-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TL1gJK+0BCwIGjOQOPIHEr54lqK0kOrAMPxfqmuWeioL5hD9xtIshzsVXzNPtSL1 WNzbqRkPOKOHVBvzrvoJLw== 0000932471-02-000811.txt : 20020927 0000932471-02-000811.hdr.sgml : 20020927 20020927165003 ACCESSION NUMBER: 0000932471-02-000811 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020731 FILED AS OF DATE: 20020927 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VANGUARD SPECIALIZED FUNDS CENTRAL INDEX KEY: 0000734383 STATE OF INCORPORATION: DE FISCAL YEAR END: 0131 FILING VALUES: FORM TYPE: N-30D SEC ACT: 1940 Act SEC FILE NUMBER: 811-03916 FILM NUMBER: 02775098 BUSINESS ADDRESS: STREET 1: PO BOX 2600 STREET 2: V26 CITY: VALLEY FORGE STATE: PA ZIP: 19482 BUSINESS PHONE: 6106696295 MAIL ADDRESS: STREET 1: PO BOX 2600 STREET 2: V26 CITY: VALLEY FORGE STATE: PA ZIP: 19482 FORMER COMPANY: FORMER CONFORMED NAME: VANGUARD SPECIALIZED PORTFOLIOS INC DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: VANGUARD SPECIALIZED FUNDS/ DATE OF NAME CHANGE: 20011121 N-30D 1 vspecializedfunds.txt VANGUARD SPECIALIZED FUNDS VANGUARD(R)PRECIOUS METALS FUND SEMIANNUAL REPORT * JULY 31, 2002 STOCK [PICTURE OF SHIP] THE VANGUARD GROUP(R) WHAT YOU CAN CONTROL As an investor, you cannot control how the financial markets perform. But there are vital variables that you can control. You can decide how much to invest. You can limit the risk in your portfolio by diversifying your holdings. And you can control the investment costs you incur. Costs may seem the least dramatic of the three. But costs have a powerful impact on how your wealth accumulates; they reduce, dollar for dollar, the returns that you can derive from an investment. Every mutual fund has operating expenses--to pay for investment managers, telephone support, and so on. These costs appear in the fund's expense ratio, which reflects the percentage of average net assets (your money) consumed each year by operating costs. In 2001, the average mutual fund had an expense ratio of 1.34% (or $13.40 per $1,000 in assets), according to data from Lipper Inc. For Vanguard(R) funds, the average expense ratio was less than one-fourth that amount (0.27%, or $2.70 per $1,000 in assets). Our average expense ratio has been less than the industry average for 25 years, and it's an advantage we aim to maintain. Under our unique corporate structure, shareholders like you own the Vanguard funds, which in turn own The Vanguard Group. No middleman makes a profit from managing the operation. You bear all of the investment risk. It's only right that you reap as much of the potential reward as possible. - -------------------------------------------------------------------------------- CONTENTS Letter from the Chairman 1 Report from the Adviser 5 Fund Profile 7 Glossary of Investment Terms 8 Performance Summary 9 Financial Statements 10 - -------------------------------------------------------------------------------- Summary * Vanguard Precious Metals Fund returned 0.2% during the first six months of its 2003 fiscal year. * Your fund's performance was far behind that of the average gold-oriented mutual fund, but it was 18 percentage points above the poor return provided by the broad stock market. * The fund was closed to all new investments on June 28 in response to a spike in cash flow. Remove white box when printing. - -------------------------------------------------------------------------------- LETTER FROM THE CHAIRMAN FELLOW SHAREHOLDER, VANGUARD(R) PRECIOUS METALS FUND earned a slightly positive return during the first half of its 2003 fiscal year. The fund's 0.2% gain was well short of the results of its average mutual fund peer but far better than the dismal return provided by the broad stock market. The table below presents the total returns--capital change plus reinvested distributions--for your fund and its benchmarks. Per-share performance figures are shown on page 4. - ---------------------------------------------------- TOTAL RETURNS SIX MONTHS ENDED JULY 31, 2002 - ---------------------------------------------------- Vanguard Precious Metals Fund 0.2% Average Gold-Oriented Fund* 10.6 Salomon Smith Barney World Equity Gold Index 2.1 Wilshire 5000 Index -17.9 - ---------------------------------------------------- *Derived from data provided by Lipper Inc. STOCK PRICES ERODED AS NEGATIVE NEWS MOUNTED The U.S. stock market was extremely volatile during the six months ended July 31, dropping to levels not seen in five years before surging at the end of the period. The late rally, however, was not enough. The broad market, as measured by the Wilshire 5000 Total Market Index, posted a sharp decline of -17.9% for the half-year. The market's slump seemed to take on a life of its own, as investors ignored reports of a recovery in the economy and of improved corporate earnings to focus on the drumbeat of negative news, including ongoing revelations of accounting problems and corporate misconduct, continued strife in the Middle East, warnings of potential terrorist attacks, and talk of war with Iraq. No market segment escaped the downdraft. As a group, even small- capitalization value stocks, which had previously flourished while the broader market declined from its March 2000 peak, posted a negative return for the six months. Across all market caps, growth stocks (those with high prices relative to their earnings or book values) continued to fare worse than value issues. THE ECONOMY GREW IN FITS AND STARTS The nation's real (inflation-adjusted) gross domestic product grew at an annual rate of 1.1% in the second quarter of 2002, according to an early estimate. This was a sharp slowdown from the first quarter's robust growth rate of 5.0%, although more than half of that quarter's growth was due to the slower depletion of inventories. (The 5.0% figure was revised from the earlier estimate of 6.1%. More surprising, however, was the Commerce Department's downward revision of GDP growth in 2001. With the first three quarters of 2001 now showing negative growth, last 1 year's recession was longer and deeper than originally thought.) With inflation of little concern and the economy sluggish, the Federal Reserve Board kept the target for the federal funds rate-- the interest rate for overnight loans between banks--at its four-decade low of 1.75%. - -------------------------------------------------------------------------------- MARKET BAROMETER TOTAL RETURNS PERIODS ENDED JULY 31, 2002 ----------------------------- SIX ONE FIVE MONTHS YEAR YEARS* - -------------------------------------------------------------------------------- Russell 1000 Index (Large-caps) -18.2% -22.9% 0.7% Russell 2000 Index (Small-caps) -18.2 -18.0 0.2 Wilshire 5000 Index (Entire market) -17.9 -22.1 0.3 MSCI EAFE Index (International) -6.4 -16.9 -3.9 - -------------------------------------------------------------------------------- Lehman Aggregate Bond Index 4.2% 7.5% 7.3% (Broad taxable market) Lehman 10 Year Municipal Bond Index 4.8 7.2 6.1 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 0.9 2.3 4.6 ================================================================================ Consumer Price Index 1.7% 1.5% 2.3% - -------------------------------------------------------------------------------- *Annualized. INVESTORS FLED TO THE QUALITY OF BONDS The overall U.S. bond market, as measured by the Lehman Brothers Aggregate Bond Index, posted a solid six-month return of 4.2%. But there was a distinct flight to quality in the period, with government and agency bonds posting the best returns as demand for these issues pushed their prices higher. A high default rate among corporate debt issues, notably those of several now-bankrupt telecommunications companies, caused investors to shun high-risk debt. The Lehman High Yield Index returned -9.6% for the six months as price declines more than offset higher yields. Prices of U.S. Treasury securities rose and yields fell. The 10-year note's yield fell 57 basis points (0.57 percentage point) during the six months to 4.46%. The decline was more dramatic for the 3-year Treasury note, whose yield fell 112 basis points to 3.01%. The yield of the 3-month Treasury bill, which lags the Fed's interest rate moves, fell 6 basis points to 1.69%. MORE GOLD WAS BETTER, BUT YOUR FUND HAD LESS As noted earlier, your fund's half-year return of 0.2% was well ahead of that of the broad stock market but considerably behind that of its average peer. Our shortfall to our mutual fund competitors was due to our broader diversification among precious metals stocks: In short, during the past six months, the more gold, the better. In fact, among mutual funds that specialize in gold-oriented shares, returns of more than 30% for the first six months of 2002 were not uncommon, according to fund-tracker Morningstar Inc. The slumping stock market, the slide in the value of the U.S. dollar, and the risks of terrorism and war combined to drive gold prices higher. The price of an ounce of gold rose from $282.30 on January 31 to $304.65 on July 31. In addition, consolidation in the gold-mining industry helped push up stock prices in the sector. Other metals also rose in value. The per-ounce price of platinum jumped about 2 18% during the period to $531.60, and silver climbed about 9% to $4.60. However, the price of palladium--a metal used to make pollution-control devices and electronic components--slipped nearly 14% during the half-year to $320.00 per ounce. Although your fund owns a significant stake in gold companies (Barrick Gold, AurionGold, Newmont Mining, Lihir Gold, and Meridian Gold are all among the fund's top ten holdings), some of its competitors offer more of a pure play on gold. By diversifying beyond gold stocks to include platinum companies and even a diamond-mining operation, Vanguard Precious Metals Fund limits the relative damage caused when gold investments sour, but it also limits the relative upside when gold is soaring. - -------------------------------------------------------------------------------- Although your fund owns a significant stake in gold companies, some of its competitors offer more of a pure play on gold. - -------------------------------------------------------------------------------- See the Report from the Adviser on page 5 for more details on the precious metals market and on specific holdings. Despite the fund's flat return over the past six months, its performance over the past couple of years has been nothing short of remarkable. From March 31, 2000, to July 31, 2002--a period when the broad stock market endured a grueling bear market, shedding about 38% of its value--Vanguard Precious Metals Fund returned 47.9%. It's important to note that the risks involved in owning the Precious Metals Fund are significant. The fund's terrific results over the past two years were certainly welcome but should not be considered a harbinger of what's to come in the future. The fund concentrates on a very small segment of the stock market--and its investments are very concentrated within this segment. In fact, the fund owns just 26 securities, and its top ten holdings account for about 68% of the fund's assets. This means that all shareholders, but particularly those who are new to the fund, must prepare themselves for a potentially bumpy ride. To all of our shareholders, including those who have been with the fund through its many turbulent periods in the past, we'd like to express our appreciation for entrusting your money to Vanguard. As you may know, the fund's strong recent performance resulted in a rush of new investments, which, in turn, prompted the fund's board of trustees to close the fund to all new investments on June 28. The decision, which was made after careful consideration, was based solely on the desire to protect the interests of the fund's shareholders. The fund will remain closed indefinitely. THE BENEFITS OF DIVERSIFICATION We will always believe that the surest path to long-term investment success is through broad diversification, both among asset classes and within them. However, if you are willing to assume some additional risk, concentrating a small portion of 3 your portfolio in a narrow segment of the stock market can be rewarding. Of course, one of the keys to selecting such a fund--or any fund, for that matter-- is to focus on the price you'll pay to own the fund. At 0.58% of average net assets ($5.80 per $1,000 in assets), our 2003 annualized expense ratio was less than one-third of the 2.06% ratio ($20.60 per $1,000 in assets) charged by our average mutual fund competitor. This makes Vanguard Precious Metals Fund a sensible choice for those seeking cost-efficient exposure to the gold and precious metals industries. Sincerely, /S/ JOHN J. BRENNAN John J. Brennan Chairman and Chief Executive Officer AUGUST 15, 2002 - -------------------------------------------------------------------------------- YOUR FUND'S PERFORMANCE AT A GLANCE: JANUARY 31-JULY 31, 2002 DISTRIBUTIONS PER SHARE ------------------------- STARTING ENDING INCOME CAPITAL SHARE PRICE SHARE PRICE DIVIDENDS GAINS - -------------------------------------------------------------------------------- Vanguard Precious Metals Fund $9.31 $9.26 $0.07 $0.00 - -------------------------------------------------------------------------------- 4 REPORT FROM THE ADVISER Vanguard Precious Metals Fund returned 0.2% during the six months ended July 31, 2002. The fund underperformed both its primary benchmark--the Salomon Smith Barney World Gold Index, which returned 2.1%--and its average competitor, which earned 10.6%. The Investment Environment The price of gold continued to rise during most of the period, as investors valued the metal's safe-haven status in light of falling equity markets and growing concerns about U.S. corporate governance. Gold stocks in general performed well, but small, speculative stocks in particular benefited, especially after a sharp price increase in early February. Gains were reduced, however, during the final two months of the period when investors took profits on gold stocks they deemed to be fully valued. The fund's relative underweighting in the smaller, more speculative end of the market--we preferred more defensive, blue-chip stocks--accounted for a significant proportion of our underperformance against the peer group. Our exposure to the Australian dollar and the South African rand, both of which weakened against the U.S. dollar, was also a negative factor. Our holding in Canadian gold mining company Placer Dome detracted from returns as well: The company, which recently made a bid to acquire AurionGold, saw its share price fall over investor concerns that its takeover offer was too high. We did have some successes, however, in our gold stock-picking during the six months. Strong gains were seen in the mid-capitalization areas of the market, and we captured those gains through our holdings in Meridian Gold. Another positive contributor was our large stake in Newmont Mining, which performed admirably following the company's three-way merger with Normandy Mining and Franco-Nevada. - -------------------------------------------------------------------------------- INVESTMENT PHILOSOPHY The fund reflects the belief that investors who seek to emphasize precious metals stocks as part of a long-term, balanced investment program are best served by holding a low-cost portfolio of carefully selected securities in the sector. - -------------------------------------------------------------------------------- The price of platinum rose--continuing its long-term trend of outperforming the price of gold--and now stands close to its all-time high. Despite this strength, our holdings in platinum stocks with interests in South Africa, such as Impala Platinum, Anglo American Platinum, and Lonmin, all of which have contributed positively to performance over the longer term, came under considerable pressure. Some of this pressure was caused by a leaked paper that suggested that the South African government may adopt legislation that could pave the way for the government to redistribute 5 shares in South African mining companies to black-empowerment groups. The share prices of these stocks fell because investors feared that the redistribution would dilute the value of the existing shares. Despite this short-term setback, we are positive on the outlook for the price of platinum, and we continue to closely monitor events in the region. THE FUND'S POSITIONING The portfolio's activity was relatively low during the period. Having increased our exposure to pure gold stocks in 2001--a decision that proved beneficial during much of the year and well into 2002--we refocused our attention on more widely diversified resource companies. In this vein, we purchased Inco, a Canadian nickel and platinum mining company, at attractive levels. We also bought shares of Compania de Minas Buenaventura, a Peruvian mining company, whose fortunes are closely tied to gold prices. High valuations of many gold-related companies prompted us to reduce our holdings in more speculative issues; we scaled back our positions in volatile gold stocks Crown Resources and Star Mining when liquidity allowed. OUR OUTLOOK In June, the fund was closed to new investments because cash flow surged as valuations of gold stocks were beginning to look stretched. In the short term, the closing proved beneficial as prices adjusted in the final month of the period. Going forward, we remain confident about the outlook for gold and for companies that benefit from a rise in the price of gold. We believe that geopolitical uncertainty surrounding developments in the Middle East, the effects of accounting issues in the United States, and ongoing market uncertainty will continue to provide a strong basis for the current level of investor interest in gold. GRAHAM E. FRENCH, PORTFOLIO MANAGER M&G Investment Management Ltd. August 13, 2002 6 FUND PROFILE AS OF JULY 31, 2002 FOR PRECIOUS METALS FUND This Profile provides a snapshot of the fund's characteristics, compared where appropriate to a broad market index. Key terms are defined on page 8. - --------------------------------------------------------- PORTFOLIO CHARACTERISTICS WILSHIRE FUND 5000 - --------------------------------------------------------- Number of Stocks 26 5,808 Median Market Cap $3.1B $27.0B Price/Earnings Ratio 90.3x 24.6x Price/Book Ratio 1.9x 2.7x Return on Equity 5.3% 21.6% Earnings Growth Rate 33.3% 9.8% Foreign Holdings 76.9% 0.3% Turnover Rate 45%* -- Expense Ratio 0.58%* -- - --------------------------------------------------------- - ---------------------------------------------- TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) Barrick Gold Corp. 10.7% Newmont Mining Corp. 10.5 AurionGold Ltd. 9.0 Lihir Gold Ltd. 7.1 Impala Platinum Holdings Ltd. ADR 7.0 AngloGold Ltd. ADR 5.2 Inco Ltd. 5.1 Meridian Gold Co. 4.6 Rio Tinto Ltd. 4.4 Anglo American Platinum Corp. ADR 4.0 - ---------------------------------------------- Top Ten 67.6% - ---------------------------------------------- - --------------------------------------------------------- VOLATILITY MEASURES WILSHIRE FUND 5000 - --------------------------------------------------------- R-Squared 0.07 1.00 Beta 0.53 1.00 - --------------------------------------------------------- - ------------------------------------------------- COUNTRY DIVERSIFICATION (% OF TOTAL NET ASSETS) Canada 27.9% Australia 22.4 South Africa 16.1 United States 12.5 Peru 3.7 Ghana 3.5 United Kingdom 3.3 - ------------------------------------------------- Subtotal 89.4% - ------------------------------------------------- Bullion 0.2% Cash Investments 10.4 - ------------------------------------------------- Total 100.0% - ------------------------------------------------- *Annualized. VISIT OUR WEBSITE WWW.VANGUARD.COM FOR REGULARLY UPDATED FUND INFORMATION. 7 GLOSSARY OF INVESTMENT TERMS BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the overall market (or appropriate market index). The market (or index) is assigned a beta of 1.00, so a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the overall market rose or fell by 10%. - -------------------------------------------------------------------------------- EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in a fund. - -------------------------------------------------------------------------------- EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. - -------------------------------------------------------------------------------- FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks or American Depositary Receipts of companies based outside the United States. - -------------------------------------------------------------------------------- MEDIAN MARKET CAP. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. - -------------------------------------------------------------------------------- PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds. - -------------------------------------------------------------------------------- PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. - -------------------------------------------------------------------------------- R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the overall market (or its benchmark index). If a fund's total returns were precisely synchronized with the overall market's return, its R-squared would be 1.00. If the fund's returns bore no relationship to the market's returns, its R-squared would be 0. - -------------------------------------------------------------------------------- RETURN ON EQUITY. The annual average rate of return generated by a company during the past five years for each dollar of shareholder's equity (net income divided by shareholder's equity). For a fund, the weighted average return on equity for the companies whose stocks it holds. - -------------------------------------------------------------------------------- TURNOVER RATE. An indication of the fund's trading activity. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). - -------------------------------------------------------------------------------- 8 PERFORMANCE SUMMARY AS OF JULY 31, 2002 FOR PRECIOUS METALS FUND All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely. An investor's shares, when redeemed, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the redemption of fund shares. - -------------------------------------------------------------------------------- FISCAL-YEAR TOTAL RETURNS (%) JANUARY 31, 1992-JULY 31, 2002 SALOMON SMITH PRECIOUS BARNEY WORLD METALS FUND GOLD INDEX* 1993 -20.6 -23.3 1994 89.2 121.5 1995 -19.2 -21.1 1996 33.2 34.7 1997 -20.5 -14.9 1998 -29.8 -31.2 1999 -11.1 -19.4 2000 17.5 14.2 2001 0.7 0.5 2002 30.1 29.4 2003** 0.2 2.1 - -------------------------------------------------------------------------------- * MSCI Gold Mines Index through December 31, 1994; Salomon Smith Barney World Gold Index thereafter. **Six months ended July 31, 2002. Note: See Financial Highlights table on page 14 for dividend information. - ------------------------------------------------------------------------------- Average Annual Total Returns for periods ended June 30, 2002 This table presents average annual total returns through the latest calendar quarter--rather than through the end of the fiscal period. Securities and Exchange Commission rules require that we provide this information. TEN YEARS ONE FIVE ----------------------------- INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL - -------------------------------------------------------------------------------- Precious Metals Fund* 5/23/1984 41.48% 4.76% 2.17% 2.31% 4.48% - -------------------------------------------------------------------------------- * Total return figures do not reflect the 1% fee assessed on redemptions of shares held for less than one year. 9 FINANCIAL STATEMENTS JULY 31, 2002 (UNAUDITED) STATEMENT OF NET ASSETS This Statement provides a detailed list of the fund's holdings, including each security's market value on the last day of the reporting period. Securities are grouped and subtotaled by asset type (common stocks, bonds, etc.) and by country. Other assets are added to, and liabilities are subtracted from, the value of Total Investments to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid-in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. - -------------------------------------------------------------------------------- MARKET VALUE* PRECIOUS METALS FUND SHARES (000) - -------------------------------------------------------------------------------- COMMON STOCKS (89.4%) - -------------------------------------------------------------------------------- Australia (22.4%) AurionGold Ltd. 25,248,941 $ 42,051 * Lihir Gold Ltd. 53,000,000 33,173 Rio Tinto Ltd. 1,141,000 20,543 Newcrest Mining Ltd. 1,800,000 6,074 * Tanami Gold NL 10,100,000 1,182 * Aurora Gold Ltd. 9,950,000 894 Bougainville Copper Ltd. 2,000,000 185 * Cape Tel Ltd. Newco Shares 12,723 -- ----------------- $ 104,102 ----------------- CANADA (27.9%) Barrick Gold Corp. 3,218,500 49,631 * Inco Ltd. 1,400,000 23,842 * Meridian Gold Co. 1,504,500 21,259 * Aber Diamond Corp. 1,175,000 18,171 Placer Dome Inc. 1,750,000 14,769 Agnico-Eagle Mines Ltd. 200,000 2,296 * Geomaque Explorations Ltd. 2,174,000 123 * Princess Resources Ltd. 6,000,000 -- ----------------- $ 130,091 ----------------- GHANA (3.5%) * Ashanti Goldfields Co., Ltd. GDR 3,934,266 16,524 ----------------- PERU (3.7%) Compania de Minas Buenaventura SAA ADR 825,000 16,995 ----------------- SOUTH AFRICA (16.1%) Impala Platinum Holdings Ltd. ADR 775,000 32,430 AngloGold Ltd. ADR 1,150,000 24,150 Anglo American Platinum Corp. ADR 600,000 18,406 ----------------- $ 74,986 ----------------- UNITED KINGDOM (3.3%) Lonmin PLC 1,216,480 15,203 UNITED STATES (12.5%) Newmont Mining Corp. Holding Co. 1,250,000 30,500 Newmont Mining Corp. Holding Co. CDI 7,570,000 18,458 Royal Gold, Inc. 450,000 5,193 Freeport-McMoRan Copper & Gold, Inc. Gold Denomination Shares Pfd. 143,700 3,913 * Crown Resources Corp. 80,000 40 * Atlas Minerals Inc. 33,333 7 ----------------- $ 58,111 ----------------- - -------------------------------------------------------------------------------- TOTAL COMMON STOCKS (Cost $428,882) $ 416,012 - -------------------------------------------------------------------------------- 10 - -------------------------------------------------------------------------------- MARKET VALUE* (000) - -------------------------------------------------------------------------------- PRECIOUS METALS (0.2%) - -------------------------------------------------------------------------------- * Platinum Bullion (2,009 Ounces) $ 1,063 - -------------------------------------------------------------------------------- TOTAL PRECIOUS METALS (Cost $1,213) 1,063 - -------------------------------------------------------------------------------- FACE AMOUNT (000) - -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (27.3%) - -------------------------------------------------------------------------------- Repurchase Agreements Collateralized by U.S. Government Obligations in a Pooled Cash Account 1.83%, 8/1/2002--Note G $ 75,805 75,805 1.84%, 8/1/2002 51,326 51,326 - -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (Cost $127,131) 127,131 - -------------------------------------------------------------------------------- TOTAL INVESTMENTS (116.9%) (Cost $557,226) 544,206 - -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-16.9%) - -------------------------------------------------------------------------------- Other Assets--Note C 2,583 Security Lending Collateral Payable to Brokers--Note G (75,805) Other Liabilities (5,438) ----------------- $ (78,660) ----------------- - -------------------------------------------------------------------------------- NET ASSETS (100%) - -------------------------------------------------------------------------------- Applicable to 50,278,974 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $ 465,546 ================================================================================ NET ASSET VALUE PER SHARE $ 9.26 ================================================================================ *See Note A in Notes to Financial Statements. *Non-income-producing security. ADR--American Depositary Receipt. CDI--CHESS Depository Interest. GDR--Global Depositary Receipt. - -------------------------------------------------------------------------------- AMOUNT PER (000) SHARE - -------------------------------------------------------------------------------- AT JULY 31, 2002, NET ASSETS CONSISTED OF: - -------------------------------------------------------------------------------- Paid-in Capital $ 567,060 $ 11.28 Undistributed Net Investment Income--Note E 2,651 .05 Accumulated Net Realized Losses--Note E (91,147) (1.81) Unrealized Appreciation (Depreciation)--Note F Investment Securities (13,020) (.26) Foreign Currencies 2 -- - -------------------------------------------------------------------------------- NET ASSETS $ 465,546 $ 9.26 ================================================================================ 11 STATEMENT OF OPERATIONS This Statement shows the types of income earned by the fund during the reporting period, and details the operating expenses charged to the fund. These expenses directly reduce the amount of investment income available to pay to shareholders as income dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) of investments during the period. - -------------------------------------------------------------------------------- PRECIOUS METALS FUND SIX MONTHS ENDED JULY 31, 2002 (000) - -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends* $ 6,293 Interest 231 Security Lending 170 - -------------------------------------------------------------------------------- Total Income $ 6,694 - -------------------------------------------------------------------------------- EXPENSES Investment Advisory Fees--Note B 513 The Vanguard Group--Note C Management and Administrative 958 Marketing and Distribution 28 Custodian Fees 38 Auditing Fees 6 Shareholders' Reports 16 - -------------------------------------------------------------------------------- Total Expenses $ 1,559 Expenses Paid Indirectly--Note D (1) - -------------------------------------------------------------------------------- Net Expenses $ 1,558 - -------------------------------------------------------------------------------- NET INVESTMENT INCOME $ 5,136 - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) Investment Securities Sold $ 36,391 Foreign Currencies (53) - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) $ 36,338 - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) Investment Securities (58,006) Foreign Currencies 3 - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (58,003) - -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $ (16,529) ================================================================================ *Dividends are net of foreign withholding taxes of $92,000. 12 STATEMENT OF CHANGES IN NET ASSETS This Statement shows how the fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the amount shareholders invested in the fund, either by purchasing shares or by reinvesting distributions, as well as the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed are shown at the end of the Statement. - -------------------------------------------------------------------------------- PRECIOUS METALS FUND ----------------------------------- SIX MONTHS YEAR ENDED ENDED JULY 31, 2002 JAN. 31, 2002 (000) (000) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 5,136 $ 11,504 Realized Net Gain (Loss) 36,338 878 Change in Unrealized Appreciation (Depreciation) (58,003) 80,108 - -------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations (16,529) 92,490 - -------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income (3,239) (16,266) Realized Capital Gain -- -- - -------------------------------------------------------------------------------- Total Distributions (3,239) (16,266) - -------------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS1 Issued 233,321 103,246 Issued in Lieu of Cash Distributions 2,996 15,025 Redeemed* (161,498) (91,406) - -------------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions 74,819 26,865 - -------------------------------------------------------------------------------- Total Increase (Decrease) 55,051 103,089 - -------------------------------------------------------------------------------- NET ASSETS Beginning of Period 410,495 307,406 - -------------------------------------------------------------------------------- End of Period $ 465,546 $ 410,495 ================================================================================ 1SHARES ISSUED (REDEEMED) Issued 20,691 12,580 Issued in Lieu of Cash Distributions 307 1,870 Redeemed (14,822) (11,275) - -------------------------------------------------------------------------------- Net Increase (Decrease) in Shares Outstanding 6,176 3,175 ================================================================================ *Net of redemption fees of $787,000 and $205,000, respectively. 13 FINANCIAL HIGHLIGHTS This table summarizes the fund's investment results and distributions to shareholders on a per-share basis. It also presents the Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year.
PRECIOUS METALS FUND - ------------------------------------------------------------------------------------------------------------------ FOR A SHARE OUTSTANDING YEAR ENDED JANUARY 31, SIX MONTHS ENDED --------------------------------------------------------- THROUGHOUT EACH PERIOD JULY 31, 2002 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF PERIOD $9.31 $7.51 $7.67 $6.61 $7.53 $10.94 - ------------------------------------------------------------------------------------------------------------------ INVESTMENT OPERATIONS Net Investment Income .12 .28 .22 .11 .10 .14 Net Realized and Unrealized Gain (Loss) on Investments (.10) 1.91 (.18) 1.05 (.93) (3.42) - ------------------------------------------------------------------------------------------------------------------ Total from Investment Operations .02 2.19 .04 1.16 (.83) (3.28) - ------------------------------------------------------------------------------------------------------------------ DISTRIBUTIONS Dividends from Net Investment Income (.07) (.39) (.20) (.10) (.09) (.13) Distributions from Realized Capital Gains -- -- -- -- -- -- - ------------------------------------------------------------------------------------------------------------------ Total Distributions (.07) (.39) (.20) (.10) (.09) (.13) - ------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, END OF PERIOD $9.26 $9.31 $7.51 $7.67 $6.61 $ 7.53 ================================================================================================================== TOTAL RETURN* 0.18% 30.05% 0.67% 17.49% -11.06% -29.85% ================================================================================================================== RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $466 $410 $307 $341 $310 $327 Ratio of Total Expenses to Average Net Assets 0.58%** 0.63% 0.65% 0.77% 0.77% 0.62% Ratio of Net Investment Income to Average Net Assets 1.90%** 3.45% 2.94% 1.42% 1.33% 1.41% Portfolio Turnover Rate 45%** 52% 17% 28% 23% 26% ================================================================================================================== * Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year. **Annualized.
14 NOTES TO FINANCIAL STATEMENTS Vanguard Precious Metals Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund invests in securities of foreign issuers, which may subject it to investment risks not normally associated with investing in securities of United States corporations. A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. The fund consistently follows such policies in preparing its financial statements. 1. SECURITY VALUATION: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. Precious metals are valued at the mean of the latest quoted bid and asked prices. Temporary cash investments are valued at cost, which approximates market value. Securities for which market quotations are not readily available are valued by methods deemed by the board of trustees to represent fair value. 2. FOREIGN CURRENCY: Securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars at the exchange rates on the valuation date as employed by Morgan Stanley Capital International in the calculation of its indexes. Realized gains (losses) and unrealized appreciation (depreciation) on investment securities include the effects of changes in exchange rates since the securities were purchased, combined with the effects of changes in security prices. Fluctuations in the value of other assets and liabilities resulting from changes in exchange rates are recorded as unrealized foreign currency gains (losses) until the asset or liability is settled in cash, when they are recorded as realized foreign currency gains (losses). 3. 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. 4. REPURCHASE AGREEMENTS: The fund, along with other members of The Vanguard Group, transfers uninvested cash balances to a pooled cash account, which is invested in repurchase agreements secured by U.S. government securities. Securities pledged as collateral for repurchase agreements are held by a custodian bank until the agreements mature. Each agreement requires that the market value of the collateral be sufficient to cover payments of interest and principal; however, in the event of default or bankruptcy by the other party to the agreement, retention of the collateral may be subject to legal proceedings. 5. DISTRIBUTIONS: Distributions to shareholders are recorded on the ex-dividend date. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. 6. OTHER: Dividend income is recorded on the ex-dividend date. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. Fees assessed on redemptions of capital shares are credited to paid-in capital. B. M&G Investment Management Ltd. provides investment advisory services to the fund for a fee calculated at an annual percentage rate of average net assets. For the six months ended July 31, 2002, the investment advisory fee represented an effective annual rate of 0.19% of the fund's average net assets. C. The Vanguard Group furnishes at cost corporate management, administrative, marketing, and distribution services. The costs of such services are allocated to the fund under methods approved by 15 NOTES TO FINANCIAL STATEMENTS (CONTINUED) the board of trustees. The fund has committed to provide up to 0.40% of its net assets in capital contributions to Vanguard. At July 31, 2002, the fund had contributed capital of $113,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 0.11% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. D. The fund's custodian bank has agreed to reduce its fees when the fund maintains cash on deposit in the non-interest-bearing custody account. For the six months ended July 31, 2002, custodian fee offset arrangements reduced expenses by $1,000. E. During the six months ended July 31, 2002, the fund purchased $150,861,000 of investment securities and sold $111,335,000 of investment securities other than temporary cash investments. During the six months ended July 31, 2002, the fund realized net foreign currency losses of $53,000, which decreased distributable net income for tax purposes; accordingly, such losses have been reclassified from accumulated net realized losses to undistributed net investment income. Certain of the fund's investments are in securities considered to be "passive foreign investment companies," for which any unrealized appreciation and/or realized gains are required to be included in distributable net income for tax purposes. During the six months ended July 31, 2002, the fund realized gains on the sale of passive foreign investment companies of $4,262,000, which were included in current and prior years' distributable net income for tax purposes; accordingly, such gains have been reclassified from accumulated net realized gains to undistributed net investment income. Unrealized appreciation on passive foreign investment company holdings at July 31, 2002, was $3,757,000. (See Note F.) During 2001, the fund elected to use a provision of the Taxpayer Relief Act of 1997 to mark-to-market certain appreciated securities held on January 1, 2001; such securities were treated as sold and repurchased, with unrealized gains of $46,006,000 becoming realized, for tax purposes. The mark-to-market created a difference between the cost of investments for financial statement and tax purposes, which will reverse when the securities are sold. During the six months ended July 31, 2002, the fund realized gains on the sale of these securities of $1,494,000, which were included in prior year mark-to-market gains for tax purposes. The remaining difference of $44,512,000 is reflected in the balance of accumulated net realized losses; the corresponding difference between the securities' cost for financial statement and tax purposes is reflected in unrealized depreciation. (See Note F.) For tax purposes, at January 31, 2002, the fund had available a capital loss carryforward of $79,127,000 to offset future net capital gains of $64,644,000 through January 31, 2007, $13,355,000 through January 31, 2008, and $1,128,000 through January 31, 2010. F. At July 31, 2002, net unrealized depreciation of investment securities for federal income tax purposes was $61,289,000, consisting of unrealized gains of $30,086,000 on securities that had risen in value since their purchase and $91,375,000 in unrealized losses on securities that had fallen in value since their purchase or since being marked-to-market for tax purposes. (See Note E.) The fund had net unrealized foreign currency gains of $2,000 resulting from the translation of other assets and liabilities at July 31, 2002. G. The market value of securities on loan to broker/dealers at July 31, 2002, was $72,873,000, for which the fund held cash collateral of $75,805,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. 16 THE PEOPLE WHO GOVERN YOUR FUND The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are a part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides services to them on an at-cost basis. A majority of Vanguard's board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. Our independent board members bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the activities of the funds. Among board members' responsibilities are selecting investment advisers for the funds; monitoring fund operations, performance, and costs; reviewing contracts; nominating and selecting new trustees/directors; and electing Vanguard officers. - -------------------------------------------------------------------------------- TRUSTEES (YEAR ELECTED) JOHN J. BRENNAN Chairman of the Board, Chief Executive Officer, and (1987) Director/Trustee of The Vanguard Group, Inc., and of each of the investment companies served by The Vanguard Group. CHARLES D. ELLIS The Partners of '63 (pro bono ventures in education); (2001) Senior Adviser to Greenwich Associates Successor Trustee of Yale University; Overseer of the Stern School of Business at New York (international business-strategy consulting); University; Trustee of the Whitehead Institute for Biomedical Research. RAJIV L. GUPTA Chairman and Chief Executive Officer of Rohm and Haas (2001) Co. (chemicals); Director of Technitrol, Inc. (electronic components), and Agere Systems (communications components); Board Member of the American Chemistry Council; and Trustee of Drexel University. JOANN HEFFERNAN HEISEN Vice President, Chief Information Officer, and Member (1998) of the Executive Committee of Johnson & Johnson (pharmaceuticals/consumer products); Director of the Medical Center at Princeton and Women's Research and Education Institute. BURTON G. MALKIEL Chemical Bank Chairman's Professor of Economics, (1977) Princeton University; Director of Vanguard Investment Series plc (Irish investment fund), Vanguard Group (Ireland) Limited (Irish investment management firm), Prudential Insurance Co.of America, BKF Capital (investment management firm), The Jeffrey Co. (holding company), and NeuVis, Inc. (software company). ALFRED M. RANKIN, JR. Chairman, President, Chief Executive Officer, and (1993) Director of NACCO Industries, Inc. (forklift trucks/ housewares/lignite); Director of Goodrich Corporation (industrial products/aircraft systems and services). J. LAWRENCE WILSON Retired Chairman and Chief Executive Officer of Rohm (1985) and Haas Co. (chemicals); Director of Cummins Inc. (diesel engines), The Mead Corp. (paper products), and AmerisourceBergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University. - -------------------------------------------------------------------------------- EXECUTIVE OFFICERS R. GREGORY BARTON Secretary; Managing Director and General Counsel of The Vanguard Group, Inc.; Secretary of The Vanguard Group and of each of the investment companies served by The Vanguard Group. THOMAS J. HIGGINS Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies served by The Vanguard Group. More information about the trustees is in the Statement of Additional Information, available from The Vanguard Group. VANGUARD SENIOR MANAGEMENT TEAM MORTIMER J. BUCKLEY, Information Technology. F. WILLIAM MCNABB, III, Institutional Investor Group. JAMES H. GATELY, Direct Investor Services. MICHAEL S. MILLER, Planning and Development. KATHLEEN C. GUBANICH, Human Resources. RALPH K. PACKARD, Finance. IAN A. MACKINNON, Fixed Income Group. GEORGE U. SAUTER, Quantitative Equity Group. - -------------------------------------------------------------------------------- JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-1996. [PICTURE OF A SHIP] THE VANGUARD(R) LOGO POST OFFICE BOX 2600 VALLEY FORGE, PA 19482-2600 Vanguard, The Vanguard Group, Vanguard.com, and the ship logo are trademarks of The Vanguard Group, Inc. All other marks are the property of their respective owners. All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. ABOUT OUR COVER Our cover photographs were taken by Michael Kahn in September 2000 aboard HMS Rose in New York's Long Island Sound. Mr. Kahn is a renowned photographer--and accomplished sailor--whose work often focuses on seascapes and nautical images. The photographs are copyrighted by Mr. Kahn. FOR MORE INFORMATION This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. To receive a free copy of the prospectus or the Statement of Additional Information, or to request additional information about the funds or other Vanguard funds, please contact us at one of the adjacent telephone numbers or by e-mail through VANGUARD.COM(R). Prospectuses may also be viewed online. WORLD WIDE WEB www.vanguard.com FUND INFORMATION 1-800-662-7447 DIRECT INVESTOR ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 TEXT TELEPHONE 1-800-952-3335 (C) 2002 THE VANGUARD GROUP, INC. ALL RIGHTS RESERVED. VANGUARD MARKETING CORPORATION, DISTRIBUTOR. Q532 092002 VANGUARD(R)ENERGY FUND SEMIANNUAL REPORT * JULY 31, 2002 STOCK [PICTURE OF SHIP] THE VANGUARD GROUP(R) WHAT YOU CAN CONTROL As an investor, you cannot control how the financial markets perform. But there are vital variables that you can control. You can decide how much to invest. You can limit the risk in your portfolio by diversifying your holdings. And you can control the investment costs you incur. Costs may seem the least dramatic of the three. But costs have a powerful impact on how your wealth accumulates; they reduce, dollar for dollar, the returns that you can derive from an investment. Every mutual fund has operating expenses--to pay for investment managers, telephone support, and so on. These costs appear in the fund's expense ratio, which reflects the percentage of average net assets (your money) consumed each year by operating costs. In 2001, the average mutual fund had an expense ratio of 1.34% (or $13.40 per $1,000 in assets), according to data from Lipper Inc. For Vanguard(R) funds, the average expense ratio was less than one-fourth that amount (0.27%, or $2.70 per $1,000 in assets). Our average expense ratio has been less than the industry average for 25 years, and it's an advantage we aim to maintain. Under our unique corporate structure, shareholders like you own the Vanguard funds, which in turn own The Vanguard Group. No middleman makes a profit from managing the operation. You bear all of the investment risk. It's only right that you reap as much of the potential reward as possible. - -------------------------------------------------------------------------------- CONTENTS Letter from the Chairman 1 Report from the Adviser 5 Fund Profile 8 Glossary of Investment Terms 9 Performance Summary 10 Financial Statements 11 Advantages of Vanguard.com 20 - -------------------------------------------------------------------------------- SUMMARY * Vanguard Energy Fund returned -1.6%, a negative result but one that was better than the returns of the fund's average competitor and its unmanaged index benchmark. * The U.S. stock market was extremely volatile during the period, dropping to levels not seen in five years. * The fund demonstrated its value during the half-year as a modest hedge against general stock market weakness. - -------------------------------------------------------------------------------- LETTER FROM THE CHAIRMAN FELLOW SHAREHOLDER, Although energy prices rose, the prices of energy stocks generally fell during the six months ended July 31, 2002, as global unrest dictated the market's direction. VANGUARD(R) ENERGY FUND returned -1.6%. This slightly negative result was better than the returns of the fund's average competitor and its unmanaged index benchmark, as shown in the table below. Your fund's return also surpassed that of the hard-hit U.S. stock market. The per-share components of the returns for both the Investor and Admiral(TM) share classes appear on page 4. - ------------------------------------------------ TOTAL RETURNS SIX MONTHS ENDED JULY 31, 2002 - ------------------------------------------------ VANGUARD ENERGY FUND Investor Shares -1.6% Admiral Shares -1.6 Average Natural Resources Fund* -6.2 S&P Energy Sector Index -7.3 Wilshire 5000 Index -17.9 - ------------------------------------------------ *Derived from data provided by Lipper Inc. STOCK PRICES DECLINED AS NEGATIVE NEWS MOUNTED The U.S. stock market was extremely volatile during the six months ended July 31, dropping to levels not seen in five years. The broad market, as measured by the Wilshire 5000 Total Market Index, posted a sharp decline of -17.9% for the half-year. The market's slump seemed to take on a life of its own, as investors ignored reports of a recovery in the economy and of improved corporate earnings to focus on the drumbeat of negative news, including ongoing revelations of corporate misconduct, continued strife in the Middle East, warnings of potential terrorist attacks, and talk of war with Iraq. No market segment escaped the downdraft. Even small-capitalization value stocks, which had previously flourished, declined. Across all market caps, growth stocks (those with high prices relative to their earnings or book values) continued to fare worse than value stocks. As a group, developed international markets fared better than the U.S. market, but they also failed to record a positive total return in the period. - -------------------------------------------------------------------------------- ADMIRAL SHARES A lower-cost class of shares available to many longtime shareholders and to those with significant investments in the fund. - -------------------------------------------------------------------------------- THE ECONOMY GREW IN FITS AND STARTS The nation's real (inflation-adjusted) gross domestic product grew at an annual rate of 1.1% in the second quarter of 2002, according to an early estimate. This was a sharp slowdown from the first quarter's robust growth rate of 5.0%. (The 5.0% figure was revised from the earlier estimate of 6.1%. More surprising, however, was the Commerce Department's downward revision of 1 GDP growth in 2001. With the first three quarters of 2001 now showing negative growth, last year's recession was longer and deeper than originally thought.) - -------------------------------------------------------------------------------- MARKET BAROMETER TOTAL RETURNS PERIODS ENDED JULY 31, 2002 -------------------------------- SIX ONE FIVE STOCK MONTHS YEAR YEARS* - -------------------------------------------------------------------------------- Russell 1000 Index (Large-caps) -18.2% -22.9% 0.7% Russell 2000 Index (Small-caps) -18.2 -18.0 0.2 Wilshire 5000 Index (Entire market) -17.9 -22.1 0.3 MSCI EAFE Index (International) -6.4 -16.9 -3.9 - -------------------------------------------------------------------------------- BONDS Lehman Aggregate Bond Index 4.2% 7.5% 7.3% (Broad taxable market) Lehman 10 Year Municipal Bond Index 4.8 7.2 6.1 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 0.9 2.3 4.6 ================================================================================ CPI Consumer Price Index 1.7% 1.5% 2.3% - -------------------------------------------------------------------------------- *Annualized. With inflation of little concern and the economy sluggish, the Federal Reserve Board kept the target for the federal funds rate--the interest rate for overnight loans between banks--at its four-decade low of 1.75%. BOND INVESTORS FLED TO QUALITY The overall U.S. bond market, as measured by the Lehman Brothers Aggregate Bond Index, posted a solid six-month return of 4.2%. But there was a distinct flight to quality in the period, with government and agency bonds posting the best returns as demand for these issues pushed their prices higher. A high default rate among corporate debt issues, notably those of several now-bankrupt telecommunications companies, caused investors to shun high-risk debt. The Lehman High Yield Index returned -9.6% for the six months, as price declines more than offset higher yields. Prices of U.S. Treasury securities rose and yields fell. The 10-year note's yield fell 57 basis points (0.57 percentage point) during the six months to 4.46%. The decline was more dramatic for shorter-maturity issues: The 3-year note's yield fell 112 basis points to 3.01%. The yield of the 3-month Treasury bill, which lags a bit behind the Fed's interest rate moves, fell 6 basis points to 1.69%. NEW CHALLENGES FOR YOUR FUND, BUT A SIMILAR HALF-YEAR RESULT As the half-year began, low energy prices weighed on energy stocks, a situation that had depressed the sector's returns during the previous six months. But energy prices rebounded sharply, with oil prices reaching $27 a barrel during the six months ended July 31--a gain of 39%--and natural gas prices rising by a similar magnitude. Just as energy prices bounced back, however, geopolitical tensions simmered to a boil. Infighting among members of the Organization of Petroleum Exporting Countries and Russia, as well as the possibility of a U.S. confrontation with Iraq, tainted the energy market's health with the prospect of near-term disruption. In 2 this unsettled environment, Vanguard Energy Fund returned -1.6%, not much different from its -1.5% return for the previous six months. In both periods, your fund's relative performance was strong. During the past six months, Vanguard Energy Fund outperformed its average competitor by 4.6 percentage points and the Standard & Poor's Energy Sector Index by 5.7 percentage points. Your fund's relative strength was a function of its broad diversification within the narrow energy sector. The fund has one-third of its assets in high-risk oil-services and exploration firms, but it balances this aggressive position with a heavy weighting in the integrated-oil giants. Some rival funds tend to place a heavier emphasis on one group or the other. Exploration and production stocks do well when energy prices rally, as they did during the past six months. The integrated-oil giants, by contrast, are better positioned to ride out a slump in fossil-fuel prices. Their diverse mix of production, refining, and retailing businesses allows these companies to offset weakness in energy prices with higher profits on the refining side, which benefits from lower raw-materials costs. We enhance the long-term benefits of this diversified approach by keeping your investment costs low. Your fund's expense ratio is 0.42% (0.35% for Admiral Shares), about one-fourth of the charge levied by the average natural resources fund. When the market's spoils are divided between fund investor and fund manager, low costs are the investor's ally. - -------------------------------------------------------------------------------- Your fund's relative strength was a function of its broad diversification within the narrow energy sector. - -------------------------------------------------------------------------------- A final note about Vanguard Energy Fund: Since your fund's 1984 inception, Ernst H. von Metzsch, a senior vice-president at Wellington Management Company, has overseen the portfolio with dedication and skill. Mr. von Metzsch will retire at year-end. His longtime Wellington colleague, Karl E. Bandtel, will assume responsibility for the fund. We foresee no change in the fund's investment practices. We thank Mr. von Metzsch for his nearly 20 years of distinguished service to our fund's shareholders. DIVERSIFY, THEN DIVERSIFY AGAIN The past six months represented the most challenging leg, thus far, of the 28-month-old bear market in stocks. Energy stocks lost value, but their decline was less severe than that of the broad market. Your fund did better still. During the half-year, Vanguard Energy Fund demonstrated its value as a component of a well-diversified stock portfolio by offering a modest hedge against general stock market weakness. You get more significant diversification benefits, of course, by balancing your stock fund investments with allocations to bond and money market funds in proportions suited to your goals, risk tolerance, and financial circumstances. We 3 recommend this balanced investment approach in any market, bear or bull. It provides some safety in the tough markets we've experienced lately, and offers the opportunity for growth when stock prices inevitably recover. We thank you for entrusting your hard-earned money to us. Sincerely, /S/JOHN J. BRENNAN John J. Brennan Chairman and Chief Executive Officer August 14, 2002 - -------------------------------------------------------------------------------- YOUR FUND'S PERFORMANCE AT A GLANCE: JANUARY 31, 2002-JULY 31, 2002 DISTRIBUTIONS PER SHARE -------------------------- STARTING ENDING INCOME CAPITAL SHARE PRICE SHARE PRICE DIVIDENDS GAINS - -------------------------------------------------------------------------------- Vanguard Energy Fund Investor Shares $24.76 $24.10 $0.000 $0.301 Admiral Shares 46.48 45.26 0.000 0.565 - -------------------------------------------------------------------------------- 4 REPORT FROM THE ADVISER VANGUARD ENERGY FUND declined -1.6% in value during the six months ended July 31, 2002. The average natural resources fund declined -6.2% in the period, and the S&P 500 Index declined -18.7%. THE INVESTMENT ENVIRONMENT Starting in late January, the price of oil gradually rose from the $20-per-barrel range to around $27 at the end of July. The Organization of Petroleum Exporting Countries (OPEC) maintained production discipline during a period of weak demand resulting from an unusually mild winter in the Northern Hemisphere. Economic activity was subdued, except for a growth spurt in the United States in the first quarter of 2002. However, an interruption in oil exports from Iraq and a perception among buyers that the United States and Iraq might go to war helped drive oil prices higher. But higher prices may not persist. Excess productive capacity in OPEC is now several million barrels per day. Production outside the cartel is increasing, and unless growth in oil demand picks up after a few years of slow growth, the price of oil could well come down in 2003. The price of natural gas moved from about $2.50 per thousand cubic feet in February to just below $4 in early May and back to $2.70 at the end of July. The high level of drilling in 2001 has done little to increase supply. Gas in storage is ample, as last winter was quite moderate, and industrial demand is low. U.S. production is declining in 2002 and is likely to do so in future years as well. Furthermore, since additional supplies from Canada are limited, as are those of liquefied natural gas, a tighter natural gas market will reemerge. OUR SUCCESSES Integrated-oil companies, oil and gas producers, mid-capitalization oil services companies, and onshore drilling companies had the most modest declines during the difficult market environment in the six-month period. We have large exposure in all these sectors. Among our better performers were the refining company Sunoco and the European integrated-oil companies BP and ENI. We also benefited from having limited exposure to natural gas transmission companies with large trading operations. OUR SHORTFALLS Our shortfalls were mainly in the oil-services sector, where large-cap companies, such as 5 Schlumberger and GlobalSantaFe, declined as their earnings prospects dimmed. One of our worst-performing holdings during the six months was the Brazilian oil giant Petrol Brasil, which declined because of fears of a financial crisis in Brazil. THE FUND'S POSITIONING The fund is positioned to participate in the improving outlook for natural gas that we expect to unfold next year. At the same time, the portfolio is somewhat defensive with respect to our more cautious expectations for oil. We continue to invest with low turnover and a sizable (about 40%) exposure to non-U.S. companies, with diversification across the important segments of the industry. This is my last report to you, as I will withdraw from Wellington Management Company at year-end 2002. I have worked since the early 1990s with Karl Bandtel, who will take over as manager and who already has had a very positive impact on the fund's results during the last ten years. In 1984, Vanguard Energy Fund began operations in a tough environment, just a year and a half before the oil-price collapse of 1986. This made it difficult to provide good returns in the early years, but I am pleased that our returns are now ahead of the S&P 500 Index on a one-, five-, and ten-year basis. Furthermore, as past results have shown, the fund's returns tend not to correlate with the general market in the short run, which makes the portfolio an attractive diversifier. The energy sector will need to invest large amounts of money in the next ten years to meet growing demand, while making up for declines in production at older oil and gas fields. The industry will be able to attract investment funds only if it provides good returns to shareholders; therefore, these dynamics suggest that the energy sector should continue to be a desirable investment. Many thanks for your support over the years. ERNST H. VON METZSCH, SENIOR VICE PRESIDENT AND PORTFOLIO MANAGER WELLINGTON MANAGEMENT COMPANY, LLP August 15, 2002 (A table showing significant changes in the fund's holdings is on the next page.) 6 - -------------------------------------------------------------------------------- PORTFOLIO CHANGES FISCAL PERIOD ENDED JULY 31, 2002 ADDITIONS COMMENTS - -------------------------------------------------------------------------------- Burlington Resources Company has valuable natural gas assets in the United States and Canada. - -------------------------------------------------------------------------------- Phillips Petroleum Successful acquirer of assets, with good growth prospects. - -------------------------------------------------------------------------------- Shell Canada Has above-average growth prospects in oil-sands projects. - -------------------------------------------------------------------------------- Sunoco Attractively priced refiner with earnings recovery ahead. ================================================================================ REDUCTIONS Noble Drilling company hit $40 per share price target in spring. - -------------------------------------------------------------------------------- Weatherford International Oil-services company reached $48 per share price target. ================================================================================ SEE PAGE 11 FOR A COMPLETE LISTING OF THE FUND'S HOLDINGS. 7 FUND PROFILE AS OF JULY 31, 2002 FOR ENERGY FUND This Profile provides a snapshot of the fund's characteristics, compared where appropriate with a broad market index. Key terms are defined on page 9. - -------------------------------------------------- PORTFOLIO CHARACTERISTICS WILSHIRE FUND 5000 - -------------------------------------------------- Number of Stocks 52 5,808 Median Market Cap $8.0B $27.0B Price/Earnings Ratio 27.9x 24.6x Price/Book Ratio 1.9x 2.7x Yield 1.6% Investor Shares 1.9% Admiral Shares 2.0% Return on Equity 15.4% 21.6% Earnings Growth Rate 11.8% 9.8% Foreign Holdings 39.0% 0.3% Turnover Rate 29%* -- Expense Ratio -- Investor Shares 0.42%* Admiral Shares 0.35%* Cash Investments 2.7% -- - -------------------------------------------------- - -------------------------------------------- TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) Sunoco, Inc. 5.0% BP PLC ADR 4.3 ChevronTexaco Corp. 3.9 Phillips Petroleum Co. 3.8 ExxonMobil Corp. 3.8 EnCana Corp. 3.6 Suncor Energy, Inc. 3.5 Norsk Hydro AS ADR 3.2 Equitable Resources, Inc. 3.1 TotalFinaElf SA ADR 3.0 - -------------------------------------------- Top Ten 37.2% - -------------------------------------------- - --------------------------- INVESTMENT FOCUS MARKET CAP Medium STYLE Value - --------------------------- - -------------------------------------------------- VOLATILITY MEASURES WILSHIRE FUND 5000 - -------------------------------------------------- R-Squared 0.17 1.00 Beta 0.55 1.00 - -------------------------------------------------- - --------------------------------------------------- SECTOR DIVERSIFICATION (% OF COMMON STOCKS) Energy Miscellaneous 7.5% International 39.0 Machinery--Oil Well Equipment & Services 16.2 Materials & Processing 1.9 Offshore Drilling 2.9 Oil--Crude Producers 9.3 Oil--Integrated Domestic 11.1 Oil--Integrated International 8.6 Utilities--Gas Pipelines 3.5 - --------------------------------------------------- *Annualized. VISIT OUR WEBSITE WWW.VANGUARD.COM FOR REGULARLY UPDATED FUND INFORMATION. 8 GLOSSARY OF INVESTMENT TERMS BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the overall market (or appropriate market index). The market (or index) is assigned a beta of 1.00, so a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the overall market rose or fell by 10%. - -------------------------------------------------------------------------------- CASH INVESTMENTS. The percentage of a fund's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. This figure does not include cash invested in futures contracts to simulate stock investment. - -------------------------------------------------------------------------------- EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in a fund. - -------------------------------------------------------------------------------- EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. - -------------------------------------------------------------------------------- FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks or American Depositary Receipts of companies based outside the United States. - -------------------------------------------------------------------------------- MEDIAN MARKET CAP. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. - -------------------------------------------------------------------------------- PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds. - -------------------------------------------------------------------------------- PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. - -------------------------------------------------------------------------------- R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the overall market (or its benchmark index). If a fund's total returns were precisely synchronized with the overall market's return, its R-squared would be 1.00. If the fund's returns bore no relationship to the market's returns, its R-squared would be 0. - -------------------------------------------------------------------------------- RETURN ON EQUITY. The annual average rate of return generated by a company during the past five years for each dollar of shareholder's equity (net income divided by shareholder's equity). For a fund, the weighted average return on equity for the companies whose stocks it holds. - -------------------------------------------------------------------------------- TURNOVER RATE. An indication of the fund's trading activity. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). - -------------------------------------------------------------------------------- YIELD. A snapshot of a fund's income from interest and dividends. The yield, expressed as a percentage of the fund's net asset value, is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. The index yield is based on the current annualized rate of dividends paid on stocks in the index. - -------------------------------------------------------------------------------- 9 PERFORMANCE SUMMARY AS OF JULY 31, 2002 FOR ENERGY FUND All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely. An investor's shares, when redeemed, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the redemption of fund shares. - -------------------------------------------------------------------------------- FISCAL-YEAR TOTAL RETURNS (%) JANUARY 31, 1992-JULY 31, 2002 ENERGY FUND S&P ENERGY INVESTOR SHARES SECTOR INDEX 1993 13.0 9.8 1994 27.3 18.4 1995 -9.1 1.1 1996 28.7 28.1 1997 40.3 32.3 1998 3.8 12.8 1999 -21.2 -1.3 2000 25.8 26.0 2001 35.1 17.8 2002 -0.6 -9.3 2003** -1.6 -7.3 - -------------------------------------------------------------------------------- *Six months ended July 31, 2002. Note: See Financial Highlights tables on pages 15 and 16 for dividend and capital gains information. - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED JUNE 30, 2002 This table presents average annual total returns through the latest calendar quarter--rather than through the end of the fiscal period. Securities and Exchange Commission rules require that we provide this information. TEN YEARS ONE FIVE ------------------------ INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL - -------------------------------------------------------------------------------- Energy Fund Investor Shares* 5/23/1984 6.98% 8.02% 11.31% 1.83% 13.14% Admiral Shares* 11/12/2001 8.86** -- -- -- -- - -------------------------------------------------------------------------------- * For the Energy Fund Investor Shares, total return figures do not reflect the 1% fee assessed on redemptions of shares held for less than one year. The Energy Fund Admiral Shares' return of 8.86% is reflective of this fee. **Return since inception. 10 FINANCIAL STATEMENTS JULY 31, 2002 (UNAUDITED) STATEMENT OF NET ASSETS This Statement provides a detailed list of the fund's holdings, including each security's market value on the last day of the reporting period. Securities are grouped and subtotaled by asset type (common stocks, bonds, etc.) and by sector within the fund's designated industry; international securities, if significant, may be presented in a separate group. Other assets are added to, and liabilities are subtracted from, the value of Total Investments to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid-in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. - -------------------------------------------------------------------------------- MARKET VALUE* ENERGY FUND SHARES (000) - -------------------------------------------------------------------------------- COMMON STOCKS (97.3%) - -------------------------------------------------------------------------------- UNITED STATES (59.3%) - -------------------------------------------------------------------------------- ENERGY MISCELLANEOUS (7.3%) Sunoco, Inc. 1,900,000 $ 67,526 Valero Energy Corp. 927,100 31,577 -------------------- $ 99,103 -------------------- MACHINERY--OIL WELL EQUIPMENT & Services (15.7%) Schlumberger Ltd. 800,000 34,336 Halliburton Co. 2,500,000 33,000 * Noble Corp. 749,000 24,268 Baker Hughes, Inc. 879,300 23,565 * Cooper Cameron Corp. 506,200 21,762 Rowan Cos., Inc. 1,097,100 21,470 * Nabors Industries, Inc. 691,100 21,092 * Smith International, Inc. 435,200 13,757 * Weatherford International Ltd. 319,800 12,971 * BJ Services Co. 244,000 7,781 -------------------- $ 214,002 -------------------- MATERIALS & Processing (1.9%) Ashland, Inc. 700,000 $ 24,969 -------------------- OFFSHORE DRILLING (2.8%) ENSCO International, Inc. 656,800 16,978 GlobalSantaFe Corp. 700,000 15,778 Transocean Inc. 210,700 5,373 -------------------- $ 38,129 -------------------- OIL--CRUDE PRODUCERS (9.0%) Burlington Resources, Inc. 1,102,800 40,307 EOG Resources, Inc. 900,000 30,861 Anadarko Petroleum Corp. 500,000 21,750 Cabot Oil & Gas Corp. 861,000 17,995 Apache Corp. 230,000 11,845 -------------------- $ 122,758 -------------------- OIL--INTEGRATED DOMESTIC (10.8%) Phillips Petroleum Co. 1,000,000 51,750 Unocal Corp. 1,000,000 32,660 Occidental Petroleum Corp. 800,000 21,672 Marathon Oil Corp. 585,800 14,200 Amerada Hess Corp. 205,400 14,050 Kerr-McGee Corp. 278,900 13,044 -------------------- $ 147,376 -------------------- OIL--INTEGRATED INTERNATIONAL (8.4%) ChevronTexaco Corp. 701,000 52,575 ExxonMobil Corp. 1,400,000 51,464 Conoco Inc. 400,000 9,648 -------------------- $ 113,687 -------------------- UTILITIES--GAS PIPELINES (3.4%) Equitable Resources, Inc. 1,228,200 41,992 El Paso Corp. 319,600 4,618 -------------------- $ 46,610 -------------------- - -------------------------------------------------------------------------------- TOTAL UNITED STATES $ 806,634 - -------------------------------------------------------------------------------- 11 - -------------------------------------------------------------------------------- MARKET VALUE* ENERGY FUND SHARES (000) - -------------------------------------------------------------------------------- INTERNATIONAL (38.0%) - -------------------------------------------------------------------------------- BRAZIL (1.5%) Petrol Brasil ADR 1,500,000 $ 19,800 -------------------- CANADA (14.7%) EnCana Corp. 1,719,907 48,708 Suncor Energy, Inc. 2,896,800 47,971 Petro Canada 1,000,000 27,980 Canadian Natural Resources Ltd. 800,000 25,904 Shell Canada Ltd. Class A 644,100 19,515 Shell Canada Ltd. 440,600 13,349 * Paramount Resources Ltd. 1,106,300 9,651 * Western Oil Sands Inc. 500,000 7,575 -------------------- $ 200,653 -------------------- CHINA (1.3%) Petrochina Co. Ltd. ADR 600,000 12,942 * China Petroleum and Chemical Corp. ADR 287,400 4,483 -------------------- $ 17,425 -------------------- FRANCE (3.5%) TotalFinaElf SA ADR 558,200 40,497 Technip-Coflexip SA ADR 428,100 7,749 -------------------- $ 48,246 -------------------- ITALY (2.8%) ENI SpA ADR 509,400 $ 38,271 -------------------- NETHERLANDS (2.0%) Royal Dutch Petroleum Co. ADR 580,600 $ 26,533 -------------------- NORWAY (3.2%) Norsk Hydro AS ADR 1,062,900 $ 43,770 -------------------- RUSSIA (1.0%) * OAO Lukoil Sponsored ADR 232,100 $ 13,230 -------------------- SPAIN (1.6%) Repsol YPF, SA ADR 1,800,000 $ 22,014 -------------------- UNITED KINGDOM (6.4%) BP PLC ADR 1,267,500 58,812 Shell Transport & Trading Co. ADR 696,600 28,470 -------------------- $ 87,282 -------------------- - -------------------------------------------------------------------------------- TOTAL INTERNATIONAL $ 517,224 - -------------------------------------------------------------------------------- TOTAL COMMON STOCKS (Cost $1,193,770) $ 1,323,858 - -------------------------------------------------------------------------------- FACE MARKET AMOUNT VALUE* (000) (000) - -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (6.0%) - -------------------------------------------------------------------------------- Repurchase Agreements Collateralized by U.S. Government Obligations in a Pooled Cash Account 1.83%, 8/1/2002--Note G $44,079 44,079 1.84%, 8/1/2002 37,878 37,878 - -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (Cost $81,957) 81,957 - -------------------------------------------------------------------------------- TOTAL INVESTMENTS (103.3%) (Cost $1,275,727) 1,405,815 - -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-3.3%) - -------------------------------------------------------------------------------- Other Assets--Note C 2,207 Security Lending Collateral Payable to Brokers--Note G (44,079) Other Liabilities (2,643) -------------------- $ (44,515) -------------------- - -------------------------------------------------------------------------------- NET ASSETS (100%) $ 1,361,300 ================================================================================ *See Note A in Notes to Financial Statements. *Non-income-producing security. ADR--American Depositary Receipt. - -------------------------------------------------------------------------------- AT JULY 31, 2002, NET ASSETS CONSISTED OF: - -------------------------------------------------------------------------------- AMOUNT (000) - -------------------------------------------------------------------------------- Paid-in Capital $1,147,960 Undistributed Net Investment Income--Note E 11,706 Accumulated Net Realized Gains--Note E 71,546 Unrealized Appreciation--Note F 130,088 - -------------------------------------------------------------------------------- NET ASSETS $1,361,300 ================================================================================ Investor Shares--Net Assets Applicable to 52,507,704 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $ 1,265,617 - -------------------------------------------------------------------------------- NET ASSET VALUE PER SHARE-- INVESTOR SHARES $ 24.10 ================================================================================ Admiral Shares--Net Assets Applicable to 2,114,103 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $ 95,683 - -------------------------------------------------------------------------------- NET ASSET VALUE PER SHARE-- ADMIRAL SHARES $ 45.26 ================================================================================ 12 STATEMENT OF OPERATIONS This Statement shows the types of income earned by the fund during the reporting period, and details the operating expenses charged to each class of its shares. These expenses directly reduce the amount of investment income available to pay to shareholders as income dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) of investments during the period. - -------------------------------------------------------------------------------- ENERGY FUND SIX MONTHS ENDED JULY 31, 2002 (000) - -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends* $ 14,658 Interest 821 Security Lending 277 - -------------------------------------------------------------------------------- Total Income $ 15,756 - -------------------------------------------------------------------------------- EXPENSES Investment Advisory Fees--Note B 428 The Vanguard Group--Note C Management and Administrative Investor Shares 2,342 Admiral Shares 144 Marketing and Distribution Investor Shares 90 Admiral Shares 4 Custodian Fees 10 Auditing Fees 6 Shareholders' Reports Investor Shares 37 Admiral Shares -- Trustees' Fees and Expenses 1 - -------------------------------------------------------------------------------- Total Expenses 3,062 Expenses Paid Indirectly--Note D (127) - -------------------------------------------------------------------------------- Net Expenses 2,935 - -------------------------------------------------------------------------------- NET INVESTMENT INCOME 12,821 - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) Investment Securities Sold 71,787 Foreign Currencies (6) - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) 71,781 - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) Investment Securities Sold (122,339) Foreign Currencies (4) - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (122,343) - -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $ (37,741) ================================================================================ *Dividends are net of foreign withholding taxes of $156,000. 13 STATEMENT OF CHANGES IN NET ASSETS This Statement shows how the fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the net amount shareholders invested in or redeemed from the fund. Distributions and Capital Share Transactions are shown separately for each class of shares. - -------------------------------------------------------------------------------- ENERGY FUND -------------------------------------- SIX MONTHS YEAR ENDED ENDED JULY 31, 2002 JAN. 31, 2002 (000) (000) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 12,821 $ 21,028 Realized Net Gain (Loss) 71,781 102,227 Change in Unrealized Appreciation (Depreciation) (122,343) (144,902) - -------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations (37,741) (21,647) - -------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income Investor Shares -- (18,854) Admiral Shares -- (745) Realized Capital Gain* Investor Shares (15,467) (72,494) Admiral Shares (754) (2,829) - -------------------------------------------------------------------------------- Total Distributions (16,221) (94,922) - -------------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS--NOTE H Investor Shares 50,717 93,486 Admiral Shares 48,692 58,161 - -------------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions 99,409 151,647 - -------------------------------------------------------------------------------- Total Increase (Decrease) 45,447 35,078 - -------------------------------------------------------------------------------- NET ASSETS Beginning of Period 1,315,853 1,280,775 - -------------------------------------------------------------------------------- End of Period $ 1,361,300 $ 1,315,853 ================================================================================ * Includes short-term gain distributions totaling $1,293,000 and $0, respectively. Short-term gain distributions are treated as ordinary income dividends for tax purposes. 14 FINANCIAL HIGHLIGHTS This table summarizes the fund's investment results and distributions to shareholders on a per-share basis for each class of shares. It also presents the Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year.
ENERGY FUND INVESTOR SHARES - ------------------------------------------------------------------------------------------------------------ YEAR ENDED JANUARY 31, FOR A SHARE OUTSTANDING SIX MONTHS ENDED ----------------------------------------------------- THROUGHOUT EACH PERIOD JULY 31, 2002 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF PERIOD $24.76 $26.93 $21.24 $17.16 $22.68 $23.44 - ------------------------------------------------------------------------------------------------------------ INVESTMENT OPERATIONS Net Investment Income .227 .428 .39 .355 .33 .32 Net Realized and Unrealized Gain (Loss) on Investments (.586) (.660) 7.04 4.080 (5.08) .57 - ------------------------------------------------------------------------------------------------------------ Total from Investment Operations (.359) (.232) 7.43 4.435 (4.75) .89 - ------------------------------------------------------------------------------------------------------------ DISTRIBUTIONS Dividends from Net Investment Income -- (.400) (.36) (.355) (.35) (.32) Distributions from Realized Capital Gains (.301) (1.538) (1.38) -- (.42) (1.33) - ------------------------------------------------------------------------------------------------------------ Total Distributions (.301) (1.938) (1.74) (.355) (.77) (1.65) - ------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, END OF PERIOD $24.10 $24.76 $26.93 $21.24 $17.16 $22.68 ============================================================================================================ TOTAL RETURN* -1.61% -0.55% 35.08% 25.83% -21.20% 3.80% ============================================================================================================ RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $1,266 $1,258 $1,281 $973 $760 $1,090 Ratio of Total Expenses to Average Net Assets 0.42%** 0.39% 0.41% 0.48% 0.41% 0.38% Ratio of Net Investment Income to Average Net Assets 1.74%** 1.57% 1.52% 1.63% 1.46% 1.36% Portfolio Turnover Rate 29%** 28% 24% 18% 22% 19% ============================================================================================================ * Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year. **Annualized.
15 FINANCIAL HIGHLIGHTS (CONTINUED) ENERGY FUND ADMIRAL SHARES - -------------------------------------------------------------------------------- SIX MONTHS ENDED NOV. 12,* 2001 JULY 31, TO JAN. 31, FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2002 2002 - -------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $ 46.48 $ 50.00 - -------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .447 .118 Net Realized and Unrealized Gain (Loss) on Investments (1.102) .010 - -------------------------------------------------------------------------------- Total from Investment Operations (.655) .128 - -------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income -- (.760) Distributions from Realized Capital Gains (.565) (2.888) - -------------------------------------------------------------------------------- Total Distributions (.565) (3.648) - -------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $ 45.26 $ 46.48 ================================================================================ TOTAL RETURN** -1.57% 0.57% ================================================================================ RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $ 96 $ 58 Ratio of Total Expenses to Average Net Assets 0.35%+ 0.34%+ Ratio of Net Investment Income to Average Net Assets 1.76%+ 0.53%+ Portfolio Turnover Rate 29%+ 28% ================================================================================ *Inception. ** Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year. +Annualized. 16 NOTES TO FINANCIAL STATEMENTS Vanguard Energy Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund may invest in securities of foreign issuers, which may subject it to investment risks not normally associated with investing in securities of United States corporations. The fund offers two classes of shares, Investor Shares and Admiral Shares. Investor Shares are available to any investor who meets the fund's minimum purchase requirements. Admiral Shares were first issued on November 12, 2001, and are designed for investors who meet certain administrative, servicing, tenure, and account-size criteria. A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. The fund consistently follows such policies in preparing its financial statements. 1. SECURITY VALUATION: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. Temporary cash investments are valued at cost, which approximates market value. Securities for which market quotations are not readily available are valued by methods deemed by the board of trustees to represent fair value. 2. FOREIGN CURRENCY: Securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars at the exchange rates on the valuation date as employed by Morgan Stanley Capital International in the calculation of its indexes. Realized gains (losses) and unrealized appreciation (depreciation) on investment securities include the effects of changes in exchange rates since the securities were purchased, combined with the effects of changes in security prices. Fluctuations in the value of other assets and liabilities resulting from changes in exchange rates are recorded as unrealized foreign currency gains (losses) until the asset or liability is settled in cash, when they are recorded as realized foreign currency gains (losses). 3. 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. 4. REPURCHASE AGREEMENTS: The fund, along with other members of The Vanguard Group, transfers uninvested cash balances to a pooled cash account, which is invested in repurchase agreements secured by U.S. government securities. Securities pledged as collateral for repurchase agreements are held by a custodian bank until the agreements mature. Each agreement requires that the market value of the collateral be sufficient to cover payments of interest and principal; however, in the event of default or bankruptcy by the other party to the agreement, retention of the collateral may be subject to legal proceedings. 5. DISTRIBUTIONS: Distributions to shareholders are recorded on the ex-dividend date. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. 6. OTHER: Dividend income is recorded on the ex-dividend date. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. Fees assessed on redemptions of capital shares are credited to paid-in capital. Each class of shares has equal rights as to assets and earnings, except that each class separately bears certain class-specific expenses related to maintenance of shareholder accounts (included in Management and Administrative expenses) and shareholder reporting. Marketing and distribution expenses are allocated to each class of shares based on a method approved by the board of trustees. Income, other non-class-specific expenses, and gains and losses on investments are allocated to each class of shares based on its relative net assets. 17 NOTES TO FINANCIAL STATEMENTS (CONTINUED) B. Wellington Management Company, llp, provides investment advisory services to the fund for a fee calculated at an annual percentage rate of average net assets. For the six months ended July 31, 2002, the advisory fee represented an effective annual rate of 0.06% of the fund's average net assets. C. The Vanguard Group furnishes at cost corporate management, administrative, marketing, and distribution services. The costs of such services are allocated to the fund under methods approved by the board of trustees. The fund has committed to provide up to 0.40% of its net assets in capital contributions to Vanguard. At July 31, 2002, the fund had contributed capital of $288,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 0.29% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. D. The fund has asked its investment adviser to direct certain security trades, subject to obtaining the best price and execution, to brokers who have agreed to rebate to the fund part of the commissions generated. Such rebates are used solely to reduce the fund's management and administrative expenses. The fund's custodian bank has also agreed to reduce its fees when the fund maintains cash on deposit in the non-interest-bearing custody account. For the six months ended July 31, 2002, directed brokerage and custodian fee offset arrangements reduced expenses by $126,000 and $1,000, respectively. The total expense reduction represented an effective annual rate of 0.02% of the fund's average net assets. E. During the six months ended July 31, 2002, the fund purchased $316,396,000 of investment securities and sold $204,846,000 of investment securities other than temporary cash investments. During the six months ended July 31, 2002, the fund realized net foreign currency losses of $6,000, which decreased distributable net income for tax purposes; accordingly, such losses have been reclassified from accumulated net realized gains to undistributed net investment income. F. At July 31, 2002, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $130,088,000, consisting of unrealized gains of $220,746,000 on securities that had risen in value since their purchase and $90,658,000 in unrealized losses on securities that had fallen in value since their purchase. G. The market value of securities on loan to broker/dealers at July 31, 2002, was $42,988,000, for which the fund held cash collateral of $44,079,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. 18 H. Capital share transactions for each class of shares were: - -------------------------------------------------------------------------------- SIX MONTHS ENDED YEAR ENDED JULY 31, 2002 JANUARY 31, 2002 --------------------------- ---------------------- AMOUNT SHARES AMOUNT SHARES (000) (000) (000) (000) - -------------------------------------------------------------------------------- INVESTOR SHARES Issued $ 194,352 7,216 $ 329,199 11,882 Issued in Lieu of Cash Distributions 14,753 533 86,765 3,655 Redeemed* (158,388) (6,060) (322,478) (12,278) ------------------------------------------------------- Net Increase (Decrease) --Investor Shares 50,717 1,689 93,486 3,259 ------------------------------------------------------- ADMIRAL SHARES Issued 63,563 1,238 55,742 1,183 Issued in Lieu of Cash Distributions 640 12 2,870 64 Redeemed* (15,511) (373) (451) (9) ------------------------------------------------------- Net Increase (Decrease) --Admiral Shares 48,692 877 58,161 1,238 - -------------------------------------------------------------------------------- *Net of redemption fees of $435,000 and $792,000, respectively (fund totals). 19 [PICTURE OF A COMPUTER] ADVANTAGES OF VANGUARD.COM(TM) Why wait for the mail? You can get fund reports like this one sooner--and reduce the amount of mail you receive from us. Simply choose to view your fund reports online. Consider the benefits of using VANGUARD.COM. On our website, you can: * Choose to stop receiving fund reports and prospectuses via U.S. mail, and view them online instead. * Request a courtesy e-mail to notify you when a new fund report or prospectus is available. When you receive fund reports and prospectuses online, you lower Vanguard's printing and postage costs--and that helps to reduce the expense ratios of your funds. You will continue to receive confirmations of purchases, redemptions, and other account activity by mail. HOW TO NOTIFY US ABOUT YOUR MAILING PREFERENCES You can easily tell us to stop mailing your fund reports and prospectuses. Just log on to Vanguard.com (or follow the easy steps to register for secure, online access to your accounts) and update your Web Profile. Registered users can also view their account values; download records of recent transactions; research and track the performance of individual securities and funds; buy, exchange, and sell fund shares; and much more. If you invest directly with us, you can also elect to receive all of your account statements online or to have us mail out only your year-end statements, which detail every transaction you make during the year. However, if you invest with us through an employer-sponsored retirement plan or a financial intermediary, some of these options may not be available to you. All Vanguard shareholders can choose to receive our electronic newsletters: ECONOMIC WEEK IN REVIEW, a recap of each week's key economic reports and market activity; and WHAT'S NEW AT VANGUARD, an update on Vanguard investments, services, and online resources, delivered every month and whenever there's breaking news. YOUR ONLINE INFORMATION IS SECURE Vanguard.com uses some of the most secure forms of online communication available, including data encryption and Secure Sockets Layer (SSL) protocol. These technologies provide a high level of security and privacy when you access your account information, initiate online transactions, or send us messages. 20 THE PEOPLE WHO GOVERN YOUR FUND The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are a part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides services to them on an at-cost basis. A majority of Vanguard's board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. Our independent board members bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the activities of the funds. Among board members' responsibilities are selecting investment advisers for the funds; monitoring fund operations, performance, and costs; reviewing contracts; nominating and selecting new trustees/directors; and electing Vanguard officers. - -------------------------------------------------------------------------------- TRUSTEES (YEAR ELECTED) JOHN J. BRENNAN Chairman of the Board, Chief Executive Officer, and (1987) Director/Trustee of The Vanguard Group, Inc., and of each of the investment companies served by The Vanguard Group. CHARLES D. ELLIS The Partners of '63 (pro bono ventures in education); (2001) Senior Adviser to Greenwich Associates Successor Trustee of Yale University; Overseer of the Stern School of Business at New York (international business-strategy consulting); University; Trustee of the Whitehead Institute for Biomedical Research. RAJIV L. GUPTA Chairman and Chief Executive Officer of Rohm and Haas (2001) Co. (chemicals); Director of Technitrol, Inc. (electronic components), and Agere Systems (communications components); Board Member of the American Chemistry Council; and Trustee of Drexel University. JOANN HEFFERNAN HEISEN Vice President, Chief Information Officer, and Member (1998) of the Executive Committee of Johnson & Johnson (pharmaceuticals/consumer products); Director of the Medical Center at Princeton and Women's Research and Education Institute. BURTON G. MALKIEL Chemical Bank Chairman's Professor of Economics, (1977) Princeton University; Director of Vanguard Investment Series plc (Irish investment fund), Vanguard Group (Ireland) Limited (Irish investment management firm), Prudential Insurance Co.of America, BKF Capital (investment management firm), The Jeffrey Co. (holding company), and NeuVis, Inc. (software company). ALFRED M. RANKIN, JR. Chairman, President, Chief Executive Officer, and (1993) Director of NACCO Industries, Inc. (forklift trucks/ housewares/lignite); Director of Goodrich Corporation (industrial products/aircraft systems and services). J. LAWRENCE WILSON Retired Chairman and Chief Executive Officer of Rohm (1985) and Haas Co. (chemicals); Director of Cummins Inc. (diesel engines), The Mead Corp. (paper products), and AmerisourceBergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University. - -------------------------------------------------------------------------------- EXECUTIVE OFFICERS R. GREGORY BARTON Secretary; Managing Director and General Counsel of The Vanguard Group, Inc.; Secretary of The Vanguard Group and of each of the investment companies served by The Vanguard Group. THOMAS J. HIGGINS Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies served by The Vanguard Group. More information about the trustees is in the Statement of Additional Information, available from The Vanguard Group. VANGUARD SENIOR MANAGEMENT TEAM MORTIMER J. BUCKLEY, Information Technology. F. WILLIAM MCNABB, III, Institutional Investor Group. JAMES H. GATELY, Direct Investor Services. MICHAEL S. MILLER, Planning and Development. KATHLEEN C. GUBANICH, Human Resources. RALPH K. PACKARD, Finance. IAN A. MACKINNON, Fixed Income Group. GEORGE U. SAUTER, Quantitative Equity Group. - -------------------------------------------------------------------------------- JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-1996. [PICTURE OF A SHIP] THE VANGUARD(R) LOGO POST OFFICE BOX 2600 VALLEY FORGE, PA 19482-2600 Vanguard, The Vanguard Group, Vanguard.com, and the ship logo are trademarks of The Vanguard Group, Inc. Standard & Poors(R), S&P 500(R), and S&P Energy Sector Index are trademarks of The McGraw-Hill Companies, Inc. All other marks are the property of their respective owners. All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. ABOUT OUR COVER Our cover photographs were taken by Michael Kahn in September 2000 aboard HMS Rose in New York's Long Island Sound. Mr. Kahn is a renowned photographer--and accomplished sailor--whose work often focuses on seascapes and nautical images. The photographs are copyrighted by Mr. Kahn. FOR MORE INFORMATION This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. To receive a free copy of the prospectus or the Statement of Additional Information, or to request additional information about the funds or other Vanguard funds, please contact us at one of the adjacent telephone numbers or by e-mail through VANGUARD.COM(R). Prospectuses may also be viewed online. WORLD WIDE WEB www.vanguard.com FUND INFORMATION 1-800-662-7447 DIRECT INVESTOR ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 TEXT TELEPHONE 1-800-952-3335 (C) 2002 THE VANGUARD GROUP, INC. ALL RIGHTS RESERVED. VANGUARD MARKETING CORPORATION, DISTRIBUTOR. Q512 092002 VANGUARD(R)HEALTH CARE FUND SEMIANNUAL REPORT * JULY 31, 2002 STOCK [PICTURE OF SHIP] THE VANGUARD GROUP (R) WHAT YOU CAN CONTROL As an investor, you cannot control how the financial markets perform. But there are vital variables that you can control. You can decide how much to invest. You can limit the risk in your portfolio by diversifying your holdings. And you can control the investment costs you incur. Costs may seem the least dramatic of the three. But costs have a powerful impact on how your wealth accumulates; they reduce, dollar for dollar, the returns that you can derive from an investment. Every mutual fund has operating expenses--to pay for investment managers, telephone support, and so on. These costs appear in the fund's expense ratio, which reflects the percentage of average net assets (your money) consumed each year by operating costs. In 2001, the average mutual fund had an expense ratio of 1.34% (or $13.40 per $1,000 in assets), according to data from Lipper Inc. For Vanguard(R) funds, the average expense ratio was less than one-fourth that amount (0.27%, or $2.70 per $1,000 in assets). Our average expense ratio has been less than the industry average for 25 years, and it's an advantage we aim to maintain. Under our unique corporate structure, shareholders like you own the Vanguard funds, which in turn own The Vanguard Group. No middleman makes a profit from managing the operation. You bear all of the investment risk. It's only right that you reap as much of the potential reward as possible. - -------------------------------------------------------------------------------- CONTENTS Letter from the Chairman 1 Report from the Adviser 5 Fund Profile 7 Glossary of Investment Terms 8 Performance Summary 9 Financial Statements 10 - -------------------------------------------------------------------------------- SUMMARY * During the past six months, Vanguard Health Care Fund fared much better than its comparative standards, but nevertheless registered a disappointing -8.3% total return. * The U.S. stock market dropped to levels not seen in five years. * Health care stocks have struggled, but your fund's prudent strategy has made the best of a bad market. - -------------------------------------------------------------------------------- LETTER FROM THE CHAIRMAN Fellow Shareholder, During the first half of fiscal 2003, VANGUARD(R) HEALTH CARE FUND returned - -8.3%, a disappointing absolute result but a fine performance relative to the health care sector. The average health/biotechnology fund returned -22.8%, while the Standard & Poor's Health Sector Index shed -17.7% of its value. The adjacent table presents the returns of Vanguard Health Care Fund and its comparative standards. The per-share components of your fund's total returns can be found on page 4. - ------------------------------------------------ Total Returns Six Months Ended July 31, 2002 - ------------------------------------------------ VANGUARD HEALTH CARE FUND Investor Shares -8.3% Admiral Shares -8.3 Average Health/Biotechnology Fund* -22.8 S&P Health Sector Index -17.7 Wilshire 5000 Index -17.9 - ------------------------------------------------ *Derived from data provided by Lipper Inc. STOCK PRICES DECLINED AS NEGATIVE NEWS MOUNTED The U.S. stock market was extremely volatile during the six months ended July 31, dropping to levels not seen in five years. The broad market, as measured by the Wilshire 5000 Total Market Index, posted a sharp decline of -17.9% for the half-year. The market's slump seemed to take on a life of its own, as investors ignored reports of a recovery in the economy and of improved corporate earnings to focus on the drumbeat of negative news, including ongoing revelations of corporate misconduct, continued strife in the Middle East, warnings of potential terrorist attacks, and talk of war with Iraq. No market segment escaped the downdraft. Even small-capitalization value stocks, which had previously flourished, declined. Across all market caps, growth stocks (those with high prices relative to their earnings or book values) continued to fare worse than value stocks. As a group, developed international markets fared better than the U.S. market, but they also failed to record a positive total return in the period. - -------------------------------------------------------------------------------- ADMIRAL(TM) SHARES A lower-cost class of shares available to many long time shareholders and to those with significant investments in the fund. - -------------------------------------------------------------------------------- THE ECONOMY GREW IN FITS AND STARTS The nation's real (inflation-adjusted) gross domestic product grew at an annual rate of 1.1% in the second quarter of 2002, according to an early estimate. This was a sharp slowdown from the first quarter's robust growth rate of 5.0%. (The 5.0% figure was revised from the earlier estimate of 6.1%. More surprising, however, 1 was the Commerce Department's downward revision of GDP growth in 2001. With the first three quarters of 2001 now showing negative growth, last year's recession was longer and deeper than originally thought.) A rise in the trade deficit played a large role in dampening GDP growth in the second quarter. Consumer spending slowed in the quarter but still remained strong, while spending by businesses on inventories, equipment, and software rose for the first time in almost two years. - ------------------------------------------------------------------------------ MARKET BAROMETER TOTAL RETURNS PERIODS ENDED JULY 31, 2002 -------------------------------------- SIX ONE FIVE STOCKS MONTHS YEAR YEARS* - ------------------------------------------------------------------------------ Russell 1000 Index (Large-caps) -18.2% -22.9% 0.7% Russell 2000 Index (Small-caps) -18.2 -18.0 0.2 Wilshire 5000 Index (Entire market) -17.9 -22.1 0.3 MSCI EAFE Index (International) -6.4 -16.9 -3.9 - ------------------------------------------------------------------------------ BONDS Lehman Aggregate Bond Index 4.2% 7.5% 7.3% (Broad taxable market) Lehman 10 Year Municipal Bond Index 4.8 7.2 6.1 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 0.9 2.3 4.6 ============================================================================== CPI Consumer Price Index 1.7% 1.5% 2.3% - ------------------------------------------------------------------------------ *Annualized. With inflation of little concern and the economy sluggish, the Federal Reserve Board kept the target for the federal funds rate--the interest rate for overnight loans between banks--at its four-decade low of 1.75%. BOND INVESTORS FLED TO QUALITY The overall U.S. bond market, as measured by the Lehman Brothers Aggregate Bond Index, posted a solid six-month return of 4.2%. But there was a distinct flight to quality in the period, with government and agency bonds posting the best returns as demand for these issues pushed their prices higher. A high default rate among corporate debt issues, notably those of several now-bankrupt telecommunications companies, caused investors to shun high-risk debt. The Lehman High Yield Index returned -9.6% for the six months, as price declines more than offset higher yields. Prices of U.S. Treasury securities rose and yields fell. The 10-year note's yield fell 57 basis points (0.57 percentage point) during the six months to 4.46%. The decline was more dramatic for the 3-year Treasury note, whose yield fell 112 basis points to 3.01%. The yield of the 3-month Treasury bill, which lags a bit behind the Fed's interest rate moves, fell 6 basis points to 1.69%. YOUR FUND HELD TOUGH AGAINST BIG CHALLENGES Vanguard Health Care Fund returned-8.3% during the six months, a tough period in which the U.S. stock market returned -17.9%. Though disappointing on an absolute basis, your fund's result was far better than the returns recorded by its benchmark index and the average heath/biotechnology fund. 2 During the past year and a half, health care stocks declined in response to a number of developments. The pharmaceutical giants are contending with the expiration of several lucrative patents, even as the pace of new drug introductions slows. And fast-rising health care costs have revived talk of government intervention that could pinch the drugmakers' profits. Because many of these stocks had been priced so optimistically, they fell sharply as the sector's near-term prospects dimmed. - -------------------------------------------------------------------------------- Because many health care stocks had been priced so optimistically, they fell sharply as the sector's near-term prospects dimmed. - -------------------------------------------------------------------------------- Vanguard Health Care Fund negotiated the changing currents with skill. Your fund benefited from its emphasis on diversification, investing not only in the drugmakers that dominate the sector but also in smaller biotech firms, insurance and health-management companies, and even health-care-related stocks such as drugstores. Relative strength in health-management companies and in retailers during the period offset some of the weakness in the pharmaceutical giants. Your fund also benefited from its long-standing emphasis on growth and price, which helped limit the damage to shareholder capital as investors punished stocks with the highest valuations. A bonus of this dual emphasis was that it led your fund to build up a big position in Pharmacia. Pharmaceutical giant Pfizer--perhaps recognizing the same combination of growth and value that piqued the interest of Wellington Management Company, your fund's adviser--recently made a bid to acquire Pharmacia, giving Pharmacia's stock price a significant boost. A GOOD PLAN IS TIMELESS The past six months have been one of the toughest stretches in the stock market's long downturn. Our advice in bear markets is the same as it is in bull markets, not because these two beasts are the same, but because a sound investment strategy works in all environments: Make sure that you've developed an investment plan that includes broadly diversified stock and bond funds and cash reserves in proportions suited to your goals, time horizon, and financial circumstances. - -------------------------------------------------------------------------------- Our advice in bear markets is the same as it is in bull markets, not because these two beasts are the same, but because a sound investment strategy works in all environments. - -------------------------------------------------------------------------------- The narrowly focused Vanguard Health Care Fund can be one small component of that plan. Your fund also boasts another key to investment success: low costs. With an annualized expense ratio of 0.29%, the Investor Shares of Vanguard Health Care Fund charge about one-sixth the cost of the average health care fund, leaving you with a larger 3 share of the fund's returns. The expense ratio of our Admiral Shares is an even smaller 0.21%. We thank you for your continued confidence in Vanguard. Sincerely, /S/JOHN J. BRENNAN John J. Brennan Chairman and Chief Executive Officer August 9, 2002 - -------------------------------------------------------------------------------- YOUR FUND'S PERFORMANCE AT A GLANCE: JANUARY 31, 2002-JULY 31, 2002 DISTRIBUTIONS PER SHARE ------------------------------------------------ STARTING ENDING INCOME CAPITAL SHARE PRICE SHARE PRICE DIVIDENDS GAINS - -------------------------------------------------------------------------------- Vanguard Health Care Fund Investor Shares $115.01 $105.00 $0.055 $0.438 Admiral Shares 48.52 44.32 0.026 0.185 - -------------------------------------------------------------------------------- 4 REPORT FROM THE ADVISER Vanguard Health Care Fund declined -8.3% during the fiscal half-year ended July 31, 2002. This period was very challenging, with the S&P 500 Index down -18.7%, the S&P Health Sector Index down -17.7%, and the average health/ biotechnology fund dropping -22.8%. Fortunately, the fund continued to perform better than these benchmarks. THE INVESTMENT ENVIRONMENT The slow economic recovery, combined with reduced investor confidence in corporate management and financial statements, depressed equities generally. Despite their limited sensitivity to the broader economy, health care stocks were not spared. Nevertheless, the future fundamentals of the sector and the industry's potential to develop and sell breakthrough medicines remain unchanged. OUR SUCCESSES Our largest holding, Pharmacia, was the biggest contributor to the fund's performance, thanks to its agreement in mid-July to be acquired by Pfizer at a significant premium. We were also helped considerably by our holdings in the Swiss pharmaceutical companies Novartis and Roche. Health-services stocks (a diverse group that includes facilities owners, management companies, and medical-service providers, among others) were the best performers during the first half of our fiscal year. In particular, we saw good results from HCA, Aetna, and Coventry Health Care. OUR SHORTFALLS Pharmaceutical and biotechnology stocks turned in the sector's poorest results. Our holdings in the two groups suffered, but we escaped more extensive damage by having lower exposure to these categories than did the indexes and our peer funds. - -------------------------------------------------------------------------------- INVESTMENT PHILOSOPHY The fund reflects the belief that investors who seek to emphasize health care stocks as part of a long-term, balanced investment program are best served by holding a portfolio of securities well diversified across the sector. - -------------------------------------------------------------------------------- THE FUND'S POSITIONING We took advantage of the weakness in pharmaceutical and biotech stocks to increase our exposure to these sectors during the six months. The fund is now more aggressively positioned than it has been in several years, while still retaining its traditional diversification and attention to value. We are hopeful that the largest part of the stock market 5 decline is behind us, but we still do not expect a return to the euphoria of the late 1990s. EDWARD P. OWENS, SENIOR VICE PRESIDENT AND PORTFOLIO MANAGER WELLINGTON MANAGEMENT COMPANY, LLP August 15, 2002 - -------------------------------------------------------------------------------- PORTFOLIO CHANGES FISCAL PERIOD ENDED JULY 31, 2002 ADDITIONS COMMENTS - -------------------------------------------------------------------------------- Schering-Plough Added as a result of severe price weakness. - -------------------------------------------------------------------------------- Amgen Acquired Immunex, which we held. - -------------------------------------------------------------------------------- Genzyme Bought because of severe price weakness. - -------------------------------------------------------------------------------- Cephalon Outstanding sales growth. ================================================================================ REDUCTIONS Johnson & Johnson Strongest-performing drug stock. - -------------------------------------------------------------------------------- Tenet Healthcare Strongest-performing hospital company. - -------------------------------------------------------------------------------- Immunex Acquired by Amgen. - -------------------------------------------------------------------------------- UnitedHealth Group Strongest-performing health maintenance organization. - -------------------------------------------------------------------------------- SEE PAGE 10 FOR A COMPLETE LISTING OF THE FUND'S HOLDINGS. 6 FUND PROFILE AS OF JULY 31, 2002 FOR HEALTH CARE FUND This Profile provides a snapshot of the fund's characteristics, compared where appropriate with a broad market index. Key terms are defined on page 8. - --------------------------------------------------- PORTFOLIO CHARACTERISTICS WILSHIRE FUND 5000 - --------------------------------------------------- Number of Stocks 128 5,808 Median Market Cap $26.0B $27.0B Price/Earnings Ratio 28.5x 24.6x Price/Book Ratio 3.8x 2.7x Yield 1.6% Investor Shares 0.9% Admiral Shares 1.0% Return on Equity 21.5% 21.6% Earnings Growth Rate 11.8% 9.8% Foreign Holdings 25.8% 0.3% Turnover Rate 26%* -- Expense Ratio -- Investor Shares 0.29%* Admiral Shares 0.21%* Cash Investments 7.6% -- - --------------------------------------------------- - --------------------------------------------- TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) Pharmacia Corp. 7.3% Schering-Plough Corp. 5.5 Eli Lilly & Co. 3.4 Pfizer, Inc. 3.3 McKesson Corp. 2.9 Wyeth 2.8 Merck & Co., Inc. 2.7 Abbott Laboratories 2.7 Roche Holdings AG 2.7 Amgen, Inc. 2.6 - --------------------------------------------- Top Ten 35.9% - --------------------------------------------- - ------------------------------------ INVESTMENT FOCUS MARKET CAP Large STYLE Growth - ------------------------------------ - ------------------------------------------------ VOLATILITY MEASURES WILSHIRE FUND (000) - ------------------------------------------------ R-Squared 0.17 1.00 Beta 0.31 1.00 - ------------------------------------------------ - ------------------------------------------------- SECTOR DIVERSIFICATION (% OF COMMON STOCKS) Biotech Research & Production 8.8% Consumer Staples 2.5 Drugs & Pharmaceuticals 39.3 Electronics--Medical Systems 0.6 Financial Services 0.4 Health & Personal Care 3.2 Health Care Facilities 5.2 Health Care Management Services 4.6 International 25.8 Materials & Processing 1.6 Medical & Dental Instruments & Supplies 6.4 Medical Services 0.9 Producer Durables 0.6 Technology 0.1 - ------------------------------------------------- *Annualized. [PICTURE OF A COMPUTER] Visit our website www.vanguard.com for regularly updated fund information. 7 GLOSSARY OF INVESTMENT TERMS BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the overall market (or appropriate market index). The market (or index) is assigned a beta of 1.00, so a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the overall market rose or fell by 10%. - -------------------------------------------------------------------------------- CASH INVESTMENTS. The percentage of a fund's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. This figure does not include cash invested in futures contracts to simulate stock investment. - ------------------------------------------------------------------------------- EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in a fund. - -------------------------------------------------------------------------------- EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. - -------------------------------------------------------------------------------- FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks or American Depositary Receipts of companies based outside the United States. - -------------------------------------------------------------------------------- MEDIAN MARKET CAp. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. - -------------------------------------------------------------------------------- PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds. - -------------------------------------------------------------------------------- PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. - -------------------------------------------------------------------------------- R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the overall market (or its benchmark index). If a fund's total returns were precisely synchronized with the overall market's return, its R-squared would be 1.00. If the fund's returns bore no relationship to the market's returns, its R-squared would be 0. - -------------------------------------------------------------------------------- RETURN ON EQUITY. The annual average rate of return generated by a company during the past five years for each dollar of shareholder's equity (net income divided by shareholder's equity). For a fund, the weighted average return on equity for the companies whose stocks it holds. - -------------------------------------------------------------------------------- TURNOVER RATE. An indication of the fund's trading activity. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). - -------------------------------------------------------------------------------- YIELD. A snapshot of a fund's income from interest and dividends. The yield, expressed as a percentage of the fund's net asset value, is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. The index yield is based on the current annualized rate of dividends paid on stocks in the index. - -------------------------------------------------------------------------------- 8 PERFORMANCE SUMMARY AS OF JULY 31, 2002 FOR HEALTH CARE FUND All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely. An investor's shares, when redeemed, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the redemption of fund shares. - -------------------------------------------------------------------------------- FISCAL-YEAR TOTAL RETURNS (%) JANUARY 31, 1992-JULY 31, 2002 HEALTH CARE FUND S&P HEALTH INVESTOR SHARES SECTOR INDEX 1993 -2.9 -17 1994 21.2 0.1 1995 9.8 21 1996 45.5 54.2 1997 20.6 28.1 1998 27.4 38.6 1999 37.4 35.5 2000 10.6 -2.9 2001 43.4 17.3 2002 -1.1 -5.2 2003* -8.3 -17.7 - -------------------------------------------------------------------------------- *Six months ended July 31, 2002. Note: See Financial Highlights tables on pages 16 and 17 for dividend and capital gains information. - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED JUNE 30, 2002 This table presents average annual total returns through the latest calendar quarter--rather than through the end of the fiscal period. Securities and Exchange Commission rules require that we provide this information. TEN YEARS ONE FIVE ------------------------- INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL - -------------------------------------------------------------------------------- Health Care Fund Investor Shares 5/23/1984 -5.69% 17.25% 18.74% 1.53% 20.27% Fee-Adjusted Returns* -6.59 17.25 18.74 1.53 20.27 Admiral Shares 11/12/2001 -3.80** -- -- -- -- Fee-Adjusted Returns* -4.72** -- -- -- -- - -------------------------------------------------------------------------------- * Reflective of the 1% fee assessed on redemptions of shares held less than five years. **Returns since inception. 9 FINANCIAL STATEMENTS JULY 31, 2002 (UNAUDITED) STATEMENT OF NET ASSETS This Statement provides a detailed list of the fund's holdings, including each security's market value on the last day of the reporting period. Securities are grouped and subtotaled by asset type (common stocks, bonds, etc.) and by sector within the fund's designated industry; international securities, if significant, may be presented in a separate group. Other assets are added to, and liabilities are subtracted from, the value of Total Investments to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid-in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. - -------------------------------------------------------------------------------- MARKET VALUE* HEALTH CARE FUND SHARES (000) - -------------------------------------------------------------------------------- COMMON STOCKS (92.4%) - -------------------------------------------------------------------------------- UNITED STATES (68.6%) - -------------------------------------------------------------------------------- Biotech Research & Production (8.1%) * Amgen, Inc. 9,123,828 416,412 * Genzyme Corp. 7,995,540 182,138 * Genentech, Inc. 4,709,200 163,645 * IDEC Pharmaceuticals Corp. 3,188,600 142,180 * Cephalon, Inc. 2,227,600 106,925 * Biogen, Inc. 2,200,000 79,134 *(1)Quintiles Transnational Corp. 7,417,600 73,657 * Human Genome Sciences, Inc. 2,738,500 47,458 * IDEXX Laboratories Corp. 909,300 26,597 Gen-Probe Inc. 808,400 15,071 * Ribapharm Inc. 2,243,800 12,790 * Celera Genomics Group Applera Corp. 1,067,400 11,240 * Millennium Pharmaceuticals, Inc. 900,000 11,178 -------------------- $ 1,288,425 -------------------- CONSUMER STAPLES (2.3%) CVS Corp. 12,256,300 350,530 Longs Drug Stores, Inc. 507,700 12,408 -------------------- $ 362,938 -------------------- DRUGS & Pharmaceuticals (36.4%) Pharmacia Corp. 25,707,182 1,150,139 Schering-Plough Corp. 34,413,000 877,532 Eli Lilly & Co. 9,275,100 541,851 Pfizer, Inc. 15,929,836 515,330 Wyeth 10,984,900 438,298 Merck & Co., Inc. 8,690,000 431,024 Abbott Laboratories 10,280,700 425,724 Cardinal Health, Inc. 4,601,608 265,053 * Gilead Sciences, Inc. 8,349,924 254,422 Allergan, Inc. 3,044,100 184,138 AmerisourceBergen Corp. 2,634,480 176,484 * Forest Laboratories, Inc. 1,751,000 135,650 Bristol-Myers Squibb Co. 4,425,800 103,696 * Vertex Pharmaceuticals, Inc. 3,755,400 74,132 *(1)Perrigo Co. 5,322,320 61,526 Mylan Laboratories, Inc. 1,300,000 42,172 * Watson Pharmaceuticals, Inc. 1,289,200 27,163 Johnson & Johnson 400,000 21,200 * Scios, Inc. 491,750 15,421 Alpharma, Inc. Class A 748,313 8,351 ICN Pharmaceuticals, Inc. 698,900 7,331 * Pharmacyclics, Inc. 738,000 2,649 * Genaera Corp. 1,328,100 1,793 * Triangle Pharmaceuticals, Inc. 564,800 1,627 -------------------- $ 5,762,706 -------------------- ELECTRONICS--MEDICAL SYSTEMS (0.6%) *(1)Haemonetics Corp. 1,983,900 52,673 Medtronic, Inc. 700,000 28,280 Datascope Corp. 342,100 8,912 -------------------- $ 89,865 -------------------- 10 - -------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) - -------------------------------------------------------------------------------- FINANCIAL SERVICES (0.3%) CIGNA Corp. 550,000 49,500 NDCHealth Corp. 181,800 3,925 -------------------- $ 53,425 -------------------- HEALTH & Personal Care (3.0%) McKesson Corp. 13,909,350 457,896 * IDX Systems Corp. 1,109,200 12,772 -------------------- $ 470,668 -------------------- HEALTH CARE FACILITIES (4.8%) HCA Inc. 7,900,520 371,324 * Quest Diagnostics, Inc. 2,050,000 123,800 * HealthSouth Corp. 7,600,000 77,900 * Tenet Healthcare Corp. 1,502,500 71,594 * Laboratory Corp. of America Holdings 2,067,360 70,910 * Triad Hospitals, Inc. 672,666 26,893 * LifePoint Hospitals, Inc. 460,715 15,687 -------------------- $ 758,108 -------------------- HEALTH CARE MANAGEMENT SERVICES (4.2%) Aetna Inc. 5,150,200 224,961 IMS Health, Inc. 8,447,400 133,638 *(1)Humana Inc. 10,195,000 125,500 * Cerner Corp. 1,346,600 58,442 UnitedHealth Group Inc. 600,000 52,596 * Health Net Inc. 900,000 20,142 * Universal Health Services Class B 300,000 14,184 * WebMD Corp. 2,175,600 10,639 * Pediatrix Medical Group, Inc. 348,100 10,373 * Cobalt Corp. 578,000 10,173 * American Medical Security Group, Inc. 578,000 8,115 -------------------- $ 668,763 -------------------- MATERIALS AND PROCESSING (1.5%) (1) Sigma-Aldrich Corp. 4,881,300 233,912 -------------------- $ 233,912 -------------------- MEDICAL & Dental Instruments & Supplies (5.9%) Becton, Dickinson & Co. 9,251,800 268,857 * St. Jude Medical, Inc. 4,200,000 159,600 (1) Bausch & Lomb, Inc. 4,450,000 147,206 Beckman Coulter, Inc. 2,529,400 99,152 Biomet, Inc. 2,851,925 73,950 DENTSPLY International Inc. 1,442,700 57,189 (1) Owens & Minor, Inc. Holding Co. 2,312,100 34,103 * STERIS Corp. 1,150,000 24,024 * Zimmer Holdings, Inc. 414,450 15,430 * Ventana Medical Systems, Inc. 614,400 14,402 * Guidant Corp. 400,000 13,920 * Viasys Healthcare Inc. 482,130 7,063 * Advanced Medical Optics 676,466 6,900 * PSS World Medical, Inc. 1,216,100 6,567 * E-Z-EM, Inc. Class B 304,344 2,360 * E-Z-EM, Inc. Class A 219,258 1,644 -------------------- $ 932,367 -------------------- MEDICAL SERVICES (0.8%) *(1)Coventry Health Care Inc. 3,585,000 108,088 *(1)PAREXEL International Corp. 1,570,200 18,623 -------------------- $ 126,711 -------------------- PRODUCER DURABLES (0.6%) * Thermo Electron Corp. 3,000,000 50,940 Pall Corp. 2,154,600 37,878 -------------------- $ 88,818 -------------------- TECHNOLOGY (0.1%) * Varian, Inc. 253,000 8,058 * DAOU Systems, Inc. 473,500 355 -------------------- $ 8,413 -------------------- - -------------------------------------------------------------------------------- TOTAL UNITED STATES $ 10,845,119 - -------------------------------------------------------------------------------- INTERNATIONAL (23.8%) - -------------------------------------------------------------------------------- Belgium (0.2%) UCB SA 983,593 33,954 -------------------- CANADA (0.1%) * Axcan Pharma Inc. 1,356,900 17,644 -------------------- DENMARK (0.2%) Novo Nordisk A/S B Shares 700,000 16,490 Novozymes A/S 400,000 7,998 -------------------- $ 24,488 -------------------- FRANCE (2.3%) Aventis SA 2,975,168 195,433 Aventis SA ADR 2,064,015 135,626 Sanofi-Synthelabo SA 615,004 36,298 -------------------- $ 367,357 -------------------- GERMANY (1.5%) Bayer AG 6,243,031 154,244 Bayer AG ADR 1,921,500 48,422 Schering AG 640,410 34,037 Fresenius Medical Care Pfd. ADR 645,400 5,563 -------------------- $ 242,266 -------------------- IRELAND (0.1%) * Elan Corp. PLC ADR 4,985,300 12,613 JAPAN (6.2%) Fujisawa Pharmaceutical Co., Ltd. 13,398,000 281,931 Eisai Co., Ltd. 8,106,000 195,279 Chugai Pharmaceutical Co., Ltd. 9,400,000 90,163 11 - -------------------------------------------------------------------------------- MARKET VALUE* HEALTH CARE FUND SHARES (000) - -------------------------------------------------------------------------------- Yamanouchi Pharmaceuticals Co., Ltd. 3,380,000 $ 84,672 Banyu Pharmaceutical Co. 7,415,000 82,103 Takeda Chemical Industries Ltd. 1,500,000 62,377 Shionogi & Co., Ltd. 6,131,000 61,742 Tanabe Seiyaku Co., Ltd. 5,700,000 47,359 Daiichi Pharmaceutical Co., Ltd. 2,104,000 34,980 Sankyo Co., Ltd. 1,450,000 18,646 Ono Pharmaceutical Co., Ltd. 482,000 17,226 Olympus Optical Co., Ltd. 900,000 11,897 -------------------- $ 988,375 -------------------- NETHERLANDS (0.6%) Akzo Nobel NV 2,500,000 88,704 -------------------- SWEDEN (0.5%) Gambro AB A Shares 7,531,120 39,444 Gambro AB B Shares 7,314,580 38,849 -------------------- $ 78,293 -------------------- SWITZERLAND (5.9%) Roche Holdings AG 5,923,977 421,748 Novartis AG (Registered) 7,169,880 291,995 Roche Holdings AG (Bearer) 800,000 88,536 * Alcon, Inc. 1,659,600 58,418 Serono SA Class B 111,049 58,077 Syngenta AG 234,247 11,950 Syngenta AG ADR 752,843 7,649 -------------------- $ 938,373 -------------------- UNITED KINGDOM (6.2%) GlaxoSmithKline PLC ADR 7,248,881 286,331 AstraZeneca Group PLC ADR 7,581,772 277,417 AstraZeneca Group PLC 6,916,500 247,435 Amersham PLC 13,565,820 114,652 SSL International PLC 6,400,000 29,494 Shire Pharmaceuticals Group PLC 2,000,000 16,716 Boots Co. PLC 1,403,342 12,299 -------------------- $ 984,344 -------------------- - -------------------------------------------------------------------------------- TOTAL INTERNATIONAL $ 3,776,411 - -------------------------------------------------------------------------------- TOTAL COMMON STOCKS (Cost $12,024,475) $ 14,621,530 - -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (9.0%) - -------------------------------------------------------------------------------- U.S. GOVERNMENT AND AGENCY OBLIGATIONS (3.2%) Federal Home Loan Bank 1.70%, 8/21/2002 $100,000 99,905 1.70%, 8/21/2002 23,000 22,978 1.71%, 8/21/2002 100,000 99,905 1.69%, 8/23/2002 52,000 51,947 Federal Home Loan Mortgage Corp. 1.66%, 8/16/2002 60,000 59,958 1.70%, 8/20/2002 23,000 22,979 1.72%, 8/27/2002 13,302 13,285 1.74%, 10/3/2002 73,887 73,670 Federal National Mortgage Assn. 1.74%, 10/2/2002 66,619 66,426 -------------------- $ 511,053 -------------------- COMMERCIAL PAPER (3.1%) General Electric Capital Corp. 1.75%, 8/16/2002 70,000 69,950 1.75%, 8/21/2002 220,000 219,786 1.78%, 8/21/2002 50,000 49,920 1.75%, 8/29/2002 50,000 49,932 1.75%, 9/9/2002 100,000 99,810 -------------------- $ 489,398 -------------------- REPURCHASE AGREEMENTS (2.7%) UBS Warburg LLC 1.79%, 8/1/2002 (Dated 7/31/2002, Repurchase Value $167,731,000, collateralized by U.S. Treasury Bonds 6.25%, 5/15/2030) 167,723 167,723 Collateralized by U.S. Government Obligations in a Pooled Cash Account 1.83%, 8/1/2002--Note G 258,204 258,204 -------------------- $ 425,927 -------------------- - -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (Cost $1,426,367) $ 1,426,378 - -------------------------------------------------------------------------------- TOTAL INVESTMENTS (101.4%) (Cost $13,450,842) 16,047,908 - -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-1.4%) - -------------------------------------------------------------------------------- Other Assets--Note C $ 70,563 Liabilities--Note G (293,111) -------------------- $ (222,548) -------------------- - -------------------------------------------------------------------------------- NET ASSETS (100%) $ 15,825,360 ================================================================================ *See Note A in Notes 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 such company. The total market value of investments in affiliated companies was $855,288,000. ADR--American Depositary Receipt. 12 - ------------------------------------------------------------ AMOUNT (000) - ------------------------------------------------------------ AT JULY 31, 2002, NET ASSETS CONSISTED OF: - ------------------------------------------------------------ Paid-in Capital $12,312,556 Undistributed Net Investment Income--Note E 78,675 Accumulated Net Realized Gains--Note E 836,957 Unrealized Appreciation--Note F Investment Securities 2,597,066 Foreign Currencies 106 - ------------------------------------------------------------ NET ASSETS $15,825,360 ============================================================ Investor Shares--Net Assets Applicable to 135,137,662 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $14,189,728 - ------------------------------------------------------------ NET ASSET VALUE PER SHARE-- INVESTOR SHARES $105.00 ============================================================ Admiral Shares--Net Assets Applicable to 36,907,508 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $1,635,632 - ------------------------------------------------------------ NET ASSET VALUE PER SHARE-- ADMIRAL SHARES $44.32 ============================================================ 13 STATEMENT OF OPERATIONS This Statement shows the types of income earned by the fund during the reporting period, and details the operating expenses charged to each class of its shares. These expenses directly reduce the amount of investment income available to pay to shareholders as income dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) of investments during the period. - -------------------------------------------------------------------------------- HEALTH CARE FUND SIX MONTHS ENDED JULY 31, 2002 (000) - -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends*+ $ 98,972 Interest 12,332 Security Lending 882 - -------------------------------------------------------------------------------- Total Income $ 112,186 - -------------------------------------------------------------------------------- EXPENSES Investment Advisory Fees--Note B 4,962 The Vanguard Group--Note C Management and Administrative Investor Shares 14,032 Admiral Shares 944 Marketing and Distribution Investor Shares 1,049 Admiral Shares 78 Custodian Fees 747 Auditing Fees 6 Shareholders' Reports Investor Shares 248 Admiral Shares 3 Trustees' Fees and Expenses 11 - -------------------------------------------------------------------------------- Total Expenses 22,080 Expenses Paid Indirectly--Note D (851) - -------------------------------------------------------------------------------- Net Expenses $ 21,229 - -------------------------------------------------------------------------------- NET INVESTMENT INCOME $ 90,957 - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) Investment Securities SoldY 837,264 Foreign Currencies 542 - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) 837,806 - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) Investment Securities (2,463,190) Foreign Currencies 275 - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (2,462,915) - -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $ (1,534,152) ================================================================================ *Dividends are net of foreign withholding taxes of $4,156,000. + Dividend income and realized net gain (loss) from affiliated companies were $2,972,000 and $(11,000), respectively. 14 STATEMENT OF CHANGES IN NET ASSETs This Statement shows how the fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the net amount shareholders invested in or redeemed from the fund. Distributions and Capital Share Transactions are shown separately for each class of shares. - -------------------------------------------------------------------------------- HEALTH CARE FUND --------------------------- SIX MONTHS YEAR ENDED ENDED JULY 31, 2002 JAN. 31, 2002 (000) (000) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 90,957 $ 142,942 Realized Net Gain (Loss) 837,806 714,662 Change in Unrealized Appreciation (Depreciation) (2,462,915) (1,074,946) - -------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations (1,534,152) (217,342) - -------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income Investor Shares (7,670) (138,966) Admiral Shares (924) (10,721) Realized Capital Gain* Investor Shares (61,077) (741,844) Admiral Shares (6,574) (46,678) - -------------------------------------------------------------------------------- Total Distributions (76,245) (938,209) - -------------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS--NOTE H Investor Shares (353,206) (181,612) Admiral Shares 177,513 1,706,176 - -------------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions (175,693) 1,524,564 - -------------------------------------------------------------------------------- Total Increase (Decrease) (1,786,090) 369,013 - -------------------------------------------------------------------------------- NET ASSETS Beginning of Period 17,611,450 17,242,437 - -------------------------------------------------------------------------------- End of Period $15,825,360 $17,611,450 ================================================================================ * Includes short-term gain distributions totaling $618,000 and $130,142,000, respectively. Short-term gain distributions are treated as ordinary income dividends for tax purposes. 15 FINANCIAL HIGHLIGHTS This table summarizes the fund's investment results and distributions to shareholders on a per-share basis for each class of shares. It also presents the Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year.
HEALTH CARE FUND INVESTOR SHARES - ------------------------------------------------------------------------------------------------------------------- YEAR ENDED JANUARY 31, FOR A SHARE OUTSTANDING SIX MONTHS ENDED ------------------------------------------------ THROUGHOUT EACH PERIOD JULY 31, 2002 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------- Net Asset Value, Beginning of Period $115.01 $123.04 $ 98.83 $97.32 $74.02 $60.65 - ------------------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .576 .980 1.16 .92 .86 .80 Net Realized and Unrealized Gain (Loss) on Investments (10.093) (2.516) 40.05 8.70 26.36 15.49 - ------------------------------------------------------------------------------------------------------------------- Total from Investment Operations (9.517) (1.536) 41.21 9.62 27.22 16.29 - ------------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.055) (1.030) (1.07) (.97) (.84) (.78) Distributions from Realized Capital Gains (.438) (5.464) (15.93) (7.14) (3.08) (2.14) - ------------------------------------------------------------------------------------------------------------------- Total Distributions (.493) (6.494) (17.00) (8.11) (3.92) (2.92) - ------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $105.00 $115.01 $123.04 $98.83 $97.32 $74.02 =================================================================================================================== TOTAL RETURN* -8.33% -1.11% 43.37% 10.57% 37.39% 27.37% =================================================================================================================== RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $14,190 $15,981 $17,242 $10,726 $9,884 $4,720 Ratio of Total Expenses to Average Net Assets 0.29%** 0.31% 0.34% 0.41% 0.36% 0.40% Ratio of Net Investment Income to Average Net Assets 1.04%** 0.84% 1.03% 0.92% 1.13% 1.28% Portfolio Turnover Rate 26%** 13% 21% 27% 11% 10% =================================================================================================================== * Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than five years (or less than one year in the case of shares purchased prior to April 19, 1999). **Annualized.
16 HEALTH CARE FUND ADMIRAL SHARES - -------------------------------------------------------------------------------- SIX MONTHS NOV. 12, ENDED 2001* TO JULY 31, JAN. 31, FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2002 2002 - -------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $48.52 $50.00 - -------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .263 .066 Net Realized and Unrealized Gain (Loss) on Investments (4.252) .542 - -------------------------------------------------------------------------------- Total from Investment Operations (3.989) .608 - -------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.026) (.390) Distributions from Realized Capital Gains (.185) (1.698) - -------------------------------------------------------------------------------- Total Distributions (.211) (2.088) - -------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $44.32 $48.52 ================================================================================ TOTAL RETURN** -8.28% 1.23% ================================================================================ RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $1,636 $1,631 Ratio of Total Expenses to Average Net Assets 0.21%+ 0.23%+ Ratio of Net Investment Income to Average Net Assets 1.11%+ 0.50%+ Portfolio Turnover Rate 26%+ 13% ================================================================================ *Inception. ** Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than five years. +Annualized. 17 NOTES TO FINANCIAL STATEMENTS Vanguard Health Care Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund may invest in securities of foreign issuers, which may subject it to investment risks not normally associated with investing in securities of United States corporations. The fund offers two classes of shares, Investor Shares and Admiral Shares. Investor Shares are available to any investor who meets the fund's minimum purchase requirements. Admiral Shares were first issued on November 12, 2001, and are designed for investors who meet certain administrative, servicing, tenure, and account-size criteria. A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. The fund consistently follows such policies in preparing its financial statements. 1. SECURITY VALUATION: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. Temporary cash investments acquired over 60 days to maturity are valued using the latest bid prices or using valuations based on a matrix system (which considers such factors as security prices, yields, maturities, and ratings), both as furnished by independent pricing services. Other temporary cash investments are valued at amortized cost, which approximates market value. Securities for which market quotations are not readily available are valued by methods deemed by the board of trustees to represent fair value. 2. FOREIGN CURRENCY: Securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars at the exchange rates on the valuation date as employed by Morgan Stanley Capital International in the calculation of its indexes. Realized gains (losses) and unrealized appreciation (depreciation) on investment securities include the effects of changes in exchange rates since the securities were purchased, combined with the effects of changes in security prices. Fluctuations in the value of other assets and liabilities resulting from changes in exchange rates are recorded as unrealized foreign currency gains (losses) until the asset or liability is settled in cash, when they are recorded as realized foreign currency gains (losses). 3. 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. 4. REPURCHASE AGREEMENTS: The fund, along with other members of The Vanguard Group, transfers uninvested cash balances to a pooled cash account, which is invested in repurchase agreements secured by U.S. government securities. The fund may also invest directly in repurchase agreements. Securities pledged as collateral for repurchase agreements are held by a custodian bank until the agreements mature. Each agreement requires that the market value of the collateral be sufficient to cover payments of interest and principal; however, in the event of default or bankruptcy by the other party to the agreement, retention of the collateral may be subject to legal proceedings. 5. DISTRIBUTIONS: Distributions to shareholders are recorded on the ex-dividend date. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. 6. OTHER: Dividend income is recorded on the ex-dividend date. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. Fees assessed on redemptions of capital shares are credited to paid-in capital. Each class of shares has equal rights as to assets and earnings, except that each class separately bears certain class-specific expenses related to maintenance of shareholder accounts (included in Management and Administrative expenses) and shareholder reporting. Marketing and distribution 18 expenses are allocated to each class of shares based on a method approved by the board of trustees. Income, other non-class-specific expenses, and gains and losses on investments are allocated to each class of shares based on its relative net assets. B. Wellington Management Company, llp, provides investment advisory services to the fund for a fee calculated at an annual percentage rate of average net assets. For the six months ended July 31, 2002, the investment advisory fee represented an effective annual rate of 0.06% of the fund's average net assets. C. The Vanguard Group furnishes at cost corporate management, administrative, marketing, and distribution services. The costs of such services are allocated to the fund under methods approved by the board of trustees. The fund has committed to provide up to 0.40% of its net assets in capital contributions to Vanguard. At July 31, 2002, the fund had contributed capital of $3,146,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 3.14% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. D. The fund has asked its investment adviser to direct certain security trades, subject to obtaining the best price and execution, to brokers who have agreed to rebate to the fund part of the commissions generated. Such rebates are used solely to reduce the fund's management and administrative expenses. For the six months ended July 31, 2002, these arrangements reduced the fund's expenses by $851,000 (an annual rate of 0.01% of average net assets). E. During the six months ended July 31, 2002, the fund purchased $2,472,486,000 of investment securities and sold $2,117,112,000 of investment securities other than temporary cash investments. During the six months ended July 31, 2002, the fund realized net foreign currency gains of $542,000, which increased distributable net income for tax purposes; accordingly such gains have been reclassified from accumulated net realized gains to undistributed net investment income. F. At July 31, 2002, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $2,597,066,000, consisting of unrealized gains of $3,571,397,000 on securities that had risen in value since their purchase and $974,331,000 in unrealized losses on securities that had fallen in value since their purchase. The fund had net unrealized foreign currency gains of $106,000 resulting from the translation of other assets and liabilities at July 31, 2002. G. The market value of securities on loan to broker/dealers at July 31, 2002, was $245,669,000, for which the fund held cash collateral of $258,204,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. 19 H. Capital share transactions for each class of shares were: - -------------------------------------------------------------------------------- SIX MONTHS ENDED YEAR ENDED JULY 31, 2002 JANUARY 31, 2002 ---------------------------- ---------------------- AMOUNT SHARES AMOUNT SHARES (000) (000) (000) (000) - -------------------------------------------------------------------------------- INVESTOR SHARES Issued $ 969,847 8,457 $ 2,209,879 18,569 Issued in Lieu of Cash Distributions 65,787 543 839,983 7,423 Redeemed* (1,388,840) (12,815) (3,231,474) (27,177) ----------------------------------------------------- Net Increase (Decrease) --Investor Shares (353,206) (3,815) (181,612) (1,185) ----------------------------------------------------- Admiral Shares Issued 313,229 6,422 1,672,978 32,914 Issued in Lieu of Cash Distributions 6,681 131 51,584 1,067 Redeemed* (142,397) (3,254) (18,386) (372) ----------------------------------------------------- Net Increase (Decrease) --Admiral Shares 177,513 3,299 1,706,176 33,609 - -------------------------------------------------------------------------------- * Net of redemption fees of $3,751,000 and $3,883,000, respectively (fund totals). 20 THE PEOPLE WHO GOVERN YOUR FUND The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are a part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides services to them on an at-cost basis. A majority of Vanguard's board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. Our independent board members bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the activities of the funds. Among board members' responsibilities are selecting investment advisers for the funds; monitoring fund operations, performance, and costs; reviewing contracts; nominating and selecting new trustees/directors; and electing Vanguard officers. - -------------------------------------------------------------------------------- TRUSTEES (YEAR ELECTED) JOHN J. BRENNAN Chairman of the Board, Chief Executive Officer, and (1987) Director/Trustee of The Vanguard Group, Inc., and of each of the investment companies served by The Vanguard Group. CHARLES D. ELLIS The Partners of '63 (pro bono ventures in education); (2001) Senior Adviser to Greenwich Associates Successor Trustee of Yale University; Overseer of the Stern School of Business at New York (international business-strategy consulting); University; Trustee of the Whitehead Institute for Biomedical Research. RAJIV L. GUPTA Chairman and Chief Executive Officer of Rohm and Haas (2001) Co. (chemicals); Director of Technitrol, Inc. (electronic components), and Agere Systems (communications components); Board Member of the American Chemistry Council; and Trustee of Drexel University. JOANN HEFFERNAN HEISEN Vice President, Chief Information Officer, and Member (1998) of the Executive Committee of Johnson & Johnson (pharmaceuticals/consumer products); Director of the Medical Center at Princeton and Women's Research and Education Institute. BURTON G. MALKIEL Chemical Bank Chairman's Professor of Economics, (1977) Princeton University; Director of Vanguard Investment Series plc (Irish investment fund), Vanguard Group (Ireland) Limited (Irish investment management firm), Prudential Insurance Co.of America, BKF Capital (investment management firm), The Jeffrey Co. (holding company), and NeuVis, Inc. (software company). ALFRED M. RANKIN, JR. Chairman, President, Chief Executive Officer, and (1993) Director of NACCO Industries, Inc. (forklift trucks/ housewares/lignite); Director of Goodrich Corporation (industrial products/aircraft systems and services). J. LAWRENCE WILSON Retired Chairman and Chief Executive Officer of Rohm (1985) and Haas Co. (chemicals); Director of Cummins Inc. (diesel engines), The Mead Corp. (paper products), and AmerisourceBergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University. - -------------------------------------------------------------------------------- EXECUTIVE OFFICERS R. GREGORY BARTON Secretary; Managing Director and General Counsel of The Vanguard Group, Inc.; Secretary of The Vanguard Group and of each of the investment companies served by The Vanguard Group. THOMAS J. HIGGINS Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies served by The Vanguard Group. More information about the trustees is in the Statement of Additional Information, available from The Vanguard Group. VANGUARD SENIOR MANAGEMENT TEAM MORTIMER J. BUCKLEY, Information Technology. F. WILLIAM MCNABB, III, Institutional Investor Group. JAMES H. GATELY, Direct Investor Services. MICHAEL S. MILLER, Planning and Development. KATHLEEN C. GUBANICH, Human Resources. RALPH K. PACKARD, Finance. IAN A. MACKINNON, Fixed Income Group. GEORGE U. SAUTER, Quantitative Equity Group. - -------------------------------------------------------------------------------- JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-1996. [PICTURE OF A SHIP] THE VANGUARD(R) LOGO POST OFFICE BOX 2600 VALLEY FORGE, PA 19482-2600 Vanguard, The Vanguard Group, Vanguard.com, and the ship logo are trademarks of The Vanguard Group, Inc. Standard & Poors(R), S&P 500(R), and S&P Energy Sector Index are trademarks of The McGraw-Hill Companies, Inc. All other marks are the property of their respective owners. All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. ABOUT OUR COVER Our cover photographs were taken by Michael Kahn in September 2000 aboard HMS Rose in New York's Long Island Sound. Mr. Kahn is a renowned photographer--and accomplished sailor--whose work often focuses on seascapes and nautical images. The photographs are copyrighted by Mr. Kahn. FOR MORE INFORMATION This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. To receive a free copy of the prospectus or the Statement of Additional Information, or to request additional information about the funds or other Vanguard funds, please contact us at one of the adjacent telephone numbers or by e-mail through VANGUARD.COM(R). Prospectuses may also be viewed online. WORLD WIDE WEB www.vanguard.com FUND INFORMATION 1-800-662-7447 DIRECT INVESTOR ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 TEXT TELEPHONE 1-800-952-3335 (C) 2002 THE VANGUARD GROUP, INC. ALL RIGHTS RESERVED. VANGUARD MARKETING CORPORATION, DISTRIBUTOR. Q522 092002 VANGUARD(R)REIT INDEX FUND SEMIANNUAL REPORT * JULY 31, 2002 STOCK [PICTURE OF A SHIP] THE VANGUARD GROUP (R) LOGO WHAT YOU CAN CONTROL As an investor, you cannot control how the financial markets perform. But there are vital variables that you can control. You can decide how much to invest. You can limit the risk in your portfolio by diversifying your holdings. And you can control the investment costs you incur. Costs may seem the least dramatic of the three. But costs have a powerful impact on how your wealth accumulates; they reduce, dollar for dollar, the returns that you can derive from an investment. Every mutual fund has operating expenses--to pay for investment managers, telephone support, and so on. These costs appear in the fund's expense ratio, which reflects the percentage of average net assets (your money) consumed each year by operating costs. In 2001, the average mutual fund had an expense ratio of 1.34% (or $13.40 per $1,000 in assets), according to data from Lipper Inc. For Vanguard(R) funds, the average expense ratio was less than one-fourth that amount (0.27%, or $2.70 per $1,000 in assets). Our average expense ratio has been less than the industry average for 25 years, and it's an advantage we aim to maintain. Under our unique corporate structure, shareholders like you own the Vanguard funds, which in turn own The Vanguard Group. No middleman makes a profit from managing the operation. You bear all of the investment risk. It's only right that you reap as much of the potential reward as possible. - -------------------------------------------------------------------------------- CONTENTS Letter from the Chairman 1 Fund Profile 5 Glossary of Investment Terms 6 Performance Summary 7 Financial Statements 8 - -------------------------------------------------------------------------------- SUMMARY * Vanguard REIT Index Fund posted a return of 7.5% during the first half of its fiscal year, outperforming its comparative measures and far outpacing the broad stock market. * Real estate investments were a haven from the stock market's decline, but they were not spared significant volatility. * Generally, earnings growth for real estate companies was solid, although the lodging and resorts sector was still feeling the aftereffects of the September 2001 terrorist attacks. LETTER FROM THE CHAIRMAN Fellow Shareholder, During the six months ended July 31, 2002, real estate investment trusts continued to be a haven from the sharp decline in the broad stock market. VANGUARD(R) REIT INDEX FUND posted a strong 7.5% return during its fiscal half-year, topping the returns of all its comparative measures. The table below shows the six-month total returns (capital change plus reinvested dividends) for your fund's Investor and Admiral(TM) Shares; the average real estate mutual fund; the Morgan Stanley REIT Index; and the broad U.S. stock market, as represented by the Wilshire 5000 Total Market Index. - -------------------------------------------------------------------------------- TOTAL RETURNS SIX MONTHS ENDED JULY 31, 2002 - -------------------------------------------------------------------------------- VANGUARD REIT INDEX FUND Investor Shares 7.5% Admiral Shares 7.5 Average Real Estate Fund* 6.9 Morgan Stanley REIT Index 7.4 Wilshire 5000 Index -17.9 - -------------------------------------------------------------------------------- *Derived from data provided by Lipper Inc. The total returns for the fund's two share classes are based on changes in net asset value, adjusted for distributions. For those figures, please see the table on page 4. STOCK PRICES ERODED AS NEGATIVE NEWS MOUNTED The U.S. stock market was extremely volatile during the six months ended July 31, dropping to levels not seen in five years before surging at the end of the period. The late rally, however, was not enough. The broad market, as measured by the Wilshire 5000 Index, posted a sharp decline of -17.9% for the half-year. The market's slump seemed to take on a life of its own as investors ignored reports of a recovery in the economy and of improved corporate earnings to focus on the drumbeat of negative news, including ongoing revelations of accounting problems and corporate misconduct, continued strife in the Middle East, warnings of potential terrorist attacks, and talk of war with Iraq. Stocks of all sizes were caught in the downdraft. Even small-capitalization value stocks, which had previously flourished while the broader market declined from its March 2000 peak, posted a negative return for the six months. Across all market caps, growth stocks (those with high prices relative to their earnings or book values) continued to fare worse than value issues. As a group, developed markets overseas fared better than the U.S. market, but they also failed to record a positive total return in the period. The Morgan Stanley Capital International Europe, Australasia, Far East Index returned - -6.4%. 1 - -------------------------------------------------------------------------------- MARKET BAROMETER TOTAL RETURNS PERIODS ENDED JULY 31, 2002 SIX ONE FIVE MONTHS YEAR YEARS* - -------------------------------------------------------------------------------- STOCKS Russell 1000 Index (Large-caps) -18.2% -22.9% 0.7% Russell 2000 Index (Small-caps) -18.2 -18.0 0.2 Wilshire 5000 Index (Entire market) -17.9 -22.1 0.3 MSCI EAFE Index (International) -6.4 -16.9 -3.9 - -------------------------------------------------------------------------------- BONDS Lehman Aggregate Bond Index 4.2% 7.5% 7.3% (Broad taxable market) Lehman 10 Year Municipal Bond Index 4.8 7.2 6.1 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 0.9 2.3 4.6 ================================================================================ CPI Consumer Price Index 1.7% 1.5% 2.3% - -------------------------------------------------------------------------------- *Annualized. THE ECONOMY GREW IN FITS AND STARTS The nation's real (inflation-adjusted) gross domestic product grew at an annual rate of 1.1% in the second quarter of 2002, according to an early estimate. This was a sharp slowdown from the first quarter's robust growth rate of 5.0%, although more than half of that quarter's growth was due to the slower depletion of inventories. (The 5.0% figure was revised from an earlier estimate of 6.1%. More surprising, however, was the Commerce Department's downward revision of GDP growth in 2001. With the first three quarters of 2001 now showing negative growth, it is plain that last year's recession was longer and deeper than originally thought.) A rise in the trade deficit played a large role in dampening GDP growth in the second quarter. Consumer spending slowed in the quarter but still remained strong, while spending by businesses on inventories, equipment, and software rose for the first time in almost two years. With inflation of little concern and the economy sluggish, the Federal Reserve Board kept the target for the federal funds rate--the interest rate for overnight loans between banks--at its four-decade low of 1.75%. INVESTORS FLED TO THE QUALITY OF BONDS The overall U.S. bond market, as measured by the Lehman Brothers Aggregate Bond Index, posted a solid six-month return of 4.2%. But there was a distinct flight to quality in the period, with government and agency bonds posting the best returns as demand for these issues pushed their prices higher. A high default rate among corporate debt issues, notably those of several now-bankrupt telecommunications companies, caused investors to shun high-risk debt. The Lehman High Yield Index returned -9.6% for the six months as price declines more than offset higher yields. Prices of U.S. Treasury securities rose and yields fell. The 10-year note's yield fell 57 basis points (0.57 percentage point) during the six months to 4.46%. The decline was more dramatic for the 3-year Treasury note, whose yield fell 112 basis points to 3.01%. The yield of the 3-month Treasury bill, which lags a bit behind the Fed's interest rate moves, fell 6 basis points to 1.69%. 2 THE REIT INDEX FUND WAS A SAFE HARBOR DURING THE STORM Vanguard REIT Index Fund's six-month return of 7.5% was more than 25 percentage points higher than the return of the broad stock market and was also 0.6 percentage point better than that of the average peer fund. Your fund also managed to slightly outpace its target index, despite the fund's small cash position. This is a notable achievement because indexes exist only on paper and carry none of the real-world operating and transaction costs that a mutual fund must bear. Credit must be given to Vanguard's Quantitative Equity Group for its skillful and cost-efficient management of fund assets. REITs continued to be attractive to investors for several reasons. Not only were they a refuge from the broad market's decline, but they generally recorded higher earnings than companies in other industries. In addition, REITs provided high yields, especially in comparison with the very low dividend and interest rates available from stocks, bonds, and money market instruments. Your fund's solid return may give the false impression that the fiscal half-year was a smooth ride. Real estate investments generally have a low correlation with the rest of the stock market--making them a valuable tool for diversifying a portfolio--but they do not always escape the broader market's volatility. As stocks hit multiyear lows in July, REIT indexes fell as well. Both then surged late in the period. Earnings growth among real estate investments for the first quarter of 2002 was mixed but generally solid, according to the National Association of Real Estate Investment Trusts. (NAREIT's figures for the second quarter were not available.) Average net income per share for equity REITs was 9.5% higher than in the same period in 2001. However, funds from operations (FFO) per share--a measure of operating earnings for REITs that excludes such factors as depreciation, amortization, and property sales--rose just 1.0% from the same quarter the year before. Notably, both figures include the dismal earnings recorded by the lodging and resorts sector, which was still suffering from the aftereffects of the September 2001 terrorist attacks and the economic slowdown. Without that sector, earnings would have been considerably higher. We should briefly point out that there was a change in the fund's target index--and hence in the composition of your fund's assets--during the period. In mid-July, the Morgan Stanley REIT Index added seven health care REITs. Previously, the index excluded this type of investment; now, health care REITs constitute about 5% of its market capitalization. DIVERSIFICATION IS KEY IN ANY MARKET Anyone invested in stocks--which includes half of all U.S. households--has been through some truly trying times recently. As the past few years have - -------------------------------------------------------------------------------- Investors sought REITs for their high yields, earnings, and relative stability during the period. - -------------------------------------------------------------------------------- 3 shown, a low-cost sector fund such as Vanguard REIT Index Fund can be a useful supplement to a well-diversified portfolio of stocks, bonds, and short-term investments. We emphasize the word supplement because no single sector should ever represent the bulk of any investor's portfolio. Just as some investors made the mistake of concentrating their assets in technology stocks at the height of the bull market, it now would be a mistake to focus on any one sector, market segment, or asset class that has performed well recently. Diversification through low-cost investments--along with a good deal of patience--is the best means to navigate through these uncertain times in the financial markets. We thank you for your loyalty and trust. Sincerely, /S/ JOHN J. BRENNAN John J. Brennan Chairman and Chief Executive Officer August 15, 2002 - -------------------------------------------------------------------------------- YOUR FUND'S PERFORMANCE AT A GLANCE: JANUARY 31, 2002-JULY 31, 2002 DISTRIBUTIONS PER SHARE ----------------------------- STARTING ENDING INCOME CAPITAL RETURN OF SHARE PRICE SHARE PRICE DIVIDENDS GAINS CAPITAL - -------------------------------------------------------------------------------- Vanguard REIT Index Fund Investor Shares $12.10 $12.74 $0.280 $0.000 $0.000 Admiral Shares 51.65 54.36 1.209 0.000 0.000 - -------------------------------------------------------------------------------- 4 FUND PROFILE AS OF JULY 31, 2002 FOR REIT INDEX FUND This Profile provides a snapshot of the fund's characteristics, compared where appropriate with a broad market index. Key terms are defined on page 6. - -------------------------------------------------------------------------------- PORTFOLIO CHARACTERISTICS WILSHIRE FUND 5000 - -------------------------------------------------------------------------------- Number of Stocks 115 5,808 Median Market Cap $2.6B $27.0B Price/Earnings Ratio 22.9x 24.6x Price/Book Ratio 1.7x 2.7x Yield 1.6% Investor Shares 6.2%* Admiral Shares 6.3%* Return on Equity 11.1% 21.6% Earnings Growth Rate 10.7% 9.8% Foreign Holdings 0.0% 0.3% Turnover Rate 18%** -- Expense Ratio -- Investor Shares 0.26%** Admiral Shares 0.20%** Cash Investments 2.0% -- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) Equity Office Properties Trust REIT 7.1% Equity Residential Properties Trust REIT 4.8 Simon Property Group, Inc. REIT 4.3 Vornado Realty Trust REIT 3.0 ProLogis Trust REIT 2.9 Archstone-Smith Trust REIT 2.9 Public Storage, Inc. REIT 2.8 Apartment Investment & Management Co. Class A REIT 2.7 Boston Properties, Inc. REIT 2.3 Duke Realty Corp. REIT 2.2 - -------------------------------------------------------------------------------- Top Ten 35.0% - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- INVESTMENT FOCUS Market Cap Small Style Value - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- VOLATILITY MEASURES WILSHIRE FUND 5000 - -------------------------------------------------------------------------------- R-Squared 0.02 1.00 Beta 0.10 1.00 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- FUND ALLOCATION BY REIT TYPE Apartments 21.4% Retail 22.6 Office 20.3 Industrial 13.4 Diversified 11.9 Hotels 5.3 Health Care 5.1 - -------------------------------------------------------------------------------- Total 100.0% - -------------------------------------------------------------------------------- (PICTURE OF COMPUTER) VISIT OUR WEBSITE WWW.VANGUARD.COM FOR REGULARLY UPDATED FUND INFORMATION. *This yield includes some payments that represent a return of capital by the underlying REITs. The amount of the return of capital is determined by each REIT only after its fiscal year ends. **Annualized. 5 GLOSSARY OF INVESTMENT TERMS BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the overall market (or appropriate market index). The market (or index) is assigned a beta of 1.00, so a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the overall market rose or fell by 10%. - -------------------------------------------------------------------------------- CASH INVESTMENTS. The percentage of a fund's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. This figure does not include cash invested in futures contracts to simulate stock investment. - -------------------------------------------------------------------------------- EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in a fund. - -------------------------------------------------------------------------------- EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. - -------------------------------------------------------------------------------- MEDIAN MARKET CAP. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. - -------------------------------------------------------------------------------- PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds. - -------------------------------------------------------------------------------- PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. - -------------------------------------------------------------------------------- R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the overall market (or its benchmark index). If a fund's total returns were precisely synchronized with the overall market's return, its R-squared would be 1.00. If the fund's returns bore no relationship to the market's returns, its R-squared would be 0. - -------------------------------------------------------------------------------- RETURN ON EQUITY. The annual average rate of return generated by a company during the past five years for each dollar of shareholder's equity (net income divided by shareholder's equity). For a fund, the weighted average return on equity for the companies whose stocks it holds. - -------------------------------------------------------------------------------- TURNOVER RATE. An indication of the fund's trading activity. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). - -------------------------------------------------------------------------------- YIELD. A snapshot of a fund's income from dividends, interest, and return-of-capital distributions. The index yield is based on the current annualized rate of dividends and other distributions paid on stocks in the index. (degree) - -------------------------------------------------------------------------------- 6 PERFORMANCE SUMMARY AS OF JULY 31, 2002 FOR REIT INDEX FUND All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely. An investor's shares, when redeemed, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the redemption of fund shares. - -------------------------------------------------------------------------------- FISCAL-YEAR TOTAL RETURNS (%) MAY 13, 1996-JULY 31, 2002 FUND INDEX 1997 30.3 31.2 1998 17.1 16.7 1999 -17.3 -18 2000 -1 -1.3 2001 26.1 26.6 2002 11.6 12.1 2003* 7.5 7.4 - -------------------------------------------------------------------------------- *Six months ended July 31, 2002. Note: See Financial Highlights tables on pages 13 and 14 for information on dividends, capital gains, and return of capital. - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED JUNE 30, 2002 This table presents average annual total returns through the latest calendar quarter--rather than through the end of the fiscal period. Securities and exchange commission rules require that we provide this information. Since Inception One Five ----------------------- Inception Date Year Years Capital Income Total - -------------------------------------------------------------------------------- REIT Index Fund* Investor Shares 5/13/1996 15.56% 7.84% 6.14% 5.79% 11.93% Admiral Shares 11/12/2001 18.89** -- -- -- -- - -------------------------------------------------------------------------------- *For the REIT Index Fund Investor Shares, total return figures do not reflect the 1% fee assessed on redemptions of shares held for less than one year. The REIT Index Fund Admiral Shares return of 18.89% is reflective of this fee. **Return since inception. 7 FINANCIAL STATEMENTS JULY 31, 2002 (UNAUDITED) STATEMENT OF NET ASSETS This Statement provides a detailed list of the fund's holdings, including each security's market value on the last day of the reporting period. Real Estate Investment Trusts are listed in descending market-value order. Temporary cash investments and other assets are added to, and liabilities are subtracted from, the value of Total Real Estate Investment Trusts to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid-in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. - -------------------------------------------------------------------------------- MARKET VALUE* REIT INDEX FUND SHARES (000) - -------------------------------------------------------------------------------- REAL ESTATE INVESTMENT TRUSTS (98.0%) - -------------------------------------------------------------------------------- Equity Office Properties Trust REIT 5,426,510 143,151 Equity Residential Properties Trust REIT 3,574,734 95,624 Simon Property Group, Inc. REIT 2,414,551 86,900 Vornado Realty Trust REIT 1,386,648 60,388 ProLogis Trust REIT 2,316,942 59,082 Archstone-Smith Trust REIT 2,291,330 58,200 Public Storage, Inc. REIT 1,515,097 57,195 Apartment Investment & Management Co. Class A REIT 1,190,836 53,540 Boston Properties, Inc. REIT 1,236,767 46,131 Duke Realty Corp. REIT 1,748,373 45,021 Kimco Realty Corp. REIT 1,359,207 43,685 Avalonbay Communities, Inc. REIT 903,581 40,616 General Growth Properties Inc. REIT 809,278 39,234 Host Marriott Corp. REIT 3,446,357 38,772 Rouse Co. REIT 1,127,850 35,527 AMB Property Corp. REIT 1,096,892 32,413 Liberty Property Trust REIT 973,983 31,314 Health Care Properties Investors REIT 692,750 30,349 Hospitality Properties Trust REIT 814,155 27,372 Weingarten Realty Investors REIT 675,957 25,078 New Plan Excel Realty Trust REIT 1,233,870 24,147 Regency Centers Corp. REIT 756,818 23,840 Crescent Real Estate, Inc. REIT 1,369,771 23,450 Mack-Cali Realty Corp. REIT 746,278 23,351 United Dominion Realty Trust REIT 1,397,030 22,632 Trizec Properties, Inc. REIT 1,595,500 22,257 Arden Realty Group, Inc. REIT 839,638 21,814 Camden Property Trust REIT 535,376 19,809 Developers Diversified Realty Corp. REIT 839,856 19,317 BRE Properties Inc. Class A REIT 597,844 19,131 CarrAmerica Realty Corp. REIT 689,770 18,969 Highwood Properties, Inc. REIT 692,762 18,462 CenterPoint Properties Corp. REIT 299,553 17,500 Healthcare Realty Trust Inc. REIT 545,600 17,186 Chelsea Property Group REIT 492,884 16,669 First Industrial Realty Trust REIT 512,722 16,587 Shurgard Storage Centers, Inc. Class A REIT 465,064 16,277 Reckson Associates Realty Corp. REIT 683,606 15,627 Cousins Properties, Inc. REIT 646,711 15,489 8 - -------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) - -------------------------------------------------------------------------------- Federal Realty Investment Trust REIT 556,874 15,203 Pan Pacific Retail Properties, Inc. REIT 433,612 14,981 Mills Corp. REIT 497,429 14,674 Realty Income Corp. REIT 433,784 14,662 Prentiss Properties Trust REIT 500,368 14,200 Health Care REIT, Inc. 481,000 14,189 Post Properties, Inc. REIT 480,512 14,156 The Macerich Co. REIT 471,847 14,108 CBL & Associates Properties, Inc. REIT 379,611 13,936 HRPT Properties Trust REIT 1,676,949 13,868 Washington REIT 507,627 13,300 SL Green Realty Corp. REIT 391,654 12,631 Essex Property Trust, Inc. REIT 242,273 12,356 Home Properties of New York, Inc. REIT 338,080 12,174 Chateau Communities, Inc. REIT 380,175 10,778 Brandywine Realty Trust REIT 464,457 10,682 Nationwide Health Properties, Inc. REIT 563,730 10,418 FelCor Lodging Trust, Inc. REIT 690,619 10,394 Ventas, Inc. REIT 792,950 10,308 Colonial Properties Trust REIT 285,925 10,279 PS Business Parks, Inc. REIT 281,225 9,899 Taubman Co. REIT 664,960 9,855 Manufactured Home Communities, Inc. REIT 283,809 9,593 Alexandria Real Estate Equities, Inc. REIT 219,315 9,463 Gables Residential Trust REIT 322,838 9,398 Senior Housing Properties Trust REIT 743,500 9,286 Sun Communities, Inc. REIT 230,997 8,826 Kilroy Realty Corp. REIT 360,599 8,752 Commercial Net Lease Realty REIT 530,617 8,591 Glimcher Realty Trust REIT 442,838 8,405 Capital Automotive REIT 358,060 8,078 MeriStar Hospitality Corp. REIT 584,091 8,031 Summit Properties, Inc. REIT 355,059 7,616 Glenborough Realty Trust, Inc. REIT 359,707 7,216 Cornerstone Realty Income Trust, Inc. REIT 624,682 6,784 Mid-America Apartment Communities, Inc. REIT 227,849 5,867 Equity One, Inc. REIT 438,347 5,760 Lexington Corporate Properties Trust REIT 350,374 5,634 Bedford Property Investors, Inc. REIT 217,356 5,540 IRT Property Co. REIT 442,813 5,464 JDN Realty Corp. REIT 453,246 5,462 Pennsylvania REIT 209,598 5,387 AMLI Residential Properties Trust REIT 235,847 5,377 Sovran Self Storage, Inc. REIT 163,033 5,356 Getty Realty Holding Corp. REIT 279,100 5,331 EastGroup Properties, Inc. REIT 209,280 5,286 Entertainment Properties Trust REIT 222,725 5,145 Koger Equity, Inc. REIT 276,553 4,931 Town & Country Trust REIT 211,510 4,729 Saul Centers, Inc. REIT 193,136 4,568 RFS Hotel Investors, Inc. REIT 370,630 4,566 Corporate Office Properties Trust, Inc. REIT 304,044 4,257 Parkway Properties Inc. REIT 120,849 4,254 Universal Health Realty Income REIT 150,253 4,147 Innkeepers USA Trust REIT 485,932 4,130 Kramont Realty Trust REIT 276,836 3,876 Crown American Realty Trust REIT 416,290 3,830 Keystone Property Trust REIT 242,500 3,759 Equity Inns, Inc. REIT 525,908 3,708 Great Lakes, Inc. REIT 215,318 3,650 Mid Atlantic Realty Trust REIT 226,876 3,625 U.S. Restaurant Properties, Inc. REIT 254,108 3,557 LaSalle Hotel Properties REIT 243,190 3,441 Investors Real Estate Trust REIT 359,206 3,319 Ramco-Gershenson Properties Trust REIT 159,000 3,244 Tanger Factory Outlet Centers, Inc. REIT 104,252 2,971 Reckson Associates Realty Corp. Class B REIT 111,899 2,718 Mission West Properties Inc. REIT 227,510 2,605 Urstadt Biddle Properties Class A REIT 194,400 2,333 Winston Hotels, Inc. REIT 261,966 2,274 Associated Estates Realty Corp. REIT 253,251 2,173 Boykin Lodging Co. REIT 225,265 1,953 Correctional Properties Trust REIT 93,400 1,910 Sizeler Property Investors, Inc. REIT 169,900 1,867 9 - -------------------------------------------------------------------------------- MARKET VALUE* REIT INDEX FUND SHARES (000) - -------------------------------------------------------------------------------- American Land Lease, Inc. REIT 88,360 1,324 Prime Group Realty Trust REIT 204,879 1,168 - -------------------------------------------------------------------------------- TOTAL REAL ESTATE INVESTMENT TRUSTS (Cost $1,794,335) 1,969,692 - -------------------------------------------------------------------------------- FACE AMOUNT (000) - -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (2.9%) - -------------------------------------------------------------------------------- REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 1.83%, 8/1/2002--Note F $13,465 13,465 1.84%, 8/1/2002 45,058 45,058 - -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (COST $58,523) 58,523 - -------------------------------------------------------------------------------- TOTAL INVESTMENTS (100.9%) (COST $1,852,858) 2,028,215 - -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-0.9%) - -------------------------------------------------------------------------------- Other Assets--Note B 11,010 Liabilities--Note F (28,514) ----------- (17,504) ----------- - -------------------------------------------------------------------------------- NET ASSETS (100%) $2,010,711 ================================================================================ *See Note A in Notes to Financial Statements. - -------------------------------------------------------------------------------- AT JULY 31, 2002, NET ASSETS CONSISTED OF: - -------------------------------------------------------------------------------- Paid-in Capital $1,904,497 Undistributed Net Investment Income 7,225 Accumulated Net Realized Losses (76,368) Unrealized Appreciation--Note E 175,357 - -------------------------------------------------------------------------------- NET ASSETS $2,010,711 ================================================================================ Investor Shares--Net Assets Applicable to 136,462,600 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $1,738,303 - -------------------------------------------------------------------------------- NET ASSET VALUE PER SHARE-- INVESTOR SHARES $12.74 ================================================================================ Admiral Shares--Net Assets Applicable to 5,011,293 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $272,408 - -------------------------------------------------------------------------------- NET ASSET VALUE PER SHARE-- ADMIRAL SHARES $54.36 ================================================================================ 10 STATEMENT OF OPERATIONS This Statement shows the types of income earned by the fund during the reporting period, and details the operating expenses charged to each class of its shares. These expenses directly reduce the amount of investment income available to pay to shareholders as income dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) of investments during the period. - -------------------------------------------------------------------------------- REIT INDEX FUND SIX MONTHS ENDED JULY 31, 2002 (000) - -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends $ 49,930 Interest 345 Security Lending 13 - -------------------------------------------------------------------------------- Total Income 50,288 - -------------------------------------------------------------------------------- EXPENSES The Vanguard Group--Note B Investment Advisory Fees 46 Management and Administrative Investor Shares 1,758 Admiral Shares 221 Marketing and Distribution Investor Shares 102 Admiral Shares 11 Custodian Fees 53 Auditing Fees 6 Shareholders' Reports Investor Shares 28 Admiral Shares -- Trustees' Fees and Expenses 1 - -------------------------------------------------------------------------------- Total Expenses 2,226 Expenses Paid Indirectly--Note C (1) - -------------------------------------------------------------------------------- Net Expenses 2,225 - -------------------------------------------------------------------------------- NET INVESTMENT INCOME 48,063 - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) ON INVESTMENT SECURITIES SOLD (28,011) - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 82,481 - -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $102,533 ================================================================================ 11 STATEMENT OF CHANGES IN NET ASSETS This Statement shows how the fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the net amount shareholders invested in or redeemed from the fund. Distributions and Capital Share Transactions are shown separately for each class of shares. - -------------------------------------------------------------------------------- REIT INDEX FUND -------------------- SIX MONTHS YEAR ENDED ENDED JULY 31, 2002 JAN. 31, 2002 (000) (000) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 48,063 $ 64,463 Realized Net Gain (Loss) (28,011) (4,335) Change in Unrealized Appreciation (Depreciation) 82,481 69,799 - -------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations 102,533 129,927 - -------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income Investor Shares (34,490) (62,068) Admiral Shares (5,355) (2,640) Realized Capital Gain Investor Shares -- -- Admiral Shares -- -- Return of Capital Investor Shares -- (17,601) Admiral Shares -- (751) - -------------------------------------------------------------------------------- Total Distributions (39,845) (83,060) - -------------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS--NOTE G Investor Shares 413,209 131,686 Admiral Shares 99,161 165,383 - -------------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions 512,370 297,069 - -------------------------------------------------------------------------------- Total Increase (Decrease) 575,058 343,936 - -------------------------------------------------------------------------------- NET ASSETS Beginning of Period 1,435,653 1,091,717 - -------------------------------------------------------------------------------- End of Period $2,010,711 $1,435,653 ================================================================================ 12 FINANCIAL HIGHLIGHTS This table summarizes the fund's investment results and distributions to shareholders on a per-share basis for each class of shares. It also presents the Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year.
REIT INDEX FUND INVESTOR SHARES - ---------------------------------------------------------------------------------------------------------------- FOR A SHARE OUTSTANDING SIX MONTHS ENDED YEAR ENDED JANUARY 31, THROUGHOUT EACH PERIOD JULY 31, 2002 --------------------------------------------- 2002 2001 2000 1999 1998 - ---------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $12.10 $11.61 $ 9.91 $10.81 $13.98 $12.64 - ---------------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .33 .631 .642 .660 .666 .590 Net Realized and Unrealized Gain (Loss) on Investments .59 .669 1.878 (.780) (3.026) 1.520 - ---------------------------------------------------------------------------------------------------------------- Total from Investment Operations .92 1.300 2.520 (.120) (2.360) 2.110 - ---------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.28) (.631) (.644) (.670) (.666) (.590) Distributions from Realized Capital Gains -- -- -- -- -- (.086) Return of Capital -- (.179) (.176) (.110) (.144) (.094) - ---------------------------------------------------------------------------------------------------------------- Total Distributions (.28) (.810) (.820) (.780) (.810) (.770) - ---------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $12.74 $12.10 $11.61 $ 9.91 $10.81 $13.98 ================================================================================================================ TOTAL RETURN* 7.54% 11.59% 26.13% -1.04% -17.31% 17.08% ================================================================================================================ RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $1,738 $1,270 $1,092 $888 $904 $1,317 Ratio of Total Expenses to Average Net Assets 0.26%+ 0.28% 0.33% 0.33% 0.26% 0.24% Ratio of Net Investment Income to Average Net Assets 5.39%+ 5.35% 5.73% 5.98% 5.19% 4.66% Portfolio Turnover Rate 18%+ 10% 21%** 12% 29% 2% ================================================================================================================
*Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year. **The portfolio turnover rate excluding in-kind redemptions was 14%. +Annualized. 13 FINANCIAL HIGHLIGHTS (CONTINUED) REIT INDEX FUND ADMIRAL SHARES - -------------------------------------------------------------------------------- SIX MONTHS NOV. 12, ENDED 2001* TO JULY 31, JAN. 31, FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2002 2002 - -------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $51.65 $50.00 - -------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income 1.441 .494 Net Realized and Unrealized Gain (Loss) on Investments 2.478 2.401 - -------------------------------------------------------------------------------- Total from Investment Operations 3.919 2.895 - -------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (1.209) (.970) Distributions from Realized Capital Gains -- -- Return of Capital -- (.275) - -------------------------------------------------------------------------------- Total Distributions (1.209) (1.245) - -------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $54.36 $51.65 ================================================================================ TOTAL RETURN** 7.53%++ 5.78% ================================================================================ RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $272 $166 Ratio of Total Expenses to Average Net Assets 0.20%+ 0.23%+ Ratio of Net Investment Income to Average Net Assets 5.49%+ 5.27%+ Portfolio Turnover Rate 18%+ 10% ================================================================================ *Inception. **Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year. +Annualized. ++Total return was 0.01% less than the Investor Shares' total return for the six months ended July 31, 2002, as a result of rounding net asset values to the nearest cent. Over longer time periods, Admiral Shares provide higher returns than Investor Shares. 14 NOTES TO FINANCIAL STATEMENTS Vanguard REIT Index Fund is registered under the Investment Company Act of 1940 as an open- end investment company, or mutual fund. The fund offers two classes of shares, Investor Shares and Admiral Shares. Investor Shares are available to any investor who meets the fund's minimum purchase requirements. Admiral Shares were first issued on November 12, 2001, and are designed for investors who meet certain administrative, servicing, tenure, and account-size criteria. A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. The fund consistently follows such policies in preparing its financial statements. 1. SECURITY VALUATION: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. Temporary cash investments are valued at cost, which approximates market value. Securities for which market quotations are not readily available are valued by methods deemed by the board of trustees to represent fair value. 2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Accordingly, no provision for federal income taxes is required in the financial statements. 3. REPURCHASE AGREEMENTS: The fund, along with other members of The Vanguard Group, transfers uninvested cash balances to a pooled cash account, which is invested in repurchase agreements secured by U.S. government securities. Securities pledged as collateral for repurchase agreements are held by a custodian bank until the agreements mature. Each agreement requires that the market value of the collateral be sufficient to cover payments of interest and principal; however, in the event of default or bankruptcy by the other party to the agreement, retention of the collateral may be subject to legal proceedings. 4. DISTRIBUTIONS: Distributions to shareholders are recorded on the ex-dividend date. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. 5. OTHER: Dividend income is recorded on the ex-dividend date. Dividend income is recorded at management's estimate of the income included in distributions received from the REIT investments. Distributions received in excess of this amount are recorded as a reduction of the cost of investments. The actual amounts of income and return of capital are determined by each REIT only after its fiscal year-end, and may differ from the estimated amounts. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. Fees assessed on redemptions of capital shares are credited to paid-in capital. Each class of shares has equal rights as to assets and earnings, except that each class separately bears certain class-specific expenses related to maintenance of shareholder accounts (included in Management and Administrative expenses) and shareholder reporting. Marketing and distribution expenses are allocated to each class of shares based on a method approved by the board of trustees. Income, other non-class-specific expenses, and gains and losses on investments are allocated to each class of shares based on its relative net assets. B. The Vanguard Group furnishes at cost investment advisory, corporate management, administrative, marketing, and distribution services. The costs of such services are allocated to the fund under methods approved by the board of trustees. The fund has committed to provide up to 0.40% of its net assets in capital contributions to Vanguard. At July 31, 2002, the fund had contributed capital of $388,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net 15 NOTES TO FINANCIAL STATEMENTS (CONTINUED) assets and 0.39% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. C. The fund's custodian bank has agreed to reduce its fees when the fund maintains cash on deposit in the non-interest-bearing custody account. For the six months ended July 31, 2002, custodian fee offset arrangements reduced expenses by $1,000. D. During the six months ended July 31, 2002, the fund purchased $675,200,000 of investment securities and sold $160,725,000 of investment securities other than temporary cash investments. At January 31, 2002, the fund had available a capital loss carryforward of $48,357,000 to offset future net capital gains of $6,707,000 through January 31, 2007, $37,315,000 through January 31, 2008, and $4,335,000 through January 31, 2010. E. At July 31, 2002, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $175,357,000, consisting of unrealized gains of $227,445,000 on securities that had risen in value since their purchase and $52,088,000 in unrealized losses on securities that had fallen in value since their purchase. F. The market value of securities on loan to broker/dealers at July 31, 2002, was $12,738,000, for which the fund held cash collateral of $13,465,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. G. Capital share transactions for each class of shares were: - -------------------------------------------------------------------------------- SIX MONTHS ENDED YEAR ENDED JULY 31, 2002 JANUARY 31, 2002 ---------------- ---------------- AMOUNT SHARES AMOUNT SHARES (000) (000) (000) (000) - -------------------------------------------------------------------------------- Investor Shares Issued $594,888 46,110 $412,985 34,364 Issued in Lieu of Cash Distributions 30,186 2,292 67,098 5,714 Redeemed* (211,865) (16,862) (348,397) (29,184) Net Increase (Decrease)-- Investor Shares 413,209 31,540 131,686 10,894 Admiral Shares Issued 125,341 2,287 164,497 3,190 Issued in Lieu of Cash Distributions 3,959 70 2,437 47 Redeemed* (30,139) (552) (1,551) (30) Net Increase (Decrease)-- Admiral Shares 99,161 1,805 165,383 3,207 - -------------------------------------------------------------------------------- *Net of redemption fees of $664,000 and $288,000, respectively (fund totals). 16 THE PEOPLE WHO GOVERN YOUR FUND The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are a part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides services to them on an at-cost basis. A majority of Vanguard's board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. Our independent board members bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the activities of the funds. Among board members' responsibilities are selecting investment advisers for the funds; monitoring fund operations, performance, and costs; reviewing contracts; nominating and selecting new trustees/directors; and electing Vanguard officers. - -------------------------------------------------------------------------------- TRUSTEES (YEAR ELECTED) JOHN J. BRENNAN Chairman of the Board, Chief Executive Officer, and (1987) Director/Trustee of The Vanguard Group, Inc., and of each of the investment companies served by The Vanguard Group. CHARLES D. ELLIS The Partners of '63 (pro bono ventures in education); (2001) Senior Adviser to Greenwich Associates Successor Trustee of Yale University; Overseer of the Stern School of Business at New York (international business-strategy consulting); University; Trustee of the Whitehead Institute for Biomedical Research. RAJIV L. GUPTA Chairman and Chief Executive Officer of Rohm and Haas (2001) Co. (chemicals); Director of Technitrol, Inc. (electronic components), and Agere Systems (communications components); Board Member of the American Chemistry Council; and Trustee of Drexel University. JOANN HEFFERNAN HEISEN Vice President, Chief Information Officer, and Member (1998) of the Executive Committee of Johnson & Johnson (pharmaceuticals/consumer products); Director of the Medical Center at Princeton and Women's Research and Education Institute. BURTON G. MALKIEL Chemical Bank Chairman's Professor of Economics, (1977) Princeton University; Director of Vanguard Investment Series plc (Irish investment fund), Vanguard Group (Ireland) Limited (Irish investment management firm), Prudential Insurance Co.of America, BKF Capital (investment management firm), The Jeffrey Co. (holding company), and NeuVis, Inc. (software company). ALFRED M. RANKIN, JR. Chairman, President, Chief Executive Officer, and (1993) Director of NACCO Industries, Inc. (forklift trucks/ housewares/lignite); Director of Goodrich Corporation (industrial products/aircraft systems and services). J. LAWRENCE WILSON Retired Chairman and Chief Executive Officer of Rohm (1985) and Haas Co. (chemicals); Director of Cummins Inc. (diesel engines), The Mead Corp. (paper products), and AmerisourceBergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University. - -------------------------------------------------------------------------------- EXECUTIVE OFFICERS R. GREGORY BARTON Secretary; Managing Director and General Counsel of The Vanguard Group, Inc.; Secretary of The Vanguard Group and of each of the investment companies served by The Vanguard Group. THOMAS J. HIGGINS Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies served by The Vanguard Group. More information about the trustees is in the Statement of Additional Information, available from The Vanguard Group. VANGUARD SENIOR MANAGEMENT TEAM MORTIMER J. BUCKLEY, Information Technology. F. WILLIAM MCNABB, III, Institutional Investor Group. JAMES H. GATELY, Direct Investor Services. MICHAEL S. MILLER, Planning and Development. KATHLEEN C. GUBANICH, Human Resources. RALPH K. PACKARD, Finance. IAN A. MACKINNON, Fixed Income Group. GEORGE U. SAUTER, Quantitative Equity Group. - -------------------------------------------------------------------------------- JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-1996. [PICTURE OF A SHIP] THE VANGUARD(R) LOGO POST OFFICE BOX 2600 VALLEY FORGE, PA 19482-2600 Vanguard, The Vanguard Group, Vanguard.com, Admiral, and the ship logo are trademarks of The Vanguard Group, Inc. All other marks are the property of their respective owners. All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. ABOUT OUR COVER Our cover photographs were taken by Michael Kahn in September 2000 aboard HMS Rose in New York's Long Island Sound. Mr. Kahn is a renowned photographer--and accomplished sailor--whose work often focuses on seascapes and nautical images. The photographs are copyrighted by Mr. Kahn. FOR MORE INFORMATION This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. To receive a free copy of the prospectus or the Statement of Additional Information, or to request additional information about the funds or other Vanguard funds, please contact us at one of the adjacent telephone numbers or by e-mail through Vanguard.com(TM). Prospectuses may also be viewed online. WORLD WIDE WEB www.vanguard.com FUND INFORMATION 1-800-662-7447 DIRECT INVESTOR ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 TEXT TELEPHONE 1-800-952-3335 (C) 2002 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. Q1232 092002 VANGUARD(R)UTILITIES INCOME FUND SEMIANNUAL REPORT * JULY 31, 2002 STOCK (PICTURE OF A SHIP) THE VANGUARD GROUP (R) LOGO WHAT YOU CAN CONTROL As an investor, you cannot control how the financial markets perform. But there are vital variables that you can control. You can decide how much to invest. You can limit the risk in your portfolio by diversifying your holdings. And you can control the investment costs you incur. Costs may seem the least dramatic of the three. But costs have a powerful impact on how your wealth accumulates; they reduce, dollar for dollar, the returns that you can derive from an investment. Every mutual fund has operating expenses--to pay for investment managers, telephone support, and so on. These costs appear in the fund's expense ratio, which reflects the percentage of average net assets (your money) consumed each year by operating costs. In 2001, the average mutual fund had an expense ratio of 1.34% (or $13.40 per $1,000 in assets), according to data from Lipper Inc. For Vanguard(R) funds, the average expense ratio was less than one-fourth that amount (0.27%, or $2.70 per $1,000 in assets). Our average expense ratio has been less than the industry average for 25 years, and it's an advantage we aim to maintain. Under our unique corporate structure, shareholders like you own the Vanguard funds, which in turn own The Vanguard Group. No middleman makes a profit from managing the operation. You bear all of the investment risk. It's only right that you reap as much of the potential reward as possible. - -------------------------------------------------------------------------------- CONTENTS Letter from the Chairman 1 Report from the Adviser 5 Fund Profile 7 Glossary of Investment Terms 8 Performance Summary 9 Financial Statements 10 - -------------------------------------------------------------------------------- SUMMARY *Vanguard Utilities Income Fund returned -14.5% during the first half of its 2003 fiscal year, a disappointing result but not quite as bad as those of its comparative measures and the broad stock market. *The fund's holdings in electric companies and gas distributors helped cushion it from sharp declines in telecommunications and energy-trading companies. *The board of trustees is asking shareholders to approve significant changes to the fund's investment objective and strategies. LETTER FROM THE CHAIRMAN Fellow Shareholder, VANGUARD(R) UTILITIES INCOME FUND returned -14.5% during the six months ended July 31, 2002, a difficult period for the broad U.S. stock market and a particularly tough stretch for certain utility companies. The table below presents the total returns--capital change plus reinvested distributions--for your fund and its benchmarks. Per-share performance figures are shown on page 3. - -------------------------------------------------------------------------------- TOTAL RETURNS SIX MONTHS ENDED JULY 31, 2002 - -------------------------------------------------------------------------------- VANGUARD UTILITIES INCOME FUND -14.5% Average Utility Fund* -19.7 Utilities Composite Index** -25.0 Wilshire 5000 Index -17.9 - -------------------------------------------------------------------------------- *Derived from data provided by Lipper Inc. **Weighted 75% Standard & Poor's Utilities Index and 25% S&P Integrated Telecommunication Services Index. As described later in this report, the fund's board of trustees is recommending several significant changes to the fund's objective and strategies. Specifically, the board is asking shareholders to approve a plan that would broaden the fund's focus beyond utility stocks while maintaining its emphasis on companies that pay dividends. If these changes are approved on December 3, the fund will be renamed Vanguard(R) Dividend Growth Fund. See page 4 for more details about the proposal. STOCK PRICES ERODED AS NEGATIVE NEWS MOUNTED The U.S. stock market was extremely volatile during the six months ended July 31, dropping to levels not seen in five years before surging at the end of the period. The late rally, however, was not enough. The broad market, as measured by the Wilshire 5000 Total Market Index, posted a sharp decline of -17.9% for the half-year. The market's slump seemed to take on a life of its own as investors ignored reports of a recovery in the economy and of improved corporate earnings to focus on the drumbeat of negative news, including ongoing revelations of accounting problems and corporate misconduct, continued strife in the Middle East, warnings of potential terrorist attacks, and talk of war with Iraq. No market segment escaped the downdraft. Even small-capitalization value stocks, which had previously flourished while the broader market declined from its March 2000 peak, posted a negative return for the six months. Across all market caps, growth stocks (those with high prices relative to their earnings or book values) continued to fare worse than value issues. Mid-cap value stocks, as measured by the Russell Midcap Value Index, recorded the best result among domestic equities, returning -8.1%. As a group, developed markets overseas fared better than the 1 U.S. market, but they also failed to record a positive total return in the period. - -------------------------------------------------------------------------------- MARKET BAROMETER TOTAL RETURNS PERIODS ENDED JULY 31, 2002 ------------------------------- SIX ONE FIVE MONTHS YEAR YEARS* - -------------------------------------------------------------------------------- STOCKS Russell 1000 Index (Large-caps) -18.2% -22.9% 0.7% Russell 2000 Index (Small-caps) -18.2 -18.0 0.2 Wilshire 5000 Index (Entire market) -17.9 -22.1 0.3 MSCI EAFE Index (International) -6.4 -16.9 -3.9 - -------------------------------------------------------------------------------- BONDS Lehman Aggregate Bond Index 4.2% 7.5% 7.3% (Broad taxable market) Lehman 10 Year Municipal Bond Index 4.8 7.2 6.1 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 0.9 2.3 4.6 ================================================================================ CPI Consumer Price Index 1.7% 1.5% 2.3% - -------------------------------------------------------------------------------- *Annualized. THE ECONOMY GREW IN FITS AND STARTS The nation's real (inflation-adjusted) gross domestic product grew at an annual rate of 1.1% in the second quarter of 2002, according to an early estimate. This was a sharp slowdown from the first quarter's robust growth rate of 5.0%, although more than half of that quarter's growth was due to the slower depletion of inventories. (The 5.0% figure was revised from an earlier estimate of 6.1%. More surprising, however, was the Commerce Department's downward revision of GDP growth in 2001. With the first three quarters of 2001 now showing negative growth, it has become plain that last year's recession was longer and deeper than originally thought.) With inflation of little concern and the economy sluggish, the Federal Reserve Board kept the target for the federal funds rate--the interest rate for overnight loans between banks--at its four-decade low of 1.75%. INVESTORS FLED TO THE QUALITY OF BONDS The overall U.S. bond market, as measured by the Lehman Brothers Aggregate Bond Index, posted a solid six-month return of 4.2%. But there was a distinct flight to quality in the period, with government and agency bonds posting the best returns as demand pushed their prices higher. A high default rate among corporate debt issues, notably those of several now-bankrupt telecommunications companies, caused investors to shun high-risk debt. The Lehman High Yield Index returned -9.6% for the six months as price declines more than offset higher yields. Prices of U.S. Treasury securities rose and yields fell. The 10-year note's yield fell 57 basis points (0.57 percentage point) during the six months to 4.46%. The decline was more dramatic for the 3-year Treasury Note, whose yield fell 112 basis points to 3.01%. The yield of the 3-month Treasury bill, which lags a bit behind the Fed's interest rate moves, fell 6 basis points to 1.69%. YOUR FUND'S DEFENSIVE STANCE HELPED ITS RELATIVE PERFORMANCE Vanguard Utilities Income Fund's half-year total return of -14.5% was disappointing in absolute terms but was quite good when compared with the results of its average peer, utility stocks in general, and the broad stock market. 2 The decline in utility stocks was widespread, but it was steepest among telecommunications and energy-trading companies. Our holdings in these areas did not fare well, but because we had a relatively small exposure to both sectors and avoided several of the biggest blowups, we escaped some of the damage suffered by our benchmark index and average competitor. What helped us most, however, were the fund's relatively large stakes in high-yielding gas and electric utilities. Several of these companies recorded positive returns during the six months, a period when investors were drawn to stocks of stable businesses that pay attractive dividends. See the Report from the Adviser on page 5 for more details. A GOOD PLAN IS TIMELESS The past six months have been one of the toughest stretches in the stock market's long downturn. Our advice in bear markets is the same as it is in bull markets, not because these two beasts are the same, but because a sound investment strategy works in all environments: Make sure that you've developed an investment plan that includes broadly diversified stock and bond funds and cash reserves in proportions suited to your goals, time horizon, and financial circumstances. We thank you for your continued confidence in Vanguard. Sincerely, /S/ John J. Brennan JOHN J. BRENNAN CHAIRMAN AND CHIEF EXECUTIVE OFFICER AUGUST 15, 2002 - -------------------------------------------------------------------------------- YOUR FUND'S PERFORMANCE AT A GLANCE: JANUARY 31, 2002-JULY 31, 2002 DISTRIBUTIONS PER SHARE ------------------ STARTING ENDING INCOME CAPITAL SHARE PRICE SHARE PRICE DIVIDENDS GAINS - -------------------------------------------------------------------------------- Vanguard Utilities Income Fund $11.47 $9.64 $0.20 $0.00 - -------------------------------------------------------------------------------- 3 - -------------------------------------------------------------------------------- NOTICE TO SHAREHOLDERS The board of trustees of Vanguard Utilities Income Fund is asking the fund's shareholders to approve significant changes to the fund's objective and its investment strategy. If these changes are approved, the fund will expand its focus beyond utility stocks while continuing to emphasize companies that pay attractive dividends. A vote on the changes will be held at a special meeting of shareholders on December 3, 2002. As part of the proposals, the fund would no longer invest at least 80% of its assets in common stocks of utility companies. Instead, it would invest in a wide range of companies from various industries. The fund, renamed Vanguard(R) Dividend Growth Fund, would not be permitted to invest more than 25% of its assets in any single industry. Shareholders are also being asked to approve a new investment objective for the fund: to provide above-average income and, secondarily, to provide long-term growth of capital and income. The board's proposals are a result of dramatic changes in the nature of utility stocks that have occurred over the past two decades. For many years, utility stocks were considered relatively conservative investments, largely because tight government regulation resulted in consistent and modestly increasing earnings and the capacity to pay stable or increasing dividends. Over the past several years, however, deregulation of various utility sectors--including electricity producers and distributors, gas transmission companies, and telephone companies--has led to far less stability in earnings and to an overall decline in dividend payments. Investors who owned shares of the fund on September 6, 2002, are entitled to vote on the proposals. If you have not received a proxy statement in the mail, you can obtain a copy online at our website, VANGUARD.COM(R), or by calling 1-800-992-0833. - -------------------------------------------------------------------------------- 4 REPORT FROM THE ADVISER Vanguard Utilities Income Fund returned -14.5% for the six months ended July 31, 2002, outperforming the -19.7% return of the average utility fund and the -25.0% return of its composite benchmark. The fund's overweight position in domestic electric and gas distribution utilities was the primary reason for its significant outperformance of the index composite. THE INVESTMENT ENVIRONMENT The downward pressure on energy-trading and -generation companies continued during the six months. The decline stemmed from depressed pricing and the investigations into potential market manipulation of power and gas prices during the energy crisis of 2001. The negative flow of news--combined with increasing pressure from credit agencies aimed at forcing companies to strengthen their balance sheets--made for a tough environment for utility equities. Weak economic demand has not helped either, and the majority of utility companies have cut earnings projections for both 2002 and 2003. Liquidity and volatility in the energy-trading market have dropped dramatically, and the future of industry deregulation is being threatened by Congress. Telecommunications companies also had to revise their earnings downward in the period as demand remained weak and the bankruptcies of WorldCom and Global Crossing led to more accounting investigations and management-fraud issues. Wireless competition and the weak economy took their toll on the large Bell companies as well. MAJOR SHORTFALLS Our stakes in several overleveraged gas utility companies (CMS Energy and El Paso) that are being investigated for "wash trades"--buying and selling the same amount of a commodity at the same price simultaneously to artificially boost trading revenue--and other potential price-manipulation strategies had a negative impact on the portfolio during the six months. Other underperformers were smaller companies that had poor international investments (Alliant Energy), firms that restructured their deregulated businesses (DQE), and companies that received negative regulatory decisions (Sierra Pacific Resources). The overall decline in telecom equities also pulled down large positions in BellSouth and Vodafone Group. MAJOR SUCCESSES Large positions in integrated electric and gas utilities with current yields of 4% to 6% were by far the biggest positive factor in our relative performance. The share prices of FPL Group, Progress Energy, KeySpan, Cinergy, and Dominion Resources rose during the half-year. Pure distribution utilities with conservative 5 strategies (Southern, Energy East, and CH Energy Group) also had positive returns and benefited our relative performance. Finally, our avoidance of aggressive companies that emphasized leveraged growth was a big positive in performance relative to the composite benchmark and to the average utility fund. THE FUND'S POSITIONING High volatility and the weak performance of trading and generation companies had a negative effect on utility concerns during the half-year. In addition, increased regulatory scrutiny has placed an even greater premium on balance-sheet strength and management integrity. We continue to focus our large positions on companies with more stable utility-distribution franchises, safe current dividends, and prospects for modest annual earnings and dividend growth. Our telecommunications investments remain concentrated in the Bell companies, but our asset allocation to the sector was at an all-time low of 13% at the end of the period. Ongoing reductions in capital spending, long-distance price wars, and accelerating competition from wireless companies are factors that make us cautious until the economy shows more visible signs of recovery. MARK J. BECKWITH, SENIOR VICE PRESIDENT AND PORTFOLIO MANAGER WELLINGTON MANAGEMENT COMPANY, LLP AUGUST 13, 2002 6 FUND PROFILE AS OF JULY 31, 2002 FOR UTILITIES INCOME FUND This Profile provides a snapshot of the fund's characteristics, compared where appropriate to a broad market index. Key terms are defined on page 8. - -------------------------------------------------------------------------------- PORTFOLIO CHARACTERISTICS WILSHIRE FUND 5000 - -------------------------------------------------------------------------------- Number of Stocks 51 5,808 Median Market Cap $7.1B $27.0B Price/Earnings Ratio 15.1x 24.6x Price/Book Ratio 1.5x 2.7x Yield 4.3% 1.6% Return on Equity 13.7% 21.6% Earnings Growth Rate 3.5% 9.8% Foreign Holdings 9.7% 0.3% Turnover Rate 24%* -- Expense Ratio 0.34%* -- Cash Investments 5.0% -- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) FPL Group, Inc. 5.2% Exelon Corp. 4.9 Progress Energy, Inc. 4.9 KeySpan Corp. 4.9 Dominion Resources, Inc. 4.1 Pinnacle West Capital Corp. 4.1 DTE Energy Co. 3.9 Cinergy Corp. 3.8 BellSouth Corp. 3.8 FirstEnergy Corp. 3.4 - -------------------------------------------------------------------------------- Top Ten 43.0% - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- INVESTMENT FOCUS Market Cap Medium Style Value - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- VOLATILITY MEASURES WILSHIRE FUND 5000 - -------------------------------------------------------------------------------- R-Squared 0.12 1.00 Beta 0.27 1.00 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECTOR DIVERSIFICATION (% OF COMMON STOCKS) Electrical 69.8% Energy 1.6 Gas Distribution 9.6 Telecommunications 13.0 Water 2.5 Other 3.5 - -------------------------------------------------------------------------------- *Annualized. (PICTURE OF COMPUTER) VISIT OUR WEBSITE WWW.VANGUARD.COM FOR REGULARLY UPDATED FUND INFORMATION. 7 GLOSSARY OF INVESTMENT TERMS BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the overall market (or appropriate market index). The market (or index) is assigned a beta of 1.00, so a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the overall market rose or fell by 10%. - -------------------------------------------------------------------------------- CASH INVESTMENTS. The percentage of a fund's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. This figure does not include cash invested in futures contracts to simulate stock investment. - -------------------------------------------------------------------------------- EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in a fund. - -------------------------------------------------------------------------------- EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. - -------------------------------------------------------------------------------- FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks or American Depositary Receipts of companies based outside the United States. - -------------------------------------------------------------------------------- MEDIAN MARKET CAP. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. - -------------------------------------------------------------------------------- PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds. - -------------------------------------------------------------------------------- PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. - -------------------------------------------------------------------------------- R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the overall market (or its benchmark index). If a fund's total returns were precisely synchronized with the overall market's return, its R-squared would be 1.00. If the fund's returns bore no relationship to the market's returns, its R-squared would be 0. - -------------------------------------------------------------------------------- RETURN ON EQUITY. The annual average rate of return generated by a company during the past five years for each dollar of shareholder's equity (net income divided by shareholder's equity). For a fund, the weighted average return on equity for the companies whose stocks it holds. - -------------------------------------------------------------------------------- TURNOVER RATE. An indication of the fund's trading activity. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). - -------------------------------------------------------------------------------- YIELD. A snapshot of a fund's income from dividends, interest, and return-of-capital distributions. The index yield is based on the current annualized rate of dividends and other distributions paid on stocks in the index. - -------------------------------------------------------------------------------- 8 PERFORMANCE SUMMARY AS OF JULY 31, 2002 FOR UTILITIES INCOME FUND All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely. An investor's shares, when redeemed, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the redemption of fund shares. - -------------------------------------------------------------------------------- FISCAL-YEAR TOTAL RETURNS (%) MAY 15, 1992-JULY 31, 2002 FISCAL YEAR UTILITIES INCOME FUND UTILITIES COMPOSITE INDEX** 1993 14.5 12.2 1994 13.1 12.9 1995 -4.5 -2 1996 29.5 30.2 1997 5.5 4.5 1998 23.2 26.4 1999 19.9 23.8 2000 2.8 3.3 2001 7.1 23.6 2002 -17.2 -26.3 2003** -14.5 -25 - -------------------------------------------------------------------------------- *80% S&P Utilities Index, 20% Lehman Utility Bond Index through June 30, 1996; 40% S&P Utilities Index, 40% S&P Telephone Index, 20% Lehman Utility Bond Index through April 30, 1999; 63.75% S&P Utilities Index, 21.25% S&P Telephone Index, 15% Lehman Utility Bond Index through March 31, 2000; 75% S&P Utilities Index, 25% S&P Telephone Index through December 31, 2001; 75% S&P Utilities Index, 25% S&P Integrated Telecommunication Services Index thereafter. **Six months ended July 31, 2002. Note: See Financial Highlights table on page 14 for dividend and capital gains information. - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED JUNE 30, 2002 This table presents average annual total returns through the latest calendar quarter--rather than through the end of the fiscal period. Securities and Exchange Commission rules require that we provide this information. ONE FIVE TEN YEARS INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL - -------------------------------------------------------------------------------- Utilities Income Fund 5/15/1992 -16.63% 4.65% 3.77% 4.40% 8.17% - -------------------------------------------------------------------------------- 9 FINANCIAL STATEMENTS JULY 31, 2002 (UNAUDITED) STATEMENT OF NET ASSETS This Statement provides a detailed list of the fund's holdings, including each security's market value on the last day of the reporting period. Securities are grouped and subtotaled by asset type (common stocks, bonds, etc.) and by industry sector. Other assets are added to, and liabilities are subtracted from, the value of Total Investments to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid-in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. - -------------------------------------------------------------------------------- MARKET VALUE* UTILITIES INCOME FUND SHARES (000) - -------------------------------------------------------------------------------- COMMON STOCKS (95.0%) - -------------------------------------------------------------------------------- ELECTRICAL (66.2%) FPL Group, Inc. 525,000 29,741 Exelon Corp. 575,000 28,204 Progress Energy, Inc. 602,900 28,186 Dominion Resources, Inc. 400,000 23,776 Pinnacle West Capital Corp. 694,300 23,606 DTE Energy Co. 546,211 22,373 Cinergy Corp. 650,000 22,035 FirstEnergy Corp. 625,000 19,219 Public Service Enterprise Group, Inc. 500,000 17,275 Northeast Utilities 1,000,000 16,650 DPL Inc. 891,693 16,585 TXU Corp. 375,000 16,174 Energy East Corp. 600,000 12,498 CH Energy Group, Inc. 216,300 10,708 Southern Co. 350,000 10,073 Endesa SA ADR 899,800 10,033 Duke Energy Corp. 355,161 9,053 Constellation Energy Group, Inc. 300,000 8,361 Black Hills Corp. 253,000 6,444 NiSource, Inc. 281,562 5,575 Allete, Inc. 230,000 5,407 E.On AG 100,000 4,897 E.On AG ADR 100,000 4,875 American Electric Power Co., Inc. 146,500 4,821 Alliant Energy Corp. 250,000 4,782 CMS Energy Corp. 500,000 4,060 PNM Resources Inc. 200,000 3,990 DQE Inc. 256,830 3,493 Xcel Energy, Inc. 400,000 2,784 Sierra Pacific Resources 425,000 2,661 * International Power PLC ADR 60,000 1,122 * NiSource Inc. SAILS 145,007 289 ---------- 379,750 ---------- ENERGY (1.5%) El Paso Corp. 603,650 8,723 ---------- GAS DISTRIBUTION (9.1%) KeySpan Corp. 800,000 27,920 National Fuel Gas Co. 600,000 11,598 ONEOK, Inc. 290,800 5,380 Sempra Energy 224,071 4,750 Peoples Energy Corp. 75,000 2,633 ---------- 52,281 ---------- TELECOMMUNICATIONS (12.4%) BellSouth Corp. 805,200 21,620 Verizon Communications 541,000 17,852 ALLTEL Corp. 205,000 8,307 SBC Communications Inc. 267,200 7,391 Vodafone Group PLC ADR 475,000 7,206 Telecom Corp. of New Zealand Ltd. ADR 250,800 4,462 * TCD A/S ADR 275,000 3,432 TELUS Corp. 100,912 529 TELUS Corp. (Non-voting) 33,637 161 ---------- 70,960 ---------- 10 - -------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) - -------------------------------------------------------------------------------- WATER (2.4%) * Suez SA 625,000 13,603 ---------- OTHER (3.4%) Vectren Corp. 308,600 7,314 MDU Resources Group, Inc. 300,000 6,768 * National Grid Group PLC 750,000 5,176 ---------- 19,258 - -------------------------------------------------------------------------------- TOTAL COMMON STOCKS (Cost $598,560) 544,575 - -------------------------------------------------------------------------------- FACE AMOUNT (000) - -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (4.8%) - -------------------------------------------------------------------------------- REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 1.83%, 8/1/2002--Note G 171 171 1.84%, 8/1/2002 27,563 27,563 - -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (Cost $27,734) 27,734 - -------------------------------------------------------------------------------- TOTAL INVESTMENTS (99.8%) (Cost $626,294) 572,309 - -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (0.2%) - -------------------------------------------------------------------------------- Other Assets--Note C 2,955 Liabilities--Note G (1,682) ---------- 1,273 ---------- - -------------------------------------------------------------------------------- NET ASSETS (100%) - -------------------------------------------------------------------------------- Applicable to 59,470,357 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $573,582 ================================================================================ NET ASSET VALUE PER SHARE $9.64 ================================================================================ *See Note A in Notes to Financial Statements. *Non-income-producing security. ADR--American Depositary Receipt. SAILS--Stock Appreciated Income Linked Securities. - -------------------------------------------------------------------------------- AMOUNT PER (000) SHARE - -------------------------------------------------------------------------------- AT JULY 31, 2002, NET ASSETS CONSISTED OF: - -------------------------------------------------------------------------------- Paid-in Capital $738,337 $12.41 Undistributed Net Investment Income 1,701 .03 Accumulated Net Realized Losses (112,471) (1.89) Unrealized Depreciation--Note F (53,985) (.91) - -------------------------------------------------------------------------------- NET ASSETS $573,582 $9.64 ================================================================================ 11 STATEMENT OF OPERATIONS This Statement shows the types of income earned by the fund during the reporting period, and details the operating expenses charged to the fund. These expenses directly reduce the amount of investment income available to pay to shareholders as income dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) of investments during the period. - -------------------------------------------------------------------------------- UTILITIES INCOME FUND SIX MONTHS ENDED JULY 31, 2002 (000) - -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends $ 12,969 Interest 186 Security Lending 56 - -------------------------------------------------------------------------------- Total Income 13,211 - -------------------------------------------------------------------------------- EXPENSES Investment Advisory Fees--Note B 192 The Vanguard Group--Note C Management and Administrative 745 Marketing and Distribution 44 Custodian Fees 4 Auditing Fees 6 Shareholders' Reports 25 Trustees' Fees and Expenses 1 - -------------------------------------------------------------------------------- Total Expenses 1,017 Expenses Paid Indirectly--Note D (2) - -------------------------------------------------------------------------------- Net Expenses 1,015 - -------------------------------------------------------------------------------- NET INVESTMENT INCOME 12,196 - -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) ON INVESTMENT SECURITIES SOLD (18,716) - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES (90,969) - -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $(97,489) ================================================================================ 12 STATEMENT OF CHANGES IN NET ASSETS This Statement shows how the fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the amount shareholders invested in the fund, either by purchasing shares or by reinvesting distributions, as well as the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed are shown at the end of the Statement. - -------------------------------------------------------------------------------- UTILITIES INCOME FUND ---------------------------------- SIX MONTHS YEAR ENDED ENDED JULY 31, 2002 JAN. 31, 2002 (000) (000) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 12,196 $ 22,506 Realized Net Gain (Loss) (18,716) (93,439) Change in Unrealized Appreciation (Depreciation) (90,969) (76,524) - -------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations (97,489) (147,457) - -------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income (11,899) (22,165) Realized Capital Gain -- (24,496) - -------------------------------------------------------------------------------- Total Distributions (11,899) (46,661) - -------------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS 1 Issued 63,601 100,154 Issued in Lieu of Cash Distributions 9,696 39,598 Redeemed (71,723) (152,083) - -------------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions 1,574 (12,331) - -------------------------------------------------------------------------------- Total Increase (Decrease) (107,814) (206,449) - -------------------------------------------------------------------------------- NET ASSETS Beginning of Period 681,396 887,845 - -------------------------------------------------------------------------------- End of Period $573,582 $681,396 ================================================================================ 1Shares Issued (Redeemed) Issued 5,730 7,738 Issued in Lieu of Cash Distributions 849 3,080 Redeemed (6,537) (11,737) - -------------------------------------------------------------------------------- Net Increase (Decrease) in Shares Outstanding 42 (919) ================================================================================ 13 FINANCIAL HIGHLIGHTS This table summarizes the fund's investment results and distributions to shareholders on a per-share basis. It also presents the Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year.
UTILITIES INCOME FUND - ------------------------------------------------------------------------------------------------------- FOR A SHARE OUTSTANDING SIX MONTHS ENDED YEAR ENDED JANUARY 31, THROUGHOUT EACH PERIOD JULY 31, 2002 ------------------------------------------- 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $11.47 $14.71 14.93 $16.27 $14.97 $12.93 - ------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .21 .37 .42 .49 .55 .58 Net Realized and Unrealized Gain (Loss) on Investments (1.84) (2.83) .62 (.12) 2.35 2.32 - ------------------------------------------------------------------------------------------------------- Total from Investment Operations (1.63) (2.46) 1.04 .37 2.90 2.90 - ------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.20) (.37) (.53) (.51) (.59) (.60) Distributions from Realized Capital Gains -- (.41) (.73) (1.20) (1.01) (.26) - ------------------------------------------------------------------------------------------------------- Total Distributions (.20) (.78) (1.26) (1.71) (1.60) (.86) - ------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $9.64 $11.47 $14.71 $14.93 $16.27 $14.97 ======================================================================================================= TOTAL RETURN -14.48% -17.21% 7.08% 2.79% 19.92% 23.17% ======================================================================================================= RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $574 $681 $888 $854 $952 $699 Ratio of Total Expenses to Average Net Assets 0.34%* 0.37% 0.37% 0.40% 0.38% 0.44% Ratio of Net Investment Income to Average Net Assets 3.66%* 2.85% 2.76% 3.13% 3.51% 4.30% Portfolio Turnover Rate 24%* 27% 48% 47% 55% 41% ======================================================================================================= *Annualized.
15 NOTES TO FINANCIAL STATEMENTS Vanguard Utilities Income Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund may invest in securities of foreign issuers, which may subject it to investment risks not normally associated with investing in securities of United States corporations. A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. The fund consistently follows such policies in preparing its financial statements. 1. SECURITY VALUATION: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. Bonds, and temporary cash investments acquired over 60 days to maturity, are valued using the latest bid prices or using valuations based on a matrix system (which considers such factors as security prices, yields, maturities, and ratings), both as furnished by independent pricing services. Other temporary cash investments are valued at amortized cost, which approximates market value. Securities for which market quotations are not readily available are valued by methods deemed by the board of trustees to represent fair value. 2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Accordingly, no provision for federal income taxes is required in the financial statements. 3. REPURCHASE AGREEMENTS: The fund, along with other members of The Vanguard Group, transfers uninvested cash balances to a pooled cash account, which is invested in repurchase agreements secured by U.S. government securities. Securities pledged as collateral for repurchase agreements are held by a custodian bank until the agreements mature. Each agreement requires that the market value of the collateral be sufficient to cover payments of interest and principal; however, in the event of default or bankruptcy by the other party to the agreement, retention of the collateral may be subject to legal proceedings. 4. DISTRIBUTIONS: Distributions to shareholders are recorded on the ex-dividend date. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. 5. OTHER: Dividend income is recorded on the ex-dividend date. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. B. Wellington Management Company, llp, provides investment advisory services to the fund for a fee calculated at an annual percentage rate of average net assets. For the six months ended July 31, 2002, the advisory fee represented an effective annual rate of 0.06% of the fund's average net assets. C. The Vanguard Group furnishes at cost corporate management, administrative, marketing, and distribution services. The costs of such services are allocated to the fund under methods approved by the board of trustees. The fund has committed to provide up to 0.40% of its net assets in capital contributions to Vanguard. At July 31, 2002, the fund had contributed capital of $122,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 0.12% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. D. The fund has asked its investment adviser to direct certain security trades, subject to obtaining the best price and execution, to brokers who have agreed to rebate to the fund part of the commissions generated. Such rebates are used solely to reduce the fund's management and administrative 15 NOTES TO FINANCIAL STATEMENTS (CONTINUED) expenses. The fund's custodian bank has also agreed to reduce its fees when the fund maintains cash on deposit in the non-interest-bearing custody account. For the six months ended July 31, 2002, directed brokerage and custodian fee offset arrangements reduced expenses by $1,000 and $1,000, respectively. E. During the six months ended July 31, 2002, the fund purchased $88,945,000 of investment securities and sold $78,217,000 of investment securities other than temporary cash investments. At January 31, 2002, the fund had available realized losses of $93,440,000 to offset future net capital gains of $70,259,000 through January 31, 2010, and $23,181,000 through January 31, 2011. F. At July 31, 2002, net unrealized depreciation of investment securities for financial reporting and federal income tax purposes was $53,985,000, consisting of unrealized gains of $55,890,000 on securities that had risen in value since their purchase and $109,875,000 in unrealized losses on securities that had fallen in value since their purchase. G. The market value of securities on loan to broker/dealers at July 31, 2002, was $168,000, for which the fund held cash collateral of $171,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. 16 THE PEOPLE WHO GOVERN YOUR FUND The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are a part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides services to them on an at-cost basis. A majority of Vanguard's board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. Our independent board members bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the activities of the funds. Among board members' responsibilities are selecting investment advisers for the funds; monitoring fund operations, performance, and costs; reviewing contracts; nominating and selecting new trustees/directors; and electing Vanguard officers. - -------------------------------------------------------------------------------- TRUSTEES (YEAR ELECTED) JOHN J. BRENNAN Chairman of the Board, Chief Executive Officer, and (1987) Director/Trustee of The Vanguard Group, Inc., and of each of the investment companies served by The Vanguard Group. CHARLES D. ELLIS The Partners of '63 (pro bono ventures in education); (2001) Senior Adviser to Greenwich Associates Successor Trustee of Yale University; Overseer of the Stern School of Business at New York (international business-strategy consulting); University; Trustee of the Whitehead Institute for Biomedical Research. RAJIV L. GUPTA Chairman and Chief Executive Officer of Rohm and Haas (2001) Co. (chemicals); Director of Technitrol, Inc. (electronic components), and Agere Systems (communications components); Board Member of the American Chemistry Council; and Trustee of Drexel University. JOANN HEFFERNAN HEISEN Vice President, Chief Information Officer, and Member (1998) of the Executive Committee of Johnson & Johnson (pharmaceuticals/consumer products); Director of the Medical Center at Princeton and Women's Research and Education Institute. BURTON G. MALKIEL Chemical Bank Chairman's Professor of Economics, (1977) Princeton University; Director of Vanguard Investment Series plc (Irish investment fund), Vanguard Group (Ireland) Limited (Irish investment management firm), Prudential Insurance Co.of America, BKF Capital (investment management firm), The Jeffrey Co. (holding company), and NeuVis, Inc. (software company). ALFRED M. RANKIN, JR. Chairman, President, Chief Executive Officer, and (1993) Director of NACCO Industries, Inc. (forklift trucks/ housewares/lignite); Director of Goodrich Corporation (industrial products/aircraft systems and services). J. LAWRENCE WILSON Retired Chairman and Chief Executive Officer of Rohm (1985) and Haas Co. (chemicals); Director of Cummins Inc. (diesel engines), The Mead Corp. (paper products), and AmerisourceBergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University. - -------------------------------------------------------------------------------- EXECUTIVE OFFICERS R. GREGORY BARTON Secretary; Managing Director and General Counsel of The Vanguard Group, Inc.; Secretary of The Vanguard Group and of each of the investment companies served by The Vanguard Group. THOMAS J. HIGGINS Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies served by The Vanguard Group. More information about the trustees is in the Statement of Additional Information, available from The Vanguard Group. VANGUARD SENIOR MANAGEMENT TEAM MORTIMER J. BUCKLEY, Information Technology. F. WILLIAM MCNABB, III, Institutional Investor Group. JAMES H. GATELY, Direct Investor Services. MICHAEL S. MILLER, Planning and Development. KATHLEEN C. GUBANICH, Human Resources. RALPH K. PACKARD, Finance. IAN A. MACKINNON, Fixed Income Group. GEORGE U. SAUTER, Quantitative Equity Group. - -------------------------------------------------------------------------------- JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-1996. [PICTURE OF A SHIP] THE VANGUARD(R) LOGO POST OFFICE BOX 2600 VALLEY FORGE, PA 19482-2600 Vanguard, The Vanguard Group, Vanguard.com, and the ship logo are trademarks of The Vanguard Group, Inc. Standard & Poor's(R), S&P(R), and the names of S&P indexes are trademarks of The McGraw-Hill Companies, Inc. All other marks are the property of their respective owners. All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. ABOUT OUR COVER Our cover photographs were taken by Michael Kahn in September 2000 aboard HMS Rose in New York's Long Island Sound. Mr. Kahn is a renowned photographer--and accomplished sailor--whose work often focuses on seascapes and nautical images. The photographs are copyrighted by Mr. Kahn. FOR MORE INFORMATION This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. To receive a free copy of the prospectus or the Statement of Additional Information, or to request additional information about the funds or other Vanguard funds, please contact us at one of the adjacent telephone numbers or by e-mail through Vanguard.com(TM). Prospectuses may also be viewed online. WORLD WIDE WEB www.vanguard.com FUND INFORMATION 1-800-662-7447 DIRECT INVESTOR ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 TEXT TELEPHONE 1-800-952-3335 (C) 2002 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. Q572 092002 -----END PRIVACY-ENHANCED MESSAGE-----