February 1, 1995 SPECIAL TAX INFORMATION SPECIAL 1994 TAX INFORMATION (UNAUDITED) FOR VANGUARD/WELLESLEY INCOME FUND, INC. Corporate shareholders should note that for the fiscal year ended December 31, 1994, 29.7% of the Fund's investment income (i.e., dividend income plus short-term capital gains, if any) qualifies for the intercorporate dividends received deduction. 19 22 DIRECTORS AND OFFICERS JOHN C. BOGLE, Chairman and Chief Executive Officer Chairman and Director of The Vanguard Group, Inc., and of each of the investment companies in The Vanguard Group. JOHN J. BRENNAN, President President and Director of The Vanguard Group, Inc., and of each of the investment companies in The Vanguard Group. ROBERT E. CAWTHORN, Chairman of Rhone-Poulenc Rorer Inc.; Director of Sun Company, Inc. BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea Company, Alco Standard Corp., Raytheon Company, Knight-Ridder, Inc., and Massachusetts Mutual Life Insurance Co. BRUCE K. MACLAURY, President of The Brookings Institution; Director of American Express Bank Ltd., The St. Paul Companies, Inc., and Scott Paper Company. BURTON G. MALKIEL, 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., Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich Company, Reliance Electric Company, and The Standard Products Company. JOHN C. SAWHILL, President and Chief Executive Officer of The Nature Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and President of New York University; Director of Pacific Gas and Electric Company and NACCO Industries. JAMES O. WELCH, JR., Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc. J. LAWRENCE WILSON, Chairman and Chief Executive Officer of Rohm & Haas Company; Director of Cummins Engine Company; Trustee of Vanderbilt University and the Culver Educational Foundation. OTHER FUND OFFICERS RICHARD F. HYLAND, Treasurer; Treasurer of The Vanguard Group, Inc., and of each of the investment companies in The Vanguard Group. 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. KAREN E. WEST, Controller; Vice President of The Vanguard Group, Inc.; Controller of each of the investment companies in The Vanguard Group. OTHER VANGUARD GROUP OFFICERS JEREMY G. DUFFIELD VINCENT S. MCCORMACK Senior Vice President Senior Vice President Planning & Development Operations JAMES H. GATELY RALPH K. PACKARD Senior Vice President Senior Vice President Institutional Chief Financial Officer IAN A. MACKINNON Senior Vice President Fixed Income Group 20 23 THE VANGUARD VOYAGE . . . STAYING THE COURSE (continued from inside front cover) * We set specific standards for each Fund's investment policies and principles. * We adhere to the highest standards of investment quality, consistent with each Fund's objectives. * We offer candor in our Fund descriptions (including full disclosure of risk) to prospective investors, and in our description to shareholders of each Fund's success (or, sometimes, lack of the same). These principles make at least as much sense today as they did in 1929, perhaps even more. For we live in an era when many fund organizations have become asset-gathering machines, capitalizing on past performance that is unrepeatable and investment fads that today, as yesterday, will come and go. The new marketing policy is too often "if investors want it, we'll sell it to them." But our principle remains "if it makes sound investment sense, we'll offer it, even if it takes years to attract substantial assets." FOUNDING CORPORATE VALUES With the founding of The Vanguard Group in 1974, a new concept of values was brought to bear on mutual fund management. Unlike other fund organizations, Vanguard alone is structured to serve only its Funds' shareholders. Vanguard's corporate structure places not the fund management company, but the fund shareholders, "at the top" of the organizational chart. Vanguard Fund shareholders are literally the owners of the firm and are entitled to all of the benefits that, at other fund firms, accrue to the owners of the management company. Because of this unique structure, Vanguard has become best known for its low costs, which we believe are just as essential a consideration in investing in mutual funds as risk potential and total return. We call this relationship between risk, return, and cost the "eternal triangle" of mutual fund investing. We take special pride in our position as (by far) the lowest-cost provider of financial services in the world. Under our "no-load" offering structure, shareholders begin their Vanguard investment program with $1,000 of assets (not, say, $950) for each $1,000 investment. Then, under our "at-cost" operating structure, each $1,000 is managed for only about $3 per year; our competitors may charge three, four, or even five times that amount. In all, Vanguard has distinguished itself by providing Funds with sound and durable goals to investors with long-term time horizons, and doing so at the fairest financial terms available. We believe that the unique Vanguard structure "promotes a healthy and viable mutual fund complex within which each Fund can better prosper; enables the Funds to realize substantial savings from advisory fee reductions; promotes savings from economies of scale; and provides the Funds with direct and conflict-free control over distribution functions." We are not alone in this belief. Indeed, the quotation is taken verbatim from the unanimous decision of the U.S. Securities and Exchange Commission when, in 1981, it approved our application for the structure under which we operate today. A CLOSING THOUGHT We are proud of what Wellington Fund, the other Vanguard Funds, and The Vanguard Group have come to represent, and we are grateful for the success and growth with which we have been blessed. We are an industry leader, and, as a competitor observed a few years ago, we are "the standard by which all fund organizations are judged." In battle terms, "the vanguard" is the first wave of troops or ships, and Vanguard surely is in the first wave of the battle for investment survival. As we look behind us, however, the "second wave" is not in sight. No fund organization has followed our lead, leaving ours a lonely course. No matter. We have an organization that places the interests of our Fund shareholders first. We have Funds that shall endure the vicissitudes of the future. Come what may, we intend to "stay the course," and we shall do our very best to continue to deserve your confidence and loyalty. We hope that you will stay the course with us. 24 THE VANGUARD FAMILY OF FUNDS FIXED INCOME FUNDS MONEY MARKET FUNDS Vanguard Admiral Funds U.S. Treasury Money Market Portfolio Vanguard Money Market Reserves TAX-EXEMPT MONEY MARKET FUNDS Vanguard Municipal Bond Fund Money Market Portfolio Vanguard State Tax-Free Funds Money Market Portfolios (CA, NJ, OH, PA) TAX-EXEMPT INCOME FUNDS Vanguard Municipal Bond Fund Vanguard State Tax-Free Funds Insured Longer-Term Portfolios (CA, FL, NJ, NY, OH, PA) INCOME FUNDS Vanguard Admiral Funds Vanguard Fixed Income Securities Fund Vanguard Preferred Stock Fund EQUITY AND BALANCED FUNDS GROWTH AND INCOME FUNDS Vanguard Convertible Securities Fund Vanguard Equity Income Fund Vanguard Quantitative Portfolios Vanguard/Trustees' Equity Fund U.S. Portfolio Vanguard/Windsor Fund Vanguard/Windsor II BALANCED FUNDS Vanguard Asset Allocation Fund Vanguard STAR Fund Vanguard/Wellesley Income Fund Vanguard/Wellington Fund GROWTH FUNDS Vanguard/Morgan Growth Fund Vanguard/PRIMECAP Fund Vanguard U.S. Growth Portfolio AGGRESSIVE GROWTH FUNDS Vanguard Explorer Fund Vanguard Specialized Portfolios INTERNATIONAL FUNDS Vanguard International Growth Portfolio Vanguard/Trustees' Equity Fund International Portfolio INDEX FUNDS Vanguard Index Trust Total Stock Market Portfolio 500 Portfolio Extended Market Portfolio Growth Portfolio Value Portfolio Small Capitalization Stock Portfolio Vanguard International Equity Index Fund European Portfolio Pacific Portfolio Emerging Markets Portfolio Vanguard Bond Index Fund Vanguard Tax-Managed Fund Vanguard Balanced Index Fund [LOGO] Vanguard Financial Center Valley Forge, Pennsylvania 19482 New Account Information: 1-(800) 662-7447 Shareholder Account Services: 1-(800) 662-2739
This Report has been prepared for shareholders and may be distributed to others only if preceded or accompanied by a current prospectus. All Funds in the Vanguard Family are offered by prospectus only. Q270-12/94 25 EDGAR APPENDIX This appendix describes the components of the printed version of this report that do not translate into a format acceptable to the EDGAR system. The front cover of the printed version of this report features the Vanguard ship in the crashing sea. A small picture of a rear view of the Vanguard ship crashing through the sea appears at the top of the inside covers of the report. A running head featuring a sextant appears on pages one through five. A photograph of John C. Bogle appears at the lower-right of page one. A Cumulative Performance line chart depicting the Indexed Value of the Lehman Long-Term Corporate Bond Index and the Standard & Poor's 500 Stock Index for the fiscal years 1990 to 1994 appears at the upper-left of page two. A Cumulative Performance line chart for the period December 31, 1984, to December 31, 1994, including average annual total returns, appears on page three. A running head featuring a lantern appears on page six. A running head featuring a map and telescope appears on pages seven and eight. A running head featuring a log book and pen appears on pages nine through nineteen. A running head featuring a compass appears on page twenty. At the bottom of the back cover there appears a triangle with the sides labeled "Risk," "Cost," and "Return." A seagull in flight is featured at the top of the outside back cover of the report. -----END PRIVACY-ENHANCED MESSAGE-----