-----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, WQPskpNwahi/jaEUh4QXVEZMfbbfin0IVXeJu3y+H/mTO+VQJef9WD9ORA3NJxY0 cYszkzRJp17FFoqPCyh+Dw== 0000932471-05-000963.txt : 20090930 0000932471-05-000963.hdr.sgml : 20090930 20050606162446 ACCESSION NUMBER: 0000932471-05-000963 CONFORMED SUBMISSION TYPE: 485APOS PUBLIC DOCUMENT COUNT: 2 FILED AS OF DATE: 20050606 DATE AS OF CHANGE: 20060315 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VANGUARD SPECIALIZED FUNDS CENTRAL INDEX KEY: 0000734383 IRS NUMBER: 000000000 STATE OF INCORPORATION: DE FISCAL YEAR END: 0131 FILING VALUES: FORM TYPE: 485APOS SEC ACT: 1933 Act SEC FILE NUMBER: 002-88116 FILM NUMBER: 05880768 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 FUNDS/ DATE OF NAME CHANGE: 20011121 FORMER COMPANY: FORMER CONFORMED NAME: VANGUARD SPECIALIZED PORTFOLIOS INC DATE OF NAME CHANGE: 19920703 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VANGUARD SPECIALIZED FUNDS CENTRAL INDEX KEY: 0000734383 IRS NUMBER: 000000000 STATE OF INCORPORATION: DE FISCAL YEAR END: 0131 FILING VALUES: FORM TYPE: 485APOS SEC ACT: 1940 Act SEC FILE NUMBER: 811-03916 FILM NUMBER: 05880769 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 FUNDS/ DATE OF NAME CHANGE: 20011121 FORMER COMPANY: FORMER CONFORMED NAME: VANGUARD SPECIALIZED PORTFOLIOS INC DATE OF NAME CHANGE: 19920703 485APOS 1 energysaiforafiling.txt VANGUARD ENERGY FUND 485A FILING - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM N-1A REGISTRATION STATEMENT (NO. 2-88116) UNDER THE SECURITIES ACT OF 1933 PRE-EFFECTIVE AMENDMENT NO. POST-EFFECTIVE AMENDMENT NO. 52 AND REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 AMENDMENT NO. 55 VANGUARD SPECIALIZED FUNDS (EXACT NAME OF REGISTRANT AS SPECIFIED IN DECLARATION OF TRUST) P.O. BOX 2600, VALLEY FORGE, PA 19482 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) REGISTRANT'S TELEPHONE NUMBER (610) 669-1000 R. GREGORY BARTON, ESQUIRE P.O. BOX 876 VALLEY FORGE, PA 19482 IT IS PROPOSED THAT THIS AMENDMENT BECOME EFFECTIVE ON JUNE 6, 2005, PURSUANT TO PARAGRAPH (A) OF RULE 485. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- VANGUARD/(R)/ ENERGY FUND Investor Shares & Admiral/(TM)/Shares . August 8, 2005 This prospectus contains financial data for the Fund through the fiscal year ended January 31, 2005. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THE VANGUARD GROUP /(R)/ VANGUARD ENERGY FUND Investor Shares and Admiral Shares Prospectus August 8, 2005 An Aggressive Stock Mutual Fund - -------------------------------------------------------------------------------- CONTENTS - -------------------------------------------------------------------------------- 1 FUND PROFILE 4 ADDITIONAL INFORMATION 5 MORE ON THE FUND 11 THE FUND AND VANGUARD 11 INVESTMENT ADVISOR 13 DIVIDENDS, CAPITAL GAINS, AND TAXES 14 SHARE PRICE 15 FINANCIAL HIGHLIGHTS 18 INVESTING WITH VANGUARD 18 Buying Shares 21 Converting Shares 22 Redeeming Shares 25 Exchanging Shares 26 Other Rules You Should Know 29 Fund and Account Updates 31 Contacting Vanguard GLOSSARY OF INVESTMENT TERMS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- WHY READING THIS PROSPECTUS IS IMPORTANT This prospectus explains the investment objective, policies, strategies, and risks associated with the Fund. To highlight terms and concepts important to mutual fund investors, we have provided Plain Talk/(R)/ explanations along the way. Reading the prospectus will help you decide whether the Fund is the right investment for you. We suggest that you keep this prospectus for future reference. - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SHARE CLASS OVERVIEW The Fund offers two separate classes of shares: Investor Shares and Admiral Shares. Please note that Admiral Shares are NOT available to: - SIMPLE IRAs and 403(b)(7) custodial accounts; - Other retirement plan accounts receiving special administrative services from Vanguard; or - Accounts maintained by financial intermediaries, except in limited circumstances. The Fund's separate share classes have different expenses; as a result, their investment performances will differ. - ------------------------------------------------------------------------------- 1 FUND PROFILE INVESTMENT OBJECTIVE The Fund seeks to provide long-term capital appreciation. PRIMARY INVESTMENT STRATEGIES The Fund invests at least 80% of its assets in the common stocks of companies principally engaged in energy-related activities, such as production and transmission of energy or energy fuels; the making of component products for such activities; energy research; and energy conservation or pollution control. The Fund may invest up to 100% of its assets in foreign stocks. The Fund uses multiple investment advisors to manage its portfolio. For more information, see "Security Selection" under MORE ON THE FUND. PRIMARY RISKS An investment in the Fund could lose money over short or even long periods. You should expect the Fund's share price and total return to fluctuate within a wide range, like the fluctuations of the overall stock market. The Fund's performance could be hurt by: - - Industry concentration risk, which is the chance that there will be overall problems affecting a particular industry. Because the Fund normally invests at least 80% of its assets in the common stocks of companies principally engaged in energy-related activities, the Fund's performance largely depends--for better or for worse--on the overall condition of the energy industry. The energy industry could be adversely affected by various political, regulatory, supply and demand, and other economic factors. - - Stock market risk, which is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. In addition, investments in foreign stock markets can be riskier than U.S. stock investments. The prices of foreign stocks and the prices of U.S. stocks have, at times, moved in opposite directions. - - Manager risk, which is the chance that poor security selection will cause the Fund to underperform relevant benchmarks or other funds with a similar investment objective. - - Country risk, which is the chance that domestic events--such as political upheaval, financial troubles, or natural disasters--will weaken a country's securities markets. - - Currency risk, which is the chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates. PERFORMANCE/RISK INFORMATION The following bar chart and table are intended to help you understand the risks of investing in the Fund. The bar chart shows how the performance of the Fund's Investor Shares has varied from one calendar year to another over the periods shown. The table shows how the average annual total returns of the share classes presented compare with those of a relevant market index and the average natural resources fund. Keep in mind that the Fund's past returns (before and after taxes) do not indicate how it will perform in the future. 2 ---------------------------------------------------- ANNUAL TOTAL RETURNS--INVESTOR SHARES ---------------------------------------------------- [BAR CHART: SCALE -40% TO 60%] 1995 25.32% 1996 34.00 1997 14.89 1998 -20.53 1999 20.98 2000 36.43 2001 -2.55 2002 -0.62 2003 33.80 2004 36.65 ---------------------------------------------------- The year-to-date return as of the most recent calendar quarter, which ended March 31, 2005, was 14.50%. ---------------------------------------------------- During the periods shown in the bar chart, the highest return for a calendar quarter was 16.70% (quarter ended December 31, 2003), and the lowest return for a quarter was -14.20% (quarter ended September 30, 1998). - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED DECEMBER 31, 2004 - -------------------------------------------------------------------------------- 1 YEAR 5 YEARS 10 YEARS - -------------------------------------------------------------------------------- VANGUARD ENERGY FUND INVESTOR SHARES Return Before Taxes 36.65% 19.29% 16.18% Return After Taxes on Distributions 36.10 17.96 14.85 Return After Taxes on Distributions and Sale of Fund Shares 24.14 16.39 13.82 - -------------------------------------------------------------------------------- VANGUARD ENERGY FUND ADMIRAL SHARES* Return Before Taxes 36.73% -- -- - -------------------------------------------------------------------------------- COMPARATIVE BENCHMARKS Standard & Poor's Energy Sector Index (reflects no deduction for fees, expenses, or taxes) 31.54% 9.48% 14.51% Average Natural Resources Fund** 30.16 13.59 11.49 - ------------------------------------------------------------------------------- *From the inception of the Fund's Admiral shares on November 12, 2001, through December 31, 2004, the average annual total returns were 22.10% for the Fund's Admiral Shares; 13.30% for the Standard & Poor's Energy Sector Index; and 17.27% for the Average Natural Resources Fund. **Derived from data provided by Lipper Inc. - ------------------------------------------------------------------------------- NOTE ON AFTER-TAX RETURNS. Actual after-tax returns depend on your tax situation and may differ from those shown in the preceding table. When calculating after-tax return figures for a fund, we assume the shareholder was in the highest federal marginal income tax bracket at the time of each distribution of income or capital gains, but we do not consider state or local income taxes. Please note that actual after-tax returns will vary for a fund's separate share classes and are not relevant for a shareholder who holds fund shares in a tax-deferred account, such as an individual retirement account or a 401(k) plan. Also, figures captioned Return After Taxes on Distributions and Sale of Fund Shares will be higher than other figures for the same period if a capital loss occurs upon redemption and results in an assumed tax deduction for the shareholder. 3 FEES AND EXPENSES The following table describes the fees and expenses you may pay if you buy and hold Investor Shares or Admiral Shares of the Fund. As is the case with all mutual funds, transaction costs incurred by the Fund for buying and selling securities are not reflected in the table. The expenses shown under Annual Fund Operating Expenses are based on estimated amounts for the current fiscal year, adjusted to account for a new advisory fee schedule effective May 27, 2005. INVESTOR ADMIRAL SHARES SHARES ------ ------ SHAREHOLDER FEES (fees paid directly from your investment) Sales Charge (Load) Imposed on Purchases: None None Purchase Fee: None None Sales Charge (Load) Imposed on Reinvested Dividends: None None Redemption Fee: 1%* 1%* ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's assets) Management Expenses: 0.31% 0.26% 12b-1 Distribution Fee: None None Other Expenses: 0.02% 0.01% TOTAL ANNUAL FUND OPERATING EXPENSES 0.33% 0.27% *The 1% fee applies to shares redeemed within one year of purchase by selling, by exchanging to another fund, or by application of the low-balance account-closure policy. The fee is withheld from redemption proceeds and retained by the Fund. Shares held for one year or more are not subject to the 1% fee. The following examples are intended to help you compare the cost of investing in the Fund's Investor Shares or Admiral Shares with the cost of investing in other mutual funds. They illustrate the hypothetical expenses that you would incur over various periods if you invest $10,000 in the Fund's shares. These examples assume that the Fund provides a return of 5% a year and that operating expenses match our estimates. The results apply whether or not you redeem your investment at the end of the given period. --------------------------------------------------------- 1 YEAR 3 YEARS 5 YEARS 10 YEARS --------------------------------------------------------- Investor Shares $34 $106 $185 $418 Admiral Shares 28 87 152 343 --------------------------------------------------------- THESE EXAMPLES SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE HIGHER OR LOWER THAN THOSE SHOWN. 4 - -------------------------------------------------------------------------------- PLAIN TALK ABOUT FUND EXPENSES All mutual funds have operating expenses. These expenses, which are deducted from a fund's gross income, are expressed as a percentage of the net assets of the fund. We expect Vanguard Energy Fund's expense ratios to be as follows: for Investor Shares, 0.33%, or $3.30 per $1,000 of average net assets; for Admiral Shares, 0.27%, or $2.70 per $1,000 of average net assets. The average natural resources mutual fund had expenses in 2004 of 1.59%, or $15.90 per $1,000 of average net assets (derived from data provided by Lipper Inc., which reports on the mutual fund industry). Management expenses, which are one part of operating expenses, include investment advisory fees as well as other costs of managing a fund--such as account maintenance, reporting, accounting, legal, and other administrative expenses. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PLAIN TALK ABOUT COSTS OF INVESTING Costs are an important consideration in choosing a mutual fund. That's because you, as a shareholder, pay the costs of operating a fund, plus any transaction costs incurred when the fund buys or sells securities. These costs can erode a substantial portion of the gross income or the capital appreciation a fund achieves. Even seemingly small differences in expenses can, over time, have a dramatic effect on a fund's performance. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ADDITIONAL INFORMATION DIVIDENDS AND CAPITAL GAINS CONVERSION FEATURES Distributed annually in December Investor Shares--May be converted to Admiral Shares if you meet certain account INVESTMENT ADVISOR balance and tenure requirements and are a Wellington Management Company, registered user of Vanguard.com LLP, Boston, Mass., since Admiral Shares--May be converted to inception Investor Shares if you are no longer eligible for Admiral Shares The Vanguard Group, Valley Forge, Pa., since 2005 INCEPTION DATE Investor Shares--May 23, 1984 NEWSPAPER ABBREVIATION Admiral Shares--November 12, 2001 Investor Shares--Energy Admiral Shares--EnergyAdml NET ASSETS (ALL SHARE CLASSES) AS OF JANUARY 31, 2005 VANGUARD FUND NUMBER $5.4 billion Investor Shares--51 Admiral Shares--551 SUITABLE FOR IRAS CUSIP NUMBER Yes Investor Shares--921908109 Admiral Shares--921908802 MINIMUM INITIAL INVESTMENT Investor Shares--$25,000, TICKER SYMBOL including IRAs and custodial Investor Shares--VGENX accounts for minors Admiral Shares--VGELX Admiral Shares--$100,000 - -------------------------------------------------------------------------------- 5 MORE ON THE FUND This prospectus describes the primary risks you would face as a Fund shareholder. It is important to keep in mind one of the main axioms of investing: The higher the risk of losing money, the higher the potential reward. The reverse, also, is generally true: The lower the risk, the lower the potential reward. As you consider an investment in any mutual fund, you should take into account your personal tolerance for daily fluctuations in the securities markets. Look for this FLAG symbol throughout the prospectus. It is used to mark detailed information about the more significant risks that you would confront as a Fund shareholder. The following sections explain the primary investment strategies and policies that the Fund uses in pursuit of its objective. The Fund's board of trustees, which oversees the Fund's management, may change investment strategies or policies in the interest of shareholders without a shareholder vote, unless those strategies or policies are designated as fundamental. Note that the Fund's investment objective is not fundamental and may be changed without a shareholder vote. MARKET EXPOSURE The Fund invests at least 80% of its assets in the common stocks of companies principally engaged in energy-related activities, such as production and transmission of energy or energy fuels; the making of component products for such activities; energy research; and energy conservation or pollution control. The Fund's policy to invest at least 80% of its assets in companies principally engaged in energy-related activities may be changed only upon 60 days' notice to shareholders. FLAG THE FUND IS SUBJECT TO INDUSTRY CONCENTRATION RISK, WHICH IS THE CHANCE THAT THERE WILL BE OVERALL PROBLEMS AFFECTING A PARTICULAR INDUSTRY. BECAUSE THE FUND NORMALLY INVESTS AT LEAST 80% OF ITS ASSETS IN THE COMMON STOCKS OF COMPANIES PRINCIPALLY ENGAGED IN ENERGY-RELATED ACTIVITIES, THE FUND'S PERFORMANCE LARGELY DEPENDS--FOR BETTER OR FOR WORSE--ON THE OVERALL CONDITION OF THE ENERGY INDUSTRY. The Fund faces the risk that the earnings, dividends, and stock prices of energy companies will be greatly affected by changes in the prices and supplies of oil and other energy fuels. Prices and supplies of energy can fluctuate significantly over short and long periods because of a variety of factors, including changes in international politics; policies of the Organization of Petroleum Exporting Countries (OPEC); relationships among OPEC members and between OPEC and oil-importing nations; energy conservation; the regulatory environment; government tax policies; and the economic growth and stability of the key energy-consuming countries. FLAG THE FUND IS SUBJECT TO STOCK MARKET RISK, WHICH IS THE CHANCE THAT STOCK PRICES OVERALL WILL DECLINE. STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS OF FALLING PRICES. IN ADDITION, INVESTMENTS IN FOREIGN STOCK MARKETS CAN BE RISKIER THAN U.S. STOCK INVESTMENTS. THE PRICES OF FOREIGN STOCKS AND THE PRICES OF U.S. STOCKS HAVE, AT TIMES, MOVED IN OPPOSITE DIRECTIONS. 6 Most of the stocks held by the Fund are mid- and large-capitalization stocks, because such stocks tend to be dominant in the energy industry. Stocks of publicly traded companies and funds that invest in stocks are often classified according to market value, or market capitalization. These classifications typically include small-, mid-, and large-cap. It's important to understand that, for both companies and stock funds, market capitalization ranges change over time. Also, interpretations of size vary, and there are no "official" definitions of small-, mid-, and large-cap, even among Vanguard fund advisors. The asset-weighted median market capitalization of the Fund as of January 31, 2005, was $24.1 billion. There is the chance that returns from the types of stocks in which the Fund invests will trail returns from the overall stock market. As a group, mid- and large-cap stocks tend to go through cycles of doing better--or worse--than the stock market in general. These periods have, in the past, lasted for as long as several years. U.S. STOCKS To illustrate the volatility of stock prices, the following table shows the best, worst, and average annual total returns for the U.S. stock market over various periods as measured by the Standard & Poor's 500 Index, a widely used barometer of market activity. (Total returns consist of dividend income plus change in market price.) Note that the returns shown do not include the costs of buying and selling stocks or other expenses that a real-world investment portfolio would incur. ---------------------------------------------------------- U.S. STOCK MARKET RETURNS (1926-2004) ---------------------------------------------------------- 1 YEAR 5 YEARS 10 YEARS 20 YEARS ---------------------------------------------------------- Best 54.2% 28.6% 19.9% 17.8% Worst -43.1 -12.4 -0.8 3.1 Average 12.4 10.6 11.2 11.4 ---------------------------------------------------------- The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926 through 2004. You can see, for example, that while the average return on common stocks for all of the 5-year periods was 10.6%, average returns for individual 5-year periods ranged from -12.4% (from 1928 through 1932) to 28.6% (from 1995 through 1999). These average returns reflect past performance on common stocks; you should not regard them as an indication of future returns from either the stock market as a whole or the Fund in particular. Keep in mind that the S&P 500 Index tracks mainly large-cap stocks. Historically, industry-specific mid- and large-cap stocks, such as those held by the Fund, have been more volatile than--and at times have performed quite differently from--the large-cap stocks found in the S&P 500 Index. This volatility is due to several factors, including special industry risks and less-certain growth and dividend prospects for smaller companies. FOREIGN STOCKS The Fund may invest up to 100% of its assets in foreign stocks. To illustrate the volatility of international stock prices, the following table shows the best, worst, and average annual total returns for foreign stock markets over various periods as measured by the Morgan Stanley Capital International Europe, Australasia, Far East (MSCI EAFE) Index, a widely used barometer of international market activity. (Total returns consist of dividend income plus change in market price.) Note that the returns shown do not include the costs of buying and selling stocks or other expenses that a real-world investment portfolio would incur. 7 INTERNATIONAL STOCK MARKET RETURNS (1969-2004) - ---------------------------------------------------------- 1 YEAR 5 YEARS 10 YEARS 20 YEARS - ---------------------------------------------------------- Best 69.4% 36.1% 22.0% 15.5% Worst -23.4 -2.9 4.0 10.2 Average 12.5 10.9 12.1 13.1 - ---------------------------------------------------------- The table covers all of the 1-, 5-, 10-, and 20-year periods from 1969 through 2004. These average returns reflect past performance on international stocks; you should not regard them as an indication of future returns from either foreign markets as a whole or the Fund in particular. Note that the MSCI EAFE Index does not take into account returns for emerging markets, which can be substantially more volatile, and substantially less liquid, than the more developed markets included in the Index. In addition, because the MSCI EAFE Index tracks the European and Pacific markets collectively, the returns in the preceding table do not reflect the variability of returns for these markets individually. To illustrate this variability, the following table shows returns for different international markets--as well as for the U.S. market for comparison--from 1995 through 2004, as measured by their respective indexes.
RETURNS FOR VARIOUS STOCK MARKETS* - ------------------------------------------------------------------------------------------------ EUROPEAN PACIFIC EMERGING U.S. MARKET MARKET MARKETS MARKET - ------------------------------------------------------------------------------------------------ 1995 21.95% 2.95% -0.01% 37.58% 1996 21.09 -8.30 15.22 22.96 1997 23.80 -25.87 -16.36 33.36 1998 28.53 2.72 -18.39 28.58 1999 15.89 56.65 60.88 21.04 2000 -8.39 -25.78 -27.94 -9.10 2001 -19.90 -25.40 -2.80 -11.89 2002 -18.38 -9.29 -7.04 -22.10 2003 38.54 38.48 58.81 28.68 2004 20.88 18.98 26.68 10.88 *European market returns are measured by the MSCI Europe Index; Pacific market returns are measured by the MSCI Pacific Index; emerging markets returns are measured by the Select Emerging Markets Index (formerly known as the Select Emerging Markets Free Index); and U.S. market returns are measured by the Standard & Poor's 500 Index. - ------------------------------------------------------------------------------------------------
Keep in mind that these returns reflect past performance of the various indexes; you should not consider them as an indication of future returns from the indexes, or from the Fund in particular. FLAG THE FUND IS SUBJECT TO COUNTRY RISK AND CURRENCY RISK. COUNTRY RISK IS THE CHANCE THAT DOMESTIC EVENTS--SUCH AS POLITICAL UPHEAVAL, FINANCIAL TROUBLES, OR NATURAL DISASTERS--WILL WEAKEN A COUNTRY'S SECURITIES MARKETS. CURRENCY RISK IS THE CHANCE THAT THE VALUE OF A FOREIGN INVESTMENT, MEASURED IN U.S. DOLLARS, WILL DECREASE BECAUSE OF UNFAVORABLE CHANGES IN CURRENCY EXCHANGE RATES. 8 - -------------------------------------------------------------------------------- PLAIN TALK ABOUT INTERNATIONAL INVESTING U.S. investors who invest abroad will encounter risks not typically associated with U.S. companies, because foreign stock and bond markets operate differently from the U.S. markets. For instance, foreign companies are not subject to the same accounting, auditing, and financial-reporting standards and practices as U.S. companies, and their stocks may not be as liquid as those of similar U.S. firms. In addition, foreign stock exchanges, brokers, and companies generally have less government supervision and regulation than their counterparts in the United States. These factors, among others, could negatively affect the returns U.S. investors receive from foreign investments. - -------------------------------------------------------------------------------- SECURITY SELECTION The Fund uses multiple investment advisors, each of which is responsible for managing a portion of the Fund's assets. Each advisor independently selects and maintains a portfolio of common stocks and other investments for the Fund. The Fund's board of trustees designates the proportion of the Fund's assets to be managed by each advisor and may change these proportions at any time. Independent of each other, the advisors use active investment management methods, which means they buy and sell securities based on their judgments about the financial prospects of companies, and the prices of the securities. While each advisor uses different processes to select securities for its portion of the Fund's assets, the investment strategy of the Fund is designed to provide returns that are broadly representative of the energy sector. To achieve this, the Fund invests in the common stocks of companies engaged in the following energy-related areas: the production, transmission, marketing, control, and measurement of energy or energy fuels; the making of component products for such activities; energy research or experimentation; and operations related to energy conservation and pollution control. These areas may involve newer sources of energy, such as geothermal, nuclear, and solar power, as well as more traditional sources of energy, such as oil, natural gas, and coal. As new sources of energy are developed and current methods of exploiting and developing energy are advanced, companies in these new areas will also be considered for the Fund. In selecting stocks, Wellington Management Company, LLP (Wellington Management), uses a "bottom up" approach, in which stocks are chosen based on the advisor's estimates of fundamental investment value. Because companies in the energy sector often have large write-offs for exploration charges, fundamental investment value is often determined by cash flow and asset valuations in addition to earnings valuations. A security will generally be considered appropriate if (as determined by the investment advisor) at least 50% of the issuer's assets, revenues, or net income is related to, or derived from, the energy industry. Also, a security will be sold when the advisor believes that an alternative investment provides more attractive risk/return characteristics or when the advisor otherwise determines that a sale is appropriate. The Vanguard Group (Vanguard) constructs a portfolio of energy-related stocks based on its assessment of the stocks' relative return potential. Vanguard's quantitative (i.e., computer-based) process integrates proprietary stock-selection methodology with a disciplined and consistently applied risk control framework. Individual stocks are selected based on variables that include improving fundamentals and attractive valuation. Vanguard applies risk controls based on market capitalization, volatility, expected growth rates, and regional exposure. The 9 result is a portfolio that invests in the advisor's most attractively ranked stocks, while maintaining a risk profile consistent with the risk profiles of global energy-related stocks. The Fund is generally managed without regard to tax ramifications. FLAG THE FUND IS SUBJECT TO MANAGER RISK, WHICH IS THE CHANCE THAT POOR SECURITY SELECTION WILL CAUSE THE FUND TO UNDERPERFORM RELEVANT BENCHMARKS OR OTHER FUNDS WITH A SIMILAR INVESTMENT OBJECTIVE. OTHER INVESTMENT POLICIES AND RISKS The Fund may invest, to a limited extent, in derivatives. Generally speaking, a derivative is a financial contract whose value is based on the value of a traditional security (such as a stock or bond), an asset (such as a commodity like gold), or a market index (such as the S&P 500 Index). The Fund will not use derivatives for speculation or for the purpose of leveraging (magnifying) investment returns. The Fund may enter into forward foreign currency exchange contracts, which are types of futures contracts, to help protect its holdings against unfavorable changes in exchange rates. A forward foreign currency exchange contract is an agreement to buy or sell a country's currency at a specific price on a specific date, usually 30, 60, or 90 days in the future. In other words, the contract guarantees an exchange rate on a given date. Managers of funds that invest in foreign securities use these contracts to guard against sudden, unfavorable changes in U.S. dollar/foreign currency exchange rates. These contracts, however, will not prevent the Fund's securities from falling in value during foreign market downswings. Note that the Fund will not enter into such contracts for speculative purposes. Under normal circumstances, the Fund will not commit more than 20% of its assets to forward foreign currency exchange contracts. Vanguard typically invests a small portion of the Fund's assets in stock index futures and/ or shares of exchange-traded funds (ETFs), including VIPER Shares issued by Vanguard stock index funds. Stock index futures and ETFs provide returns similar to those of common stocks. Vanguard may purchase them when doing so will reduce the Fund's transaction costs or add value because the instruments are favorably priced. Vanguard receives no additional revenue from investing Fund assets in VIPER Shares of other Vanguard funds. Fund assets invested in VIPER Shares are excluded when allocating to the Fund its share of the costs of Vanguard operations. CASH MANAGEMENT Vanguard may invest the Fund's daily cash balance in one or more Vanguard CMT Funds, which are very low-cost money market funds. The Fund is permitted to invest in the CMT Funds under the terms of an exemption granted by the Securities and Exchange Commission (SEC). The Fund bears its proportionate share of the "at-cost" expenses of the Vanguard CMT Fund in which it invests. TEMPORARY INVESTMENT MEASURES The Fund may temporarily depart from its normal investment policies--for instance, by allocating substantial assets to cash investments--in response to extraordinary market, economic, political, or other conditions. In doing so, the Fund may succeed in avoiding losses, but may otherwise fail to achieve its investment objective. 10 REDEMPTION AND CUSTODIAL FEES The Fund charges a fee on shares that are redeemed before they have been held for one year. This fee applies when shares are redeemed by selling, by exchanging to another Vanguard fund, or by application of the low-balance account-closure policy. Shares you have held the longest will be redeemed first. Unlike a sales charge or load paid to a broker or fund management company, the redemption fee is paid directly to the Fund to offset the costs of buying and selling securities. The fee is designed to ensure that short-term investors pay their share of the Fund's transaction costs and that long-term investors do not subsidize the activities of short-term traders. A custodial fee of $10 per year applies to certain retirement fund accounts whose balances are less than $5,000. See INVESTING WITH VANGUARD for more information about fees. FREQUENT TRADING OR MARKET-TIMING Some investors try to profit from strategies involving frequent trading of mutual fund shares, such as market-timing and, for funds holding foreign securities, time-zone arbitrage. As money is shifted in and out by a shareholder engaging in frequent trading, a fund incurs expenses for buying and selling securities, resulting in increased brokerage and administrative costs. These costs are borne by all fund shareholders, including the long-term investors who do not generate the costs. Frequent trading may also interfere with an advisor's ability to efficiently manage the fund. The Vanguard funds (other than money market funds and VIPER/(R)/ Shares) do not accommodate frequent trading. The board of trustees of each Vanguard fund has adopted policies and procedures reasonably designed to detect and discourage frequent trading and, in some cases, to compensate the fund for the costs associated with it. Although there is no assurance that Vanguard will be able to detect or prevent frequent trading or market-timing in all circumstances, the following policies have been adopted to address these issues: - - Each Vanguard fund reserves the right to reject any purchase request--including exchanges from other Vanguard funds--without notice and regardless of size. A purchase request could be rejected if Vanguard determines that such purchase may disrupt a fund's operation or performance or because of a history of frequent trading by the investor. - - Each Vanguard fund (other than money market funds and VIPER Shares) limits the number of times that an investor can exchange into and out of the fund. - - Certain Vanguard funds charge shareholders purchase and/or redemption fees on transactions. See the INVESTING WITH VANGUARD section of this prospectus for further details on Vanguard's transaction policies. Each fund (other than money market funds), in determining its net asset value, will use fair-value pricing as described in the SHARE PRICE section. When used, fair-value pricing may reduce or eliminate the profitability of certain frequent-trading strategies. DO NOT INVEST WITH VANGUARD IF YOU ARE A MARKET-TIMER. TURNOVER RATE Although the Fund normally seeks to invest for the long term, it may sell securities regardless of how long they have been held. The FINANCIAL HIGHLIGHTS section of this prospectus shows historical turnover rates for the Fund. A turnover rate of 100%, for example, would mean that the Fund had sold and replaced securities valued at 100% of its net assets within 11 a one-year period. The average turnover rate for natural resources funds was approximately 237%, as reported by Morningstar, Inc., on January 31, 2005. - -------------------------------------------------------------------------------- PLAIN TALK ABOUT TURNOVER RATE Before investing in a mutual fund, you should review its turnover rate. This gives an indication of how transaction costs, which are not included in the fund's expense ratio, could affect the fund's future returns. In general, the greater the volume of buying and selling by the fund, the greater the impact that brokerage commissions and other transaction costs will have on its return. Also, funds with high turnover rates may be more likely to generate capital gains that must be distributed to shareholders as taxable income. - -------------------------------------------------------------------------------- THE FUND AND VANGUARD The Fund is a member of The Vanguard Group, a family of 36 investment companies with more than 130 funds holding assets in excess of $810 billion. All of the funds that are members of The Vanguard Group share in the expenses associated with administrative services and business operations, such as personnel, office space, equipment, and advertising. Vanguard also provides marketing services to the funds. Although shareholders do not pay sales commissions or 12b-1 distribution fees, each fund (or in the case of a fund with multiple share classes, each share class of the fund) pays its allocated share of The Vanguard Group's marketing costs. - -------------------------------------------------------------------------------- PLAIN TALK ABOUT VANGUARD'S UNIQUE CORPORATE STRUCTURE The Vanguard Group is truly a MUTUAL mutual fund company. It is owned jointly by the funds it oversees and thus indirectly by the shareholders in those funds. Most other mutual funds are operated by for-profit management companies that may be owned by one person, by a group of individuals, or by investors who own the management company's stock. The management fees charged by these companies include a profit component over and above the companies' cost of providing services. By contrast, Vanguard provides services to its member funds on an "at-cost" basis, with no profit component, which helps to keep the funds' expenses low. - -------------------------------------------------------------------------------- INVESTMENT ADVISORS The Fund uses a multimanager approach to investing its assets. Each advisor independently manages its assigned portion of the Fund's assets subject to the supervision and oversight of Vanguard and the board of trustees. - - Wellington Management Company, LLP, 75 State Street, Boston, MA 02109, advisor to the Fund, is an investment advisory firm founded in 1928. As of April 30, 2005, Wellington Management managed approximately $468 billion in assets, including all or part of 16 Vanguard funds. - - The Vanguard Group, P. O. Box 2600, Valley Forge, PA 19482, which began operations in 1975, serves as advisor to the Fund through its Quantitative Equity Group. As of April 30, 12 2005, Vanguard's Quantitative Equity Group served as advisor for approximately $330 billion in assets. Wellington Management's advisory fee is paid quarterly and is based on certain annual percentage rates applied to the Fund's average month-end net assets managed by the advisor over the period. Vanguard provides advisory services to the Fund on an at-cost basis. Please consult the Fund's Statement of Additional Information for more information about the Fund's investment advisory arrangements. For the fiscal year ended January 31, 2005, the advisory fee represented an effective annual rate of 0.06% of the Fund's average net assets. Under the terms of an SEC exemption, the Fund's board of trustees may, without prior approval from shareholders, change the terms of an advisory agreement or hire a new investment advisor--either as a replacement for an existing advisor or as an additional advisor. Any significant change in the Fund's advisory arrangements will be communicated to shareholders in writing. In addition, as the Fund's sponsor and overall manager, The Vanguard Group may provide investment advisory services to the Fund, on an at-cost basis, at any time. Vanguard may also recommend to the board of trustees that an advisor be hired, terminated, or replaced, or that the terms of an existing advisory agreement be revised. For a discussion of why the board of trustees approved the Fund's investment advisory agreement, see the Fund's report to shareholders covering the period from February 1, 2005, to July 31, 2005. The report will be available within 60 days after July 31, 2005. - -------------------------------------------------------------------------------- PLAIN TALK ABOUT THE FUND'S PORTFOLIO MANAGERS The managers primarily responsible for the day-to-day management of the Fund's portfolio are: KARL E. BANDTEL, Senior Vice President of Wellington Management Company, LLP. He has worked in investment management with Wellington Management since 1990; had been Assistant Fund Manager since 1992; and has been Fund Manager since 2002. Education: B.S. and M.S., University of Wisconsin. JAMES A. BEVILACQUA, Senior Vice President of Wellington Management Company, LLP. He has worked in investment management with Wellington Management since 1994 and has been involved in the portfolio management and securities analysis of the Fund since 1998. Education: B.S. and M.S., Massachusetts Institute of Technology; M.B.A., Stanford Graduate School of Business. JOEL M. DICKSON, Principal of Vanguard. He has worked in investment management for Vanguard since 1996 and has managed the Fund since 2005. Education: A.B., Washington University in St. Louis; Ph.D., Stanford University. - -------------------------------------------------------------------------------- The Statement of Additional Information provides information about each portfolio manager's compensation, other accounts under management, and ownership of securities in the Fund. 13 DIVIDENDS, CAPITAL GAINS, AND TAXES FUND DISTRIBUTIONS The Fund distributes to shareholders virtually all of its net income (interest and dividends, less expenses) as well as any net capital gains realized from the sale of its holdings. Distributions generally occur in December. In addition, the Fund may occasionally be required to make supplemental distributions at some other time during the year. You can receive distributions of income or capital gains in cash, or you can have them automatically reinvested in more shares of the Fund. - -------------------------------------------------------------------------------- PLAIN TALK ABOUT DISTRIBUTIONS As a shareholder, you are entitled to your portion of a fund's income from interest and dividends as well as gains from the sale of investments. Income consists of both the dividends that the fund earns from any stock holdings and the interest it receives from any money market and bond investments. Capital gains are realized whenever the fund sells securities for higher prices than it paid for them. These capital gains are either short-term or long-term, depending on whether the fund held the securities for one year or less or for more than one year. You receive the fund's earnings as either a dividend or capital gains distribution. - -------------------------------------------------------------------------------- BASIC TAX POINTS Vanguard will send you a statement each year showing the tax status of all your distributions. In addition, investors in taxable accounts should be aware of the following basic tax points: - - Distributions are taxable to you for federal income tax purposes, whether or not you reinvest these amounts in additional Fund shares. - - Distributions declared in December--if paid to you by the end of January--are taxable for federal income tax purposes as if received in December. - - Any dividend and short-term capital gains distributions that you receive are taxable to you as ordinary income for federal income tax purposes. If you are an individual and meet certain holding-period requirements with respect to your Fund shares, you may be eligible for reduced federal tax rates on "qualified dividend income," if any, distributed by the Fund. - - Any distributions of net long-term capital gains are taxable to you as long-term capital gains for federal income tax purposes, no matter how long you've owned shares in the Fund. - - Capital gains distributions may vary considerably from year to year as a result of the Fund's normal investment activities and cash flows. - - A sale or exchange of Fund shares is a taxable event. This means that you may have a capital gain to report as income, or a capital loss to report as a deduction, when you complete your federal income tax return. - - Dividend and capital gains distributions that you receive, as well as your gains or losses from any sale or exchange of Fund shares, may be subject to state and local income taxes. - - Any conversion between classes of shares of the same fund is a nontaxable event. By contrast, an exchange between classes of shares of different funds is a taxable event. 14 - -------------------------------------------------------------------------------- PLAIN TALK ABOUT "BUYING A DIVIDEND" Unless you are investing through a tax-deferred retirement account (such as an IRA), you should consider avoiding a purchase of fund shares shortly before the fund makes a distribution, because doing so can cost you money in taxes. This is known as "buying a dividend." For example: On December 15, you invest $5,000, buying 250 shares for $20 each. If the fund pays a distribution of $1 per share on December 16, its share price will drop to $19 (not counting market change). You still have only $5,000 (250 shares x $19 = $4,750 in share value, plus 250 shares x $1 = $250 in distributions), but you owe tax on the $250 distribution you received--even if you reinvest it in more shares. To avoid "buying a dividend," check a fund's distribution schedule before you invest. - -------------------------------------------------------------------------------- GENERAL INFORMATION BACKUP WITHHOLDING. By law, Vanguard must withhold 28% of any taxable distributions or redemptions from your account if you do not: - - Provide us with your correct taxpayer identification number; - - Certify that the taxpayer identification number is correct; and - - Confirm that you are not subject to backup withholding. Similarly, Vanguard must withhold taxes from your account if the IRS instructs us to do so. FOREIGN INVESTORS. Vanguard funds generally are not sold outside the United States, except to certain qualified investors. If you reside outside the United States, please consult our website at www.vanguard.com and review "Non-U.S. Investors." Foreign investors should be aware that U.S. withholding and estate taxes may apply to any investments in Vanguard funds. INVALID ADDRESSES. If a dividend or capital gains distribution check mailed to your address of record is returned as undeliverable, Vanguard will automatically reinvest all future distributions until you provide us with a valid mailing address. TAX CONSEQUENCES. This prospectus provides general tax information only. If you are investing through a tax-deferred retirement account, such as an IRA, special tax rules apply. Please consult your tax advisor for detailed information about a fund's tax consequences for you. SHARE PRICE The Fund's share price, called its net asset value, or NAV, is calculated each business day as of the close of regular trading on the New York Stock Exchange, generally 4 p.m., Eastern time. NAV per share is computed by dividing the net assets allocated to each share class by the number of Fund shares outstanding for that class. On holidays or other days when the Exchange is closed, the NAV is not calculated, and the Fund does not transact purchase or redemption requests. However, on those days the value of the Fund's assets may be affected to the extent that the Fund holds foreign securities that trade on foreign markets that are open. Stocks held by a Vanguard fund are valued at their market value when reliable market quotations are readily available. Certain short-term debt instruments used to manage a fund's cash are valued on the basis of amortized cost. The values of any foreign securities held by a fund are converted into U.S. dollars using an exchange rate obtained from an independent third party. The values of any mutual fund shares held by a fund are based on 15 the NAVs of the underlying mutual funds (in the case of conventional share classes) or the market value of the shares (in the case of exchange-traded fund shares, such as VIPERs/(R)/). When reliable market quotations are not readily available, securities are priced at their fair value, which is the price a security's owner might reasonably expect to receive upon its sale. A fund also will use fair-value pricing if the value of a security it holds has been materially affected by events occurring before the fund's pricing time but after the close of the primary markets or exchanges on which the security is traded. This most commonly occurs with foreign securities, which may trade on foreign exchanges that close many hours before the fund's pricing time. Intervening events might be company-specific (e.g., earnings report, merger announcement); country-specific (e.g., natural disaster, economic or political news, act of terrorism, interest rate change); or global. Intervening events include price movements in U.S. markets that are deemed to affect the value of foreign securities. Although rare, fair-value pricing also may be used for domestic securities--for example, if (1) trading in a security is halted and does not resume before the fund's pricing time or if a security does not trade in the course of a day, and (2) the fund holds enough of the security that its price could affect the fund's NAV. Fair-value prices are determined by Vanguard according to procedures adopted by the board of trustees. When fair-value pricing is employed, the prices of securities used by a fund to calculate its NAV may differ from quoted or published prices for the same securities. Vanguard fund share prices can be found daily in the mutual fund listings of most major newspapers under various "Vanguard" headings. FINANCIAL HIGHLIGHTS The following financial highlights table is intended to help you understand the Fund's financial performance for the periods shown, and certain information reflects financial results for a single Fund share. The total returns in the table represent the rate that an investor would have earned or lost each period on an investment in the Fund (assuming reinvestment of all distributions). This information has been derived from the financial statements audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, whose report--along with the Fund's financial statements--is included in the Fund's most recent annual report to shareholders. To receive a free copy of the latest annual or semiannual report, you may access a report online at www.vanguard.com or you may contact Vanguard by telephone or by mail. 16 - -------------------------------------------------------------------------------- PLAIN TALK ABOUT HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE This explanation uses the Fund's Investor Shares as an example. The Investor Shares began fiscal year 2005 with a net asset value (price) of $29.99 per share. During the year, each Investor Share earned $0.529 from investment income (interest and dividends) and $11.052 from investments that had appreciated in value or that were sold for higher prices than the Fund paid for them. Shareholders received $0.721 per share in the form of dividend and capital gains distributions. A portion of each year's distributions may come from the prior year's income or capital gains. The share price at the end of the year was $40.85, reflecting earnings of $11.581 per share and distributions of $0.721 per share. This was an increase of $10.86 per share (from $29.99 at the beginning of the year to $40.85 at the end of the year). For a shareholder who reinvested the distributions in the purchase of more shares, the total return was 38.90% for the year. As of January 31, 2005, the Investor Shares had approximately $4.8 billion in net assets. For the year, the expense ratio was 0.32% ($3.20 per $1,000 of net assets), and the net investment income amounted to 1.67% of average net assets. The Fund sold and replaced securities valued at 1% of its net assets. - --------------------------------------------------------------------------------
ENERGY FUND INVESTOR SHARES - ---------------------------------------------------------------------------------------------------------------- YEAR ENDED JANUARY 31, ------------------------------------------------------------ FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2005 2004 2003 2002 2001 - ---------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $29.99 $22.85 $24.76 $26.93 $21.24 - ---------------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .529 .435 .392 .428 .39 Net Realized and Unrealized Gain (Loss) on Investments* 11.052 7.839 (.349) (.660) 7.04 - ---------------------------------------------------------------------------------------------------------------- Total from Investment Operations 11.581 8.274 .043 (.232) 7.43 - ---------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.524) (.390) (.360) (.400) (.36) Distributions from Realized Capital Gains (.197) (.744) (1.593) (1.538) (1.38) - ---------------------------------------------------------------------------------------------------------------- Total Distributions (.721) (1.134) (1.953) (1.938) (1.74) - ---------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $40.85 $29.99 $22.85 $24.76 $26.93 ================================================================================================================ TOTAL RETURN** 38.90% 36.49% -0.02% -0.55% 35.08% ================================================================================================================ RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $4,822 $2,434 $1,298 $1,258 $1,281 Ratio of Total Expenses to Average Net Assets 0.32% 0.38% 0.40% 0.39% 0.41% Ratio of Net Investment Income to Average Net Assets 1.67% 1.79% 1.56% 1.57% 1.52% Portfolio Turnover Rate 1% 26% 23% 28% 24% ================================================================================================================ *Includes increases from redemption fees of $0.02, $0.00, $0.01, $0.01, and $0.02. **Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year.
17
ENERGY FUND ADMIRAL SHARES - --------------------------------------------------------------------------------------------- NOV. 12, YEAR ENDED JANUARY 31, 2001* TO ---------------------------- JAN. 31, FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2005 2004 2003 2002 - --------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $56.30 $42.89 $46.48 $50.00 - --------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income 1.034 .847 .758 .118 Net Realized and Unrealized Gain (Loss) on Investments** 20.770 14.721 (.658) .010 - --------------------------------------------------------------------------------------------- Total from Investment Operations 21.804 15.568 .100 .128 - --------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (1.024) (.760) (.698) (.760) Distributions from Realized Capital Gains (.370) (1.398) (2.992) (2.888) - --------------------------------------------------------------------------------------------- Total Distributions (1.394) (2.158) (3.690) (3.648) - --------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $76.71 $56.30 $42.89 $46.48 ============================================================================================= TOTAL RETURN+ 39.02% 36.58% 0.02% 0.57% ============================================================================================= RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $549 $208 $103 $58 Ratio of Total Expenses to Average Net Assets 0.26% 0.32% 0.34% 0.34%++ Ratio of Net Investment Income to Average Net Assets 1.70% 1.85% 1.59% 0.53%++ Portfolio Turnover Rate 1% 26% 23% 28% ============================================================================================= *Inception. **Includes increases from redemption fees of $0.03, $0.01, $0.02, and $0.03. +Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year. ++Annualized.
18 - -------------------------------------------------------------------------------- INVESTING WITH VANGUARD This section of the prospectus explains the basics of doing business with Vanguard. Vanguard reserves the right to change these policies, without advance notice to shareholders. BUYING SHARES CONVERTING SHARES REDEEMING SHARES EXCHANGING SHARES OTHER RULES YOU SHOULD KNOW FUND AND ACCOUNT UPDATES CONTACTING VANGUARD - -------------------------------------------------------------------------------- BUYING SHARES ACCOUNT MINIMUMS FOR INVESTOR SHARES TO OPEN AND MAINTAIN AN ACCOUNT. $25,000 for regular accounts, IRAs, and custodial accounts for minors. TO ADD TO AN EXISTING ACCOUNT. $50 by Automatic Investment Plan; $100 by check, exchange, or electronic bank transfer (other than Automatic Investment Plan); $1,000 by wire. Vanguard reserves the right to increase or decrease the minimum amount required to open or maintain an account, or to add to an existing account, without prior notice. ACCOUNT MINIMUMS FOR ADMIRAL SHARES TO OPEN AND MAINTAIN AN ACCOUNT. $100,000 for new investors. Shareholders who are registered on Vanguard.com, have held shares of the Fund for ten years, and have $50,000 or more in that Fund account are eligible to convert their Investor Shares into Admiral Shares. See Converting Shares. Institutional clients should contact Vanguard for information on special rules that may apply to them. TO ADD TO AN EXISTING ACCOUNT. $50 by Automatic Investment Plan; $100 by check, exchange, or electronic bank transfer (other than Automatic Investment Plan); $1,000 by wire. Vanguard reserves the right to increase or decrease the minimum amount required to open or maintain an account, or to add to an existing account, without prior notice. Investment minimums may differ for certain categories of investors. HOW TO BUY SHARES ONLINE TRANSACTIONS. On our website at www.vanguard.com you may open certain types of accounts, initiate electronic bank transfers, and exchange the proceeds of a redemption from one fund to a new or existing fund account. BY CHECK. To open an account, mail your check and a completed account registration form to Vanguard. When adding to 19 an existing account, send your check with an Invest-by-Mail form detached from your last account statement. Make your check payable to: The Vanguard Group--"Fund number." For a list of Fund numbers and addresses, see Contacting Vanguard. BY EXCHANGE PURCHASE. You can purchase shares by telephone or mail with the proceeds of a redemption from another Vanguard fund. See Exchanging Shares and Other Rules You Should Know. BY WIRE. Call Vanguard to purchase shares by wire. See Contacting Vanguard. BY ELECTRONIC BANK TRANSFER. In order to perform electronic bank transfers, you must designate a bank account by completing a special form or the appropriate section of your account registration form. Then you can make purchases on a regular schedule (Automatic Investment Plan) or whenever you wish by electronic bank transfer. Your transaction can be accomplished online, by telephone, or by mail if your request is in good order. For further information about these options, consult our website at www.vanguard.com or see Contacting Vanguard. GOOD ORDER. You must include complete and accurate required information on your purchase request. See Other Rules You Should Know--Good Order. The requirements vary among types of accounts and transactions. YOUR PURCHASE PRICE BY CHECK (TO PURCHASE ALL FUNDS OTHER THAN MONEY MARKET FUNDS), BY EXCHANGE, OR BY WIRE. You buy shares at a fund's NAV determined as of your TRADE DATE. A purchase request received by Vanguard before the close of regular trading on the New York Stock Exchange (generally 4 p.m., Eastern time) receives a trade date of the same day, and a purchase request received after that time receives a trade date of the first business day following the date of receipt. BY CHECK (TO PURCHASE MONEY MARKET FUNDS ONLY). For a purchase request received by Vanguard before the close of regular trading on the New York Stock Exchange (generally 4 p.m., Eastern time), the trade date is the first business day following the date of receipt. For a purchase request received after that time, the trade date is the second business day following the date of receipt. Because money market instruments must be purchased with federal funds and it takes a money market mutual fund one business day to convert check proceeds into federal funds, the trade date is always one day later than for other funds. BY ELECTRONIC BANK TRANSFER (OTHER THAN AUTOMATIC INVESTMENT PLAN). For all Vanguard funds, a purchase request received by Vanguard on a business day before 10 p.m., Eastern time, will receive a trade date of the next business day. 20 BY ELECTRONIC BANK TRANSFER (WITH AUTOMATIC INVESTMENT PLAN). Your Vanguard account's trade date will be one business day before the date you designated for withdrawal from your bank account. For further information about these options, consult our website at www.vanguard.com or see Contacting Vanguard. PURCHASE RULES YOU SHOULD KNOW ^ADMIRAL SHARES. Please note that Admiral Shares are NOT available to: - SIMPLE IRAs and 403(b)(7) custodial accounts; - Other retirement plan accounts receiving special administrative services from Vanguard; or - Accounts maintained by financial intermediaries, except in limited circumstances. ^CHECK PURCHASES. All purchase checks must be written in U.S. dollars and drawn on a U.S. bank. Vanguard does not accept cash, traveler's checks, or money orders. In addition, to protect the funds from fraud, Vanguard may refuse "starter checks" and checks made payable to third parties. ^NEW ACCOUNTS. We are required by law to obtain from you certain personal information that we will use to verify your identity. If you do not provide the information, we may not be able to open your account. If we are unable to verify your identity, Vanguard reserves the right to close your account or take such other steps as we deem reasonable. ^REJECTION OF PURCHASES. Vanguard reserves the right to reject any purchase request at any time and without notice. This includes the right to reject any purchase request because of a history of frequent trading by the investor, or that may disrupt a fund's operation or performance. Please call us before attempting to invest a large dollar amount. ^NO CANCELLATIONS. Place your transaction requests carefully. Vanguard will NOT cancel any transaction once it has been initiated and a confirmation number has been assigned (if applicable). ^FUTURE PURCHASES. All Vanguard funds reserve the right to stop selling shares or to reject specific purchase requests, including purchases by exchange from another Vanguard fund. These rights apply at any time, for any reason, and without notice. 21 CONVERTING SHARES A CONVERSION BETWEEN SHARE CLASSES OF THE SAME FUND IS A NONTAXABLE EVENT. PRICING OF SHARE CLASS CONVERSIONS If you convert from one class of shares to another, the transaction will be based on the respective share prices of the separate classes on the trade date for the conversion. Consequently, a conversion may provide you with fewer shares or more shares than you originally owned, depending on that day's share prices. At the time of conversion, the total value of your "old" shares will equal the total value of your "new" shares. However, subsequent share price fluctuations may decrease or increase the total value of your "new" shares as compared with that of your "old" shares. CONVERSIONS FROM INVESTOR SHARES INTO ADMIRAL SHARES All shares purchased before the issuance of Admiral Shares are considered Investor Shares. SELF-DIRECTED CONVERSIONS. You may convert Investor Shares into Admiral Shares at any time if your account balance in the Fund is at least $100,000. Registered users of Vanguard.com may request a conversion to Admiral Shares online, or you may contact Vanguard by telephone or by mail to request this transaction. TENURE CONVERSIONS. You are eligible for a self-directed conversion from Investor Shares into Admiral Shares if you have had an account in the Fund for ten years, that account balance is at least $50,000, and you are registered with Vanguard.com. Registered users of Vanguard.com may request a tenure conversion online, or you may contact Vanguard's Admiral Service Center by telephone or by mail to request this transaction. AUTOMATIC CONVERSIONS. The Fund conducts periodic reviews of account balances and may convert an eligible investor's Investor Shares into Admiral Shares. The Fund will notify the investor in writing before any automatic conversion into Admiral Shares. You may instruct the Fund if you do not wish to convert to the lower-cost Admiral Shares. Automatic conversions do not apply to accounts that qualify for Admiral Shares on the basis of tenure in the Fund. MANDATORY CONVERSIONS INTO INVESTOR SHARES If an investor no longer meets the requirements for Admiral Shares, the Fund may convert the investor's Admiral Shares into Investor Shares. A decline in the investor's account balance because of market movement may result in such a conversion. The Fund will notify the investor in writing before any mandatory conversion into Investor Shares. 22 REDEEMING SHARES HOW TO REDEEM SHARES Be sure to check Other Rules You Should Know before initiating your request. ONLINE TRANSACTIONS. You may perform a redemption, initiate electronic bank transfers, and exchange the proceeds of a redemption from one fund to purchase shares of another fund through our website at www.vanguard.com. BY TELEPHONE. Contact Vanguard by telephone to request a redemption. For telephone numbers, see Contacting Vanguard. BY MAIL. Send your written redemption instructions in good order to Vanguard. For addresses, see Contacting Vanguard. BY ELECTRONIC BANK TRANSFER. In order to perform electronic bank transfers, you must designate a bank account by completing a special form or the appropriate section of your account registration form. Then you can make redemptions on a regular schedule (Automatic Withdrawal Plan) or whenever you wish by electronic bank transfer. Your transaction can be accomplished online, by telephone, or by mail if your request is in good order. For further information about these options, consult our website at www.vanguard.com or see Contacting Vanguard. GOOD ORDER. You must include complete and accurate required information on your redemption request. See Other Rules You Should Know--Good Order. The requirements vary among types of accounts and transactions. REDEMPTION FEES The Fund charges a 1% fee on shares redeemed within one year of purchase by selling, by exchanging to another fund, or by application of the low-balance account-closure policy. The fee is withheld from redemption proceeds and retained by the Fund. Shares held for one year or more are not subject to the 1% fee. We will redeem your "oldest" shares first. Redemption fees may not apply to certain categories of redemptions, such as those that Vanguard reasonably believes may not raise frequent-trading or market-timing concerns. These categories are: redemptions of shares purchased through the reinvestment of dividend and capital gains distributions; redemptions resulting from account transfers and share class conversions within the same fund; redemptions from or within employer-sponsored defined contribution plans serviced by Vanguard's Integrated Retirement Plan Solutions Department and Vanguard's Institutional Investment Group; redemptions resulting from required minimum distributions from an individual retirement account for which Vanguard serves as trustee or custodian; redemptions resulting from individual retirement account conversions, recharacterizations, and excess contributions; redemptions within 23 Vanguard advisory programs (such as Vanguard Fiduciary Services) and institutional rebalancing and asset allocation programs; redemptions from or within annuity programs for which Vanguard provides specialized marketing or support services; and redemptions by certain pension plans as required by law or by regulatory authorities. Redemption fees also may be waived if required by law, regulation, or court order. Certain intermediaries might not exempt redemption fees as described above. Please also see Other Rules You Should Know--Investing With Vanguard Through Other Firms regarding accounts held through intermediaries. YOUR REDEMPTION PRICE You redeem shares at a fund's next-determined NAV after Vanguard receives your redemption request, including any special documentation required under the circumstances. As long as your request is received by Vanguard before the close of regular trading on the New York Stock Exchange (generally 4 p.m., Eastern time), your shares are redeemed at that day's NAV. This is known as your TRADE DATE. TYPES OF REDEMPTIONS ^BY CHECK. Unless instructed otherwise, Vanguard will mail you a check, normally within two business days of your trade date. ^BY EXCHANGE. You may instruct Vanguard to apply the proceeds of your redemption to purchase shares of another Vanguard fund. See Exchanging Shares and Other Rules You Should Know. ^BY AUTOMATIC WITHDRAWAL PLAN OR OTHER ELECTRONIC BANK TRANSFER. Proceeds of redeemed shares will be credited to your bank account two business days after your trade date. Minimum electronic redemption is $100. ^BY WIRE. When redeeming from a money market fund or a bond fund, you may instruct Vanguard to wire your redemption proceeds ($1,000 minimum) to a previously designated bank account. Wire redemptions generally are not available for Vanguard's balanced or stock funds. The wire redemption option is not automatic; you must establish it either online or by completing a special form or the appropriate section of your account registration form. Vanguard charges a $5 fee for wire redemptions under $5,000. Money Market Funds: For telephone requests received by Vanguard by 10:45 a.m., Eastern time (2 p.m., Eastern time for Vanguard Prime Money Market Fund), the redemption proceeds will leave Vanguard by the close of business that same day. For other requests received before 4 p.m., Eastern time, the redemption proceeds will leave Vanguard by the close of business on the following business day. 24 Bond Funds: For requests received by Vanguard by 4 p.m., Eastern time, the redemption proceeds will leave Vanguard by the close of business on the following business day. REDEMPTION RULES YOU SHOULD KNOW ^SPECIAL ACCOUNTS. Special documentation may be required to redeem from certain types of accounts, such as trust, corporate, nonprofit, or retirement accounts. Please call us before attempting to redeem from these types of accounts. ^POTENTIALLY DISRUPTIVE REDEMPTIONS. Vanguard reserves the right to pay all or part of your redemption in kind--that is, in the form of securities--if we reasonably believe that a cash redemption would disrupt the fund's operation or performance or that the shareholder may be engaged in frequent trading. Under these circumstances, Vanguard also reserves the right to delay payment of your redemption proceeds for up to seven calendar days. By calling us before you attempt to redeem a large dollar amount, you may avoid in-kind or delayed payment of your redemption. ^RECENTLY PURCHASED SHARES. Although you can redeem shares at any time, proceeds may not be made available to you until the fund collects payment for your purchase. This may take up to ten calendar days for shares purchased by check or by electronic bank transfer. If you have written a check on a fund with checkwriting privileges, that check may be rejected if the fund does not have sufficient proceeds for payment. ^SHARE CERTIFICATES. If share certificates have been issued for your account, those shares cannot be redeemed until you return the certificates (unsigned) to Vanguard by registered mail. For the correct address, see Contacting Vanguard. ^ADDRESS CHANGE. If you change your address online or by telephone, there may be a 15-day hold on online and telephone redemptions. Address change confirmations are sent to both the old and new addresses. ^PAYMENT TO A DIFFERENT PERSON OR ADDRESS. At your request, we can make your redemption check payable to a different person or send it to a different address. However, this requires the written consent of all registered account owners and may require a signature guarantee. You can obtain a signature guarantee from most commercial and savings banks, credit unions, trust companies, or member firms of a U.S. stock exchange. A notary public cannot provide a signature guarantee. ^NO CANCELLATIONS. Place your transaction requests carefully. Vanguard will NOT cancel any transaction once it has been initiated and a confirmation number has been assigned (if applicable). ^EMERGENCY CIRCUMSTANCES. Vanguard funds can postpone payment of redemption proceeds for up to seven calendar 25 days. In addition, Vanguard funds can suspend redemptions and/or postpone payments of redemption proceeds beyond seven calendar days at times when the New York Stock Exchange is closed or during emergency circumstances, as determined by the U.S. Securities and Exchange Commission. EXCHANGING SHARES An exchange is the redemption of assets from one Vanguard fund that are used to purchase shares in another Vanguard fund. All open Vanguard funds accept exchange requests online (through your account registered with Vanguard.com), by telephone, or by mail. However, because excessive exchanges can disrupt management of a fund and increase the fund's costs for all shareholders, Vanguard places certain limits on the exchange privilege. For the U.S. STOCK INDEX FUNDS, 500 INDEX FUND, U.S. SECTOR INDEX FUNDS, INTERNATIONAL STOCK INDEX FUNDS, DEVELOPED MARKETS INDEX FUND, TOTAL INTERNATIONAL STOCK INDEX FUND, INSTITUTIONAL DEVELOPED MARKETS INDEX FUND, REIT INDEX FUND, BALANCED INDEX FUND, CALVERT SOCIAL INDEX FUND, INTERNATIONAL GROWTH FUND, INTERNATIONAL VALUE FUND, INTERNATIONAL EXPLORER(TM) FUND, or GROWTH AND INCOME FUND, you may request no more than two exchanges OUT of the fund online or by telephone within any 12-month period. Funds may be added to or deleted from this list at any time, without notice to shareholders. For ALL VANGUARD FUNDS, the following limit generally applies: - - No more than two substantive "round trips" through a non-money-market fund during any 12-month period. A "round trip" is an exchange redemption OUT of a fund (by any means) followed by an exchange purchase back INTO the same fund (by any means). "Substantive" means a dollar amount that Vanguard has determined, in its sole discretion, could adversely affect management of the fund. This limit does not apply to certain categories of transactions that Vanguard reasonably believes may not raise frequent-trading or market-timing concerns. These categories are: - - Systematic transactions, including those under Vanguard's Automatic Investment Plan, Automatic Exchange Service, Automatic Withdrawal Plan, and other rebalancing programs reviewed by Vanguard. 26 - - Transactions within certain Vanguard advisory programs (such as Asset Management Services and Vanguard Fiduciary Services/(R)/). - - Transactions within certain retirement plans administered by Vanguard, for which other policies apply. This limit also will not apply if it would violate a law, regulation, or court order. This limit does not apply to omnibus accounts held through intermediaries. Please also see Other Rules You Should Know--Investing With Vanguard Through Other Firms regarding accounts held through intermediaries. Please note that Vanguard reserves the right to revise or terminate the exchange privilege, limit the amount of any exchange, or reject an exchange, at any time, for any reason. Also, in the event of a conflict between the exchange- privilege limitations of two funds, the stricter policy will apply to the transaction. OTHER RULES YOU SHOULD KNOW VANGUARD.COM/(R)/ ^REGISTRATION. You can use your personal computer to review your account holdings, to buy, sell or exchange shares of most Vanguard funds, and to perform most other transactions. To establish this service, you must register online. ^ELECTRONIC DELIVERY. Vanguard can deliver your account statements, transaction confirmations, and fund financial reports electronically. If you are a registered user of Vanguard.com, you can consent to the electronic delivery of these documents by logging on and changing your mailing preference under "My Profile". You can revoke your electronic consent at any time, and we will begin to send paper copies of these documents within 30 days of receiving your notice. TELEPHONE TRANSACTIONS ^AUTOMATIC. When we set up your account, we'll automatically enable you to do business with us by telephone, unless you instruct us otherwise in writing. ^TELE-ACCOUNT/(R)/. To conduct account transactions through Vanguard's automated telephone service, you must first obtain a Personal Identification Number (PIN). Call Tele-Account at 1-800-662-6273 to obtain a PIN, and allow seven days after requesting the PIN before using this service. 27 ^PROOF OF A CALLER'S AUTHORITY. We reserve the right to refuse a telephone request if the caller is unable to provide the following information exactly as registered on the account: - Authorization to act on the account (as the account owner or by legal documentation or other means). - Account registration and address. - Social Security or employer identification number. - Fund name and account number, if applicable. ^SUBJECT TO REVISION. We reserve the right to revise or terminate Vanguard's telephone transaction service at any time, without notice. GOOD ORDER We reserve the right to reject any transaction instructions that are not in "good order." The requirements vary among types of accounts and transactions. Good order means that your instructions must include: - The fund name and account number. - The amount of the transaction (stated in dollars, shares, or percent). Written instructions also must include: - Authorized signatures of all registered owners. - Signature guarantees, if required for the type of transaction.* - Any supporting legal documentation that may be required. *Call Vanguard for specific signature-guarantee requirements. FUTURE TRADE DATE REQUESTS Vanguard does not accept requests to hold a purchase, redemption, or exchange transaction for a future date. All such requests will receive trade dates as previously described in Investing With Vanguard--Buying, Converting, Redeeming, and Exchanging Shares. ACCOUNTS WITH MORE THAN ONE OWNER If an account has more than one owner or authorized person, Vanguard will accept telephone or online instructions from any one owner or authorized person. RESPONSIBILITY FOR FRAUD Vanguard will not be responsible for any account losses because of fraud, so long as we reasonably believe that the person transacting business on an account is authorized to do so. Please take precautions to protect yourself from fraud. Keep your account information private, and immediately review any account statements that we send to you. It is important that you contact Vanguard immediately about any transactions you believe to be unauthorized. UNCASHED CHECKS Please cash your distribution or redemption checks promptly. Vanguard will not pay interest on uncashed checks. 28 UNUSUAL CIRCUMSTANCES If you experience difficulty contacting Vanguard online, by telephone, or by Tele-Account, you can send us your transaction request by regular or express mail. See Contacting Vanguard for addresses. INVESTING WITH VANGUARD THROUGH OTHER FIRMS You may purchase or sell Investor Shares of most Vanguard funds through a financial intermediary, such as a bank, broker, or investment advisor. HOWEVER, ACCESS TO ADMIRAL SHARES THROUGH A FINANCIAL INTERMEDIARY IS RESTRICTED, AND AUTOMATIC CONVERSIONS BETWEEN INVESTOR SHARES AND ADMIRAL SHARES GENERALLY ARE NOT AVAILABLE TO ACCOUNTS HELD THROUGH INTERMEDIARIES. PLEASE CONSULT YOUR FINANCIAL INTERMEDIARY TO DETERMINE WHETHER ADMIRAL SHARES ARE AVAILABLE THROUGH THAT FIRM AND TO LEARN ABOUT OTHER RULES THAT MAY APPLY. When intermediaries establish omnibus accounts in the Vanguard funds for their clients, we cannot monitor the individual clients' trading activity. However, we review trading activity at the omnibus account level, and we look for activity that may indicate potential frequent trading or market-timing. If we detect suspicious trading activity, we will seek the assistance of the intermediary to investigate that trading activity and take appropriate action, including prohibiting additional purchases of fund shares by a client. Intermediaries may apply frequent-trading policies that differ from those described in this prospectus. If you invest with Vanguard through an intermediary, please read that firm's program materials carefully to learn of any rules or fees that may apply. LOW-BALANCE ACCOUNTS All Vanguard funds reserve the right to liquidate any investment-only retirement-plan account or any nonretirement account whose balance falls below the minimum initial investment. If a fund has a redemption fee, that fee will apply to shares redeemed upon closure of the account. For most nonretirement accounts, Vanguard deducts a $10 fee in June if the fund account balance is below $2,500. This fee can be waived if your total Vanguard account assets are $50,000 or more. CUSTODIAL FEES Vanguard charges a custodial fee of $10 a year for each IRA fund account with a balance of less than $5,000. The fee can be waived if you have assets totaling $50,000 or more at Vanguard in any combination of accounts under your Social Security number, including IRAs, employer-sponsored retirement plans, brokerage accounts, annuities, and non-IRA accounts. 29 RIGHT TO CHANGE POLICIES In addition to the rights expressly stated elsewhere in this prospectus, Vanguard reserves the right to (1) alter, add, or discontinue any conditions of purchase, service, or privilege at any time without notice; (2) accept initial purchases by telephone; (3) freeze any account and suspend account services when Vanguard has received reasonable notice of a dispute between the registered or beneficial account owners or when we reasonably believe a fraudulent transaction may occur or has occurred; (4) alter, impose, discontinue, or waive any redemption, low-balance account, account maintenance, or other fees charged to a group of shareholders; and (5) redeem an account, without the owner's permission to do so, in cases of threatening conduct or suspicious, fraudulent, or illegal activity. Changes may affect all investors or only those in certain classes or groups. These actions will be taken when, in the sole discretion of Vanguard management, we reasonably believe they are deemed to be in the best interest of a fund. FUND AND ACCOUNT UPDATES CONFIRMATION STATEMENTS We will send a confirmation statement to verify your trade date and the amount of your transaction when you buy, sell, exchange, or convert shares. However, we will not send such statements if they reflect only money market checkwriting or the reinvestment of dividends or capital gains distributions. Promptly review each confirmation statement that we send to you. It is important that you contact Vanguard immediately with any questions you may have about any transaction reflected on the confirmation statement. PORTFOLIO SUMMARIES We will send quarterly portfolio summaries to help you keep track of your accounts throughout the year. Each summary shows the market value of your account at the close of the statement period, as well as all distributions, purchases, redemptions, exchanges, transfers, and conversions for the current calendar year. Promptly review each summary that we send to you. It is important that you contact Vanguard immediately with any questions you may have about any transaction reflected on the summary. TAX STATEMENTS We will send annual tax statements to assist you in preparing your income tax returns. These statements, which are generally mailed in January, will report the previous year's dividend and capital gains distributions, proceeds from the sale of shares, and distributions from IRAs and other retirement plans. 30 AVERAGE-COST REVIEW STATEMENTS For most taxable accounts, average-cost review statements will accompany annual 1099B tax statements. These statements show the average cost of shares that you redeemed during the previous calendar year, using the average-cost single-category method, which is one of the methods established by the IRS. ANNUAL AND SEMIANNUAL REPORTS We will send you (electronically or by mail, as you prefer) financial reports about Vanguard Energy Fund twice a year, in March and September. These comprehensive reports include overviews of the financial markets and provide the following specific Fund information: - - Performance assessments with comparisons with industry benchmarks. - - Reports from the advisor. - - Financial statements with detailed listings of the Fund's holdings. Vanguard attempts to eliminate the unnecessary expense of duplicate mailings by sending just one report when two or more shareholders have the same last name and address. You may request individual reports by contacting our Client Services Department in writing, by telephone, or by e-mail. PORTFOLIO HOLDINGS We generally post on our website at www.vanguard.com a detailed list of the securities held in the Fund (portfolio holdings) as of the most recent calendar-quarter end in the "Holdings" section of the Fund's Profile page, 30 days after the end of the calendar quarter. Vanguard may exclude any portion of these portfolio holdings from publication when deemed in the best interest of the Fund. We generally post on our website at www.vanguard.com the ten largest stock portfolio holdings of the Fund, and the percentage that each of these holdings represents of the Fund's total assets, as of the most recent calendar-quarter end in the "Holdings" section of the Fund's Profile page, 15 calendar days after the end of the calendar quarter. These postings generally remain until replaced by new postings as described above. Please consult the Fund's Statement of Additional Information or our website for a description of the policies and procedures that govern disclosure of the Fund's portfolio holdings. 31 CONTACTING VANGUARD ONLINE VANGUARD.COM - - For the most complete source of Vanguard news - - For fund, account, and service information - - For most account transactions - - For literature requests - - 24 hours a day, 7 days a week VANGUARD TELE-ACCOUNT/(R)/ 1-800-662-6273 (ON-BOARD) - - For automated fund and account information - - For redemptions by check, exchange (subject to certain limitations), or wire - - Toll-free, 24 hours a day, 7 days a week INVESTOR INFORMATION 1-800-662-7447 (SHIP) (Text telephone at 1-800-952-3335) - - For fund and service information - - For literature requests - - Business hours only CLIENT SERVICES 1-800-662-2739 (CREW) (Text telephone at 1-800-749-7273) - - For account information - - For most account transactions - - Business hours only ADMIRAL SERVICE CENTER 1-888-237-9949 - - For Admiral account information - - For most Admiral transactions - - Business hours only INSTITUTIONAL DIVISION 1-888-809-8102 - - For information and services for large institutional investors - - Business hours only INTERMEDIARY SALES SUPPORT 1-800-997-2798 - - For information and services for financial intermediaries including broker-dealers, trust institutions, insurance companies, and financial advisors - - Business hours only VANGUARD ADDRESSES Please be sure to use the correct address, depending on your method of delivery. Use of an incorrect address could delay the processing of your transaction. REGULAR MAIL (INDIVIDUALS): The Vanguard Group P.O. Box 1110 Valley Forge, PA 19482-1110 REGULAR MAIL (INSTITUTIONS): The Vanguard Group P.O. Box 2900 Valley Forge, PA 19482-2900 32 REGISTERED, EXPRESS, OR OVERNIGHT MAIL: The Vanguard Group 455 Devon Park Drive Wayne, PA 19087-1815 FUND NUMBERS Please use the specific fund number when contacting us about Vanguard Energy Fund--51 (Investor Shares) or 551 (Admiral Shares). The Vanguard Group, Vanguard, Vanguard.com, Plain Talk, Admiral, Vanguard Tele-Account, Tele-Account, Explorer, VIPER, VIPERs, Vanguard Fiduciary Services, and the ship logo are trademarks of The Vanguard Group, Inc. 500 is a trademark of The McGraw-Hill Companies, Inc., and has been licensed for use by The Vanguard Group, Inc. Vanguard mutual funds are not sponsored, endorsed, sold, or promoted by Standard & Poor's, and Standard & Poor's makes no representation regarding the advisability of investing in the fund. Calvert Social Index is a trademark of Calvert Group, Ltd., and has been licensed for use by The Vanguard Group, Inc. Vanguard Calvert Social Index Fund is not sponsored, endorsed, sold, or promoted by Calvert Group, Ltd., and Calvert Group, Ltd., makes no representation regarding the advisability of investing in the fund. All other marks are the exclusive property of their respective owners. GLOSSARY OF INVESTMENT TERMS CAPITAL GAINS DISTRIBUTION Payment to mutual fund shareholders of gains realized on securities that a fund has sold at a profit, minus any realized losses. CASH INVESTMENTS Cash deposits, short-term bank deposits, and money market instruments that include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase agreements, commercial paper, and banker's acceptances. COMMON STOCK A security representing ownership rights in a corporation. A stockholder is entitled to share in the company's profits, some of which may be paid out as dividends. COUNTRY RISK The chance that domestic events--such as political upheaval, financial troubles, or natural disasters--will weaken a country's securities markets. CURRENCY RISK The chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates. DIVIDEND DISTRIBUTION Payment to mutual fund shareholders of income from interest or dividends generated by a fund's investments. EXPENSE RATIO The percentage of a fund's average net assets used to pay its expenses during a fiscal year. The expense ratio includes management fees, administrative fees, and any 12b-1 distribution fees. It does not include the transaction costs of buying and selling portfolio securities. INDUSTRY CONCENTRATION Focusing on the securities of a specific industry (such as energy, precious metals, health care, or real estate). INVESTMENT ADVISOR An organization that makes the day-to-day decisions regarding a fund's investments. 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. NET ASSET VALUE (NAV) The market value of a mutual fund's total assets, minus liabilities, divided by the number of shares outstanding. The value of a single share is also called its share value or share price. PRICE/EARNINGS (P/E) RATIO The current share price of a stock, divided by its per-share earnings (profits). A stock selling for $20, with earnings of $2 per share, has a price/earnings ratio of 10. PRINCIPAL The face value of a debt instrument or the amount of money put into an investment. SECURITIES Stocks, bonds, money market instruments, and other investment vehicles. TOTAL RETURN A percentage change, over a specified time period, in a mutual fund's net asset value, assuming the reinvestment of all distributions of dividends and capital gains. VOLATILITY The fluctuations in value of a mutual fund or other security. The greater a fund's volatility, the wider the fluctuations in its returns. YIELD Income (interest or dividends) earned by an investment, expressed as a percentage of the investment's price. SHIP LOGO THE VANGUARD GROUP /(R)/ Post Office Box 2600 Valley Forge, PA 19482-2600 FOR MORE INFORMATION If you would like more information about Vanguard Energy Fund, the following documents are available free upon request: ANNUAL/SEMIANNUAL REPORTS TO SHAREHOLDERS Additional information about the Fund's investments is available in the Fund's annual and semiannual reports to shareholders. In the annual report, you will find a discussion of the market conditions and investment strategies that significantly affected the Fund's performance during its last fiscal year. STATEMENT OF ADDITIONAL INFORMATION (SAI) The SAI provides more detailed information about the Fund. The current annual and semiannual reports and the SAI are incorporated by reference into (and are thus legally a part of) this prospectus. To receive a free copy of the latest annual or semiannual report or the SAI, or to request additional information about the Fund or other Vanguard funds, please contact us as follows: THE VANGUARD GROUP INVESTOR INFORMATION DEPARTMENT P.O. BOX 2600 VALLEY FORGE, PA 19482-2600 TELEPHONE: 1-800-662-7447 (SHIP) TEXT TELEPHONE: 1-800-952-3335 WORLD WIDE WEB: WWW.VANGUARD.COM If you are a current Vanguard shareholder and would like information about your account, account transactions, and/or account statements, please call: CLIENT SERVICES DEPARTMENT TELEPHONE: 1-800-662-2739 (CREW) TEXT TELEPHONE: 1-800-749-7273 INFORMATION PROVIDED BY THE SECURITIES AND EXCHANGE COMMISSION (SEC) You can review and copy information about the Fund (including the SAI) at the SEC's Public Reference Room in Washington, DC. To find out more about this public service, call the SEC at 1-202-942-8090. Reports and other information about the Fund are also available in the EDGAR Database on the SEC's Internet site at http://www.sec.gov, or you can receive copies of this information, for a fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the Public Reference Section, Securities and Exchange Commission, Washington, DC 20549-0102. Fund's Investment Company Act file number: 811-3916 (C) 2005 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. P051 082005 PART B VANGUARD/(R)/ SPECIALIZED FUNDS STATEMENT OF ADDITIONAL INFORMATION AUGUST 8, 2005 This Statement is not a prospectus but should be read in conjunction with the Funds' current prospectuses (for Vanguard Energy Fund dated August 8, 2005; for Vanguard Dividend Growth Fund, Vanguard Health Care Fund, Vanguard Precious Metals and Mining Fund, and Vanguard REIT Index Fund dated May 31, 2005). To obtain, without charge, a prospectus or the most recent Annual Report to Shareholders, which contains the Funds' financial statements as hereby incorporated by reference, please call: INVESTOR INFORMATION DEPARTMENT: 1-800-662-7447 TABLE OF CONTENTS DESCRIPTION OF THE TRUST..............................................B-1 INVESTMENT POLICIES...................................................B-3 INVESTMENT LIMITATIONS................................................B-17 SHARE PRICE...........................................................B-18 PURCHASE AND REDEMPTION OF SHARES.....................................B-18 MANAGEMENT OF THE FUNDS ..............................................B-20 INVESTMENT ADVISORY SERVICES..........................................B-30 PORTFOLIO TRANSACTIONS................................................B-44 PROXY VOTING GUIDELINES ..............................................B-45 YIELD AND TOTAL RETURNS...............................................B-50 INFORMATION ABOUT THE VIPER SHARE CLASS...............................B-51 FINANCIAL STATEMENTS..................................................B-58 DESCRIPTION OF THE TRUST ORGANIZATION Vanguard Specialized Funds (the Trust) was organized as a Pennsylvania business trust in 1983, was reorganized as a Maryland corporation in 1986 and then was reorganized as a Delaware statutory trust in June 1998. Prior to its reorganization as a Delaware statutory trust, the Trust was known as Vanguard Specialized Portfolios, Inc. The Trust is registered with the United States Securities and Exchange Commission (the SEC) under the Investment Company Act of 1940 (the 1940 Act). Each Fund, other than the Vanguard Precious Metals and Mining and REIT Index Funds, is registered as a diversified open-end management investment company. The Precious Metals and Mining and REIT Index Funds are registered as nondiversified open-end management investment companies. As the market values of the Precious Metals and Mining and REIT Index Funds' largest holdings rise and fall, there may be times when the Funds are diversified under SEC standards and other times when they are not. The Trust currently offers the following funds (and classes thereof): SHARE CLASSES* ------------- FUND** INVESTOR ADMIRAL INSTITUTIONAL VIPERS - ---- Vanguard Dividend Yes No No No Growth Fund+ Vanguard Energy Fund Yes Yes No No Vanguard Health Care Fund Yes Yes No No Vanguard Precious Metals and Mining Fund Yes No No No Vanguard REIT Index Fund Yes Yes Yes Yes *Individually, a class; collectively, the classes. **Individually, a Fund; collectively, the Funds. +Prior to December 6, 2002, Vanguard Dividend Growth Fund was known as Vanguard Utilities Income Fund B-1 The Trust has the ability to offer additional funds, which in turn may issue classes of shares. There is no limit on the number of full and fractional shares that may be issued for a single fund or class of shares. Throughout this document, any references to "class" apply only to the extent the Fund issues multiple classes. Each Fund described in this Statement of Additional Information is a member fund. There are two types of "Vanguard funds," member funds and non-member funds. Member funds jointly own The Vanguard Group, Inc. (Vanguard), contribute to Vanguard's capital, and receive services at cost from Vanguard pursuant to a Funds' Service Agreement. Non-member funds do not contribute to Vanguard's capital, but they do receive services pursuant to special services agreements. See "Management of the Funds" for more information. SERVICE PROVIDERS CUSTODIANS. JPMorgan Chase Bank, 270 Park Avenue, New York, NY 10017-2070 (for the Health Care, Precious Metals and Mining, and REIT Index Funds), and Citibank, N.A., 111 Wall Street, New York, NY 10005 (for the Energy and Dividend Growth Funds), serve as the Funds' custodians. The custodians are responsible for maintaining the Funds' assets, keeping all necessary accounts and records of Fund assets, and appointing any foreign sub-custodians or foreign securities depositories. INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM. PricewaterhouseCoopers LLP, Two Commerce Square, Suite 1700, 2001 Market Street, Philadelphia, PA, 19103-7042, serves as the Funds' independent registered public accounting firm. The independent registered public accounting firm audits the Funds' annual financial statements and provides other related services. TRANSFER AND DIVIDEND-PAYING AGENT. The Funds' transfer agent and dividend-paying agent is Vanguard, 100 Vanguard Boulevard, Malvern, PA 19355. CHARACTERISTICS OF THE FUNDS' SHARES RESTRICTIONS ON HOLDING OR DISPOSING OF SHARES. There are no restrictions on the right of shareholders to retain or dispose of the Funds' shares, other than the possible future termination of a Fund or share class. Each Fund or class may be terminated by reorganization into another mutual fund or class or by liquidation and distribution of the assets of the Fund or class. Unless terminated by reorganization or liquidation, each Fund and share class will continue indefinitely. SHAREHOLDER LIABILITY. The Trust is organized under Delaware law, which provides that shareholders of a statutory trust are entitled to the same limitations of personal liability as shareholders of a corporation organized under Delaware law. Effectively, this means that a shareholder of a Fund will not be personally liable for payment of the Fund's debts except by reason of his or her own conduct or acts. In addition, a shareholder could incur a financial loss as a result of a Fund obligation only if the Fund itself had no remaining assets with which to meet such obligation. We believe that the possibility of such a situation arising is extremely remote. DIVIDEND RIGHTS. The shareholders of a Fund are entitled to receive any dividends or other distributions declared by the Fund. No shares of a Fund have priority or preference over any other shares of the Fund with respect to distributions. Distributions will be made from the assets of the Fund and will be paid ratably to all shareholders of the Fund (or class) according to the number of shares of the Fund (or class) held by shareholders on the record date. The amount of dividends per share may vary between separate share classes of the Fund based upon differences in the way that expenses are allocated between share classes pursuant to a multiple class plan. VOTING RIGHTS. Shareholders are entitled to vote on a matter if: (1) a shareholder vote is required under the 1940 Act; (2) the matter concerns an amendment to the Declaration of Trust that would adversely affect to a material degree the rights and preferences of the shares of a Fund or any class; (3) the trustees determine that it is necessary or desirable to obtain a shareholder vote; or (4) a certain type of merger or consolidation, share conversion, share exchange, or sale of assets is proposed. The 1940 Act requires a shareholder vote under various circumstances, including to elect or remove trustees upon the written request of shareholders representing 10% or more of a Fund's net assets and to change any fundamental policy of a Fund. Unless otherwise required by applicable law, shareholders of a Fund receive one vote for each dollar of net asset value owned on the record date, and a fractional vote for each fractional dollar of net asset value owned on the record date. However, only the shares of the Fund or class affected by a particular matter are entitled to vote on that matter. In addition, each class has exclusive voting rights on any matter submitted to shareholders that relates solely to that class, and each class has separate voting rights on any matter submitted to shareholders in which B-2 the interests of one class differ from the interests of another. Voting rights are noncumulative and cannot be modified without a majority vote. LIQUIDATION RIGHTS. In the event that a Fund is liquidated, shareholders will be entitled to receive a pro rata share of the Fund's net assets. In the event that a class of shares is liquidated, shareholders of that class will be entitled to receive a pro rata share of the Fund's net assets that are allocated to that class. Shareholders may receive cash, securities, or a combination of the two. PREEMPTIVE RIGHTS. There are no preemptive rights associated with the Funds' shares. CONVERSION RIGHTS. Shareholders of each Fund (except the Precious Metals and Mining and Dividend Growth Funds) may convert their shares into another class of shares of the same Fund upon satisfaction of any then applicable eligibility requirements. There are no conversion rights associated with the Precious Metals and Mining and Dividend Growth Funds. REDEMPTION PROVISIONS. Each Fund's redemption provisions are described in its current prospectus and elsewhere in this Statement of Additional Information. SINKING FUND PROVISIONS. The Funds have no sinking fund provisions. CALLS OR ASSESSMENT. The Funds' shares, when issued, are fully paid and non-assessable. TAX STATUS OF THE FUNDS Each Fund intends to continue to qualify as a "regulated investment company" under Subchapter M of the Internal Revenue Code of 1986, as amended (the IRC). This special tax status means that the Fund will not be liable for federal tax on income and capital gains distributed to shareholders. In order to preserve its tax status, each Fund must comply with certain requirements. If a Fund fails to meet these requirements in any taxable year, it will be subject to tax on its taxable income at corporate rates, and all distributions from earnings and profits, including any distributions of net tax-exempt income and net long-term capital gains, will be taxable to shareholders as ordinary income. In addition, a Fund could be required to recognize unrealized gains, pay substantial taxes and interest, and make substantial distributions before regaining its tax status as a regulated investment company. Dividends received and distributed by each Fund on shares of stock of domestic corporations may be eligible for the dividends-received deduction applicable to corporate shareholders. Corporations must satisfy certain requirements in order to claim the deduction. Capital gains distributed by the Funds are not eligible for the dividends-received deduction. Each Fund may invest in passive foreign investment companies (PFICs). A foreign company is a PFIC if 75% or more of its gross income is passive or if 50% or more of its assets produce passive income. Capital gains on the sale of a PFIC will be deemed ordinary income regardless of how long the Fund held it. Also, the Fund may be subject to corporate income tax and an interest charge on certain dividends and capital gains earned from PFICs, whether or not they are distributed to shareholders. To avoid such tax and interest, the Fund may elect to treat PFICs as sold on the last day of the Fund's fiscal year and mark to market the gains (or losses, to the extent of previously recognized gains) and recognize ordinary income each year. Distributions from the Fund that are attributable to PFICs are characterized as ordinary income. INVESTMENT POLICIES Some of the investment policies described below and in each Fund's prospectus set forth percentage limitations on a Fund's investment in, or holdings of, certain securities or other assets. Unless otherwise required by law, compliance with these policies will be determined immediately after the acquisition of such securities or assets. Subsequent changes in values, net assets, or other circumstances will not be considered when determining whether the investment complies with the Fund's investment policies and limitations. The following policies and explanations supplement each Fund's investment objective and policies set forth in the prospectus. With respect to the different investments discussed below, a Fund may acquire such investments to the extent consistent with its investment objective and policies. 80% POLICY. Each Fund (except the Dividend Growth Fund and the REIT Index Fund) will invest at least 80% of their assets in stocks of a particular industry. In applying this 80% policy, each Fund's assets will include its net assets and borrowings for investment purposes. B-3 BORROWING. A fund's ability to borrow money is limited by its investment policies and limitations, by the 1940 Act, and by applicable exemptions, no-action letters, interpretations, and other pronouncements by the SEC, and any other regulatory authority having jurisdiction, from time to time. Under the 1940 Act, a fund is required to maintain continuous asset coverage (that is, total assets including borrowings, less liabilities exclusive of borrowings) of 300% of the amount borrowed, with an exception for borrowings not in excess of 5% of the fund's total assets made for temporary or emergency purposes. Any borrowings for temporary purposes in excess of 5% of the fund's total assets must maintain continuous asset coverage. If the 300% asset coverage should decline as a result of market fluctuations or for other reasons, a fund may be required to sell some of its portfolio holdings within three days (excluding Sundays and holidays) to reduce the debt and restore the 300% asset coverage, even though it may be disadvantageous from an investment standpoint to sell securities at that time. Borrowing will tend to exaggerate the effect on net asset value of any increase or decrease in the market value of a fund's portfolio. Money borrowed will be subject to interest costs which may or may not be recovered by earnings on the securities purchased. A fund also may be required to maintain minimum average balances in connection with a borrowing or to pay a commitment or other fee to maintain a line of credit; either of these requirements would increase the cost of borrowing over the stated interest rate. The SEC takes the position that other transactions that have a leveraging effect on the capital structure of a fund or are economically equivalent to borrowing can be viewed as constituting a form of borrowing by the fund for purposes of the 1940 Act. These transactions can include entering into reverse repurchase agreements, engaging in mortgage-dollar-roll transactions, selling securities short (other than short sales "against-the-box"), buying and selling certain derivatives (such as futures contracts), selling (or writing) put and call options, engaging in sale-buybacks, entering into firm-commitment and standby-commitment agreements, engaging in when-issued, delayed-delivery, or forward-commitment transactions, and other trading practices that have a leveraging effect on the capital structure of a fund or are economically equivalent to borrowing (additional discussion about a number of these transactions can be found below). A borrowing transaction will not be considered to constitute the issuance of a "senior security" by a fund, and therefore such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund (1) maintains an offsetting financial position, (2) segregates liquid assets (with such liquidity determined by the advisor in accordance with procedures established by the board of trustees) equal (as determined on a daily mark-to-market basis) in value to the fund's potential economic exposure under the borrowing transaction, or (3) otherwise "covers" the transaction in accordance with applicable SEC guidance (collectively, "covers" the transaction). A fund may have to buy or sell a security at a disadvantageous time or price in order to cover a borrowing transaction. In addition, segregated assets may not be available to satisfy redemptions or for other purposes. COMMON STOCK. Common stock represents an equity or ownership interest in an issuer. Common stock typically entitles the owner to vote on the election of directors and other important matters as well as to receive dividends on such stock. In the event an issuer is liquidated or declares bankruptcy, the claims of owners of bonds, other debt holders, and owners of preferred stock take precedence over the claims of those who own common stock. CONVERTIBLE SECURITIES. Convertible securities are hybrid securities that combine the investment characteristics of bonds and common stocks. Convertible securities typically consist of debt securities or preferred stock that may be converted (on a voluntary or mandatory basis) within a specified period of time (normally for the entire life of the security) into a certain amount of common stock or other equity security of the same or a different issuer at a predetermined price. Convertible securities also include debt securities with warrants or common stock attached and derivatives combining the features of debt securities and equity securities. Other convertible securities with features and risks not specifically referred to herein may become available in the future. Convertible securities involve risks similar to those of both fixed income and equity securities. The market value of a convertible security is a function of its "investment value" and its "conversion value." A security's "investment value" represents the value of the security without its conversion feature (i.e., a nonconvertible fixed income security). The investment value may be determined by reference to its credit quality and the current value of its yield to maturity or probable call date. At any given time, investment value is dependent upon such factors as the general level of interest rates, the yield of similar nonconvertible securities, the financial strength of the issuer, and the seniority of the security in the issuer's capital structure. A security's "conversion value" is determined by multiplying the number of shares the holder is entitled to receive upon conversion or exchange by the current price of the underlying security. If the conversion value of a convertible security is significantly below its investment value, the convertible security will trade like nonconvertible debt or preferred stock and its market value will not be influenced greatly by B-4 fluctuations in the market price of the underlying security. In that circumstance, the convertible security takes on the characteristics of a bond, and its price moves in the opposite direction from interest rates. Conversely, if the conversion value of a convertible security is near or above its investment value, the market value of the convertible security will be more heavily influenced by fluctuations in the market price of the underlying security. In that case, the convertible security's price may be as volatile as that of common stock. Because both interest rate and market movements can influence its value, a convertible security generally is not as sensitive to interest rates as a similar fixed income security, nor is it as sensitive to changes in share price as its underlying equity security. Convertible securities are often rated below investment-grade or are not rated, and are generally subject to a high degree of credit risk. While all markets are prone to change over time, the generally high rate at which convertible securities are retired (through mandatory or scheduled conversions by issuers or voluntary redemptions by holders) and replaced with newly issued convertibles may cause the convertible securities market to change more rapidly than other markets. For example, a concentration of available convertible securities in a few economic sectors could elevate the sensitivity of the convertible securities market to the volatility of the equity markets and to the specific risks of those sectors. Moreover, convertible securities with innovative structures, such as mandatory conversion securities and equity-linked securities, have increased the sensitivity of the convertible securities market to the volatility of the equity markets and to the special risks of those innovations, which may include risks different from, and possibly greater than, those associated with traditional convertible securities. DEBT SECURITIES. A debt security is a security consisting of a certificate or other evidence of a debt (secured or unsecured) on which the issuing company or governmental body promises to pay the holder thereof a fixed, variable, or floating rate of interest for a specified length of time, and to repay the debt on the specified maturity date. Some debt securities, such as zero coupon bonds, do not make regular interest payments but are issued at a discount to their principal or maturity value. Debt securities include a variety of fixed income obligations, including, but not limited to, corporate bonds, government securities, municipal securities, convertible securities, mortgage-backed securities, and asset-backed securities. Debt securities include investment-grade securities, non-investment-grade securities, and unrated securities. Debt securities are subject to a variety of risks, such as interest rate risk, income risk, call/ prepayment risk, inflation risk, credit risk, and (in the case of foreign securities) country risk and currency risk. DEBT SECURITIES -- NON-INVESTMENT-GRADE SECURITIES. Non-investment-grade securities, also referred to as "high-yield securities" or "junk bonds," are debt securities that are rated lower than the four highest rating categories by a nationally recognized statistical rating organization (for example, lower than Baa3 by Moody's Investors Service, Inc. or lower than BBB- by Standard & Poor's) or are determined to be of comparable quality by the fund's advisor. These securities are generally considered to be, on balance, predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation and will generally involve more credit risk than securities in the investment-grade categories. Investment in these securities generally provides greater income and increased opportunity for capital appreciation than investments in higher quality securities, but they also typically entail greater price volatility and principal and income risk. Analysis of the creditworthiness of issuers of high yield securities may be more complex than for issuers of investment-grade securities. Thus, reliance on credit ratings in making investment decisions entails greater risks for high-yield securities than for investment-grade debt securities. The success of a fund's advisor in managing high-yield securities is more dependent upon its own credit analysis than is the case with investment-grade securities. Some high-yield securities are issued by smaller, less-seasoned companies, while others are issued as part of a corporate restructuring, such as an acquisition, merger, or leveraged buyout. Companies that issue high-yield securities are often highly leveraged and may not have available to them more traditional methods of financing. Therefore, the risk associated with acquiring the securities of such issuers generally is greater than is the case with investment-grade securities. Some high-yield securities were once rated as investment-grade but have been downgraded to junk bond status because of financial difficulties experienced by their issuers. The market values of high-yield securities tend to reflect individual issuer developments to a greater extent than do investment-grade securities, which in general react to fluctuations in the general level of interest rates. High-yield securities also tend to be more sensitive to economic conditions than are investment-grade securities. A projection of an economic downturn or of a sustained period of rising interest rates, for example, could cause a decline in junk bond prices because the advent of a recession could lessen the ability of a highly leveraged company to make principal and B-5 interest payments on its debt securities. If an issuer of high-yield securities defaults, in addition to risking payment of all or a portion of interest and principal, a fund investing in such securities may incur additional expenses to seek recovery. The secondary market on which high-yield securities are traded may be less liquid than the market for investment-grade securities. Less liquidity in the secondary trading market could adversely affect the ability of a fund to sell a high-yield security or the price at which a fund could sell a high-yield security, and could adversely affect the daily net asset value of fund shares. When secondary markets for high-yield securities are less liquid than the market for investment-grade securities, it may be more difficult to value the securities because such valuation may require more research, and elements of judgment may play a greater role in the valuation because there is less reliable, objective data available. Except as otherwise provided in a fund's prospectus, if a credit-rating agency changes the rating of a portfolio security held by a fund, the fund may retain the portfolio security if the advisor deems it in the best interests of shareholders. DEPOSITARY RECEIPTS. Depositary receipts are securities that evidence ownership interests in a security or a pool of securities that have been deposited with a "depository." Depositary receipts may be sponsored or unsponsored and include American Depositary Receipts (ADRs), European Depositary Receipts (EDRs) and Global Depositary Receipts (GDRs). For ADRs, the depository is typically a U.S. financial institution and the underlying securities are issued by a foreign issuer. For other depositary receipts, the depository may be a foreign or a U.S. entity, and the underlying securities may have a foreign or a U.S. issuer. Depositary receipts will not necessarily be denominated in the same currency as their underlying securities. Generally, ADRs are issued in registered form, denominated in U.S. dollars, and designed for use in the U.S. securities markets. Other depositary receipts, such as GDRs and EDRs, may be issued in bearer form and denominated in other currencies, and are generally designed for use in securities markets outside the U.S. Although the two types of depositary receipt facilities (unsponsored or sponsored) are similar, there are differences regarding a holder's rights and obligations and the practices of market participants. A depository may establish an unsponsored facility without participation by (or acquiescence of) the underlying issuer; typically, however, the depository requests a letter of non-objection from the underlying issuer prior to establishing the facility. Holders of unsponsored depositary receipts generally bear all the costs of the facility. The depository usually charges fees upon the deposit and withdrawal of the underlying securities, the conversion of dividends into U.S. dollars or other currency, the disposition of non-cash distributions, and the performance of other services. The depository of an unsponsored facility frequently is under no obligation to distribute shareholder communications received from the underlying issuer or to pass through voting rights to depositary receipt holders with respect to the underlying securities. Sponsored depositary receipt facilities are created in generally the same manner as unsponsored facilities, except that sponsored depositary receipts are established jointly by a depository and the underlying issuer through a deposit agreement. The deposit agreement sets out the rights and responsibilities of the underlying issuer, the depository, and the depositary receipt holders. With sponsored facilities, the underlying issuer typically bears some of the costs of the depositary receipts (such as dividend payment fees of the depository), although most sponsored depositary receipts holders may bear costs such as deposit and withdrawal fees. Depositories of most sponsored depositary receipts agree to distribute notices of shareholder meetings, voting instructions, and other shareholder communications and information to the depositary receipt holders at the underlying issuer's request. The depositary of an unsponsored facility frequently is under no obligation to distribute shareholder communications received from the issuer of the deposited security or to pass through, to the holders of the receipts, voting rights with respect to the deposited securities. For purposes of a fund's investment policies, investments in depositary receipts will be deemed to be investments in the underlying securities. Thus, a depositary receipt representing ownership of common stock will be treated as common stock. Depository receipts do not eliminate all of the risks associated with directly investing in the securities of foreign issuers. DERIVATIVES. A derivative is a financial instrument which has a value that is based on--or "derived from"--the values of other assets, reference rates, or indexes. Derivatives may relate to a wide variety of underlying references, such as commodities, stocks, bonds, interest rates, currency exchange rates, and related indexes. Derivatives include futures contracts and options on futures contracts (see additional discussion below), forward-commitment transactions (see additional discussion below), options on securities (see additional discussion below), caps, floors, collars, swap agreements (see additional discussion below), and other financial instruments. Some derivatives, such as futures contracts and certain options, are traded on U.S. commodity and securities exchanges, while other derivatives, such as swap agreements, are privately negotiated and entered into in the over-the-counter (OTC) market. The risks associated with the use of derivatives are different from, and possibly greater than, the risks associated with investing directly in the B-6 securities, assets, or market indexes on which the derivatives are based. Derivatives are used by some investors for speculative purposes. Derivatives also may be used for a variety of purposes that do not constitute speculation, such as hedging, risk management, seeking to stay fully invested, seeking to reduce transaction costs, seeking to simulate an investment in equity or debt securities or other investments, seeking to add value by using derivatives to more efficiently implement portfolio positions when derivatives are favorably priced relative to equity or debt securities or other investments, and for other purposes. A fund will not use derivatives for speculation or for the purpose of leveraging (magnifying) investment returns. There is no assurance that any derivatives strategy used by a fund's advisor will succeed. Derivative products are highly specialized instruments that require investment techniques and risk analyses different from those associated with stocks, bonds, and other traditional investments. The use of a derivative requires an understanding not only of the underlying instrument but also of the derivative itself, without the benefit of observing the performance of the derivative under all possible market conditions. The use of a derivative involves the risk that a loss may be sustained as a result of the insolvency or bankruptcy of the other party to the contract (usually referred to as a "counterparty") or the failure of the counterparty to make required payments or otherwise comply with the terms of the contract. Additionally, the use of credit derivatives can result in losses if a fund's advisor does not correctly evaluate the creditworthiness of the issuer on which the credit derivative is based. Derivatives may be subject to liquidity risk, which exists when a particular derivative is difficult to purchase or sell. If a derivative transaction is particularly large or if the relevant market is illiquid (as is the case with many OTC derivatives), it may not be possible to initiate a transaction or liquidate a position at an advantageous time or price. Derivatives may be subject to pricing or "basis" risk, which exists when a particular derivative becomes extraordinarily expensive relative to historical prices or the prices of corresponding cash market instruments. Under certain market conditions, it may not be economically feasible to initiate a transaction or liquidate a position in time to avoid a loss or take advantage of an opportunity. Because many derivatives have a leverage component, adverse changes in the value or level of the underlying asset, reference rate, or index can result in a loss substantially greater than the amount invested in the derivative itself. Certain derivatives have the potential for unlimited loss, regardless of the size of the initial investment. A derivative transaction will not be considered to constitute the issuance of a "senior security" by a fund, and therefore such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." Like most other investments, derivative instruments are subject to the risk that the market value of the instrument will change in a way detrimental to a fund's interest. A fund bears the risk that its advisor will incorrectly forecast future market trends or the values of assets, reference rates, indexes, or other financial or economic factors in establishing derivative positions for the fund. If the advisor attempts to use a derivative as a hedge against, or as a substitute for, a portfolio investment, the fund will be exposed to the risk that the derivative will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the fund. While hedging strategies involving derivative instruments can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other fund investments. Many derivatives, in particular OTC derivatives, are complex and often valued subjectively. Improper valuations can result in increased cash payment requirements to counterparties or a loss of value to a fund. EXCHANGE-TRADED FUNDS. The funds may purchase shares of exchange-traded funds (ETFs), including ETF shares issued by other Vanguard funds. Typically, the funds would purchase ETF shares for the same reason it would purchase (and as an alternative to purchasing) futures contracts: to obtain exposure to all or a portion of the stock or bond market. ETF shares enjoy several advantages over futures. Depending on the market, the holding period, and other factors, ETF shares can be less costly and more tax-efficient than futures. In addition, ETF shares can be purchased for smaller sums, offer exposure to market sectors and styles for which there is no suitable or liquid futures contract, and do not involve leverage. Most ETFs are investment companies. Therefore, each fund's purchases of ETF shares generally are subject to the limitations on, and the risks of, a fund's investments in other investment companies, which are described below under the heading "Other Investment Companies." An investment in an ETF generally presents the same primary risks as an investment in a conventional fund (i.e., one that is not exchange traded) that has the same investment objectives, strategies, and policies. The price of an ETF can B-7 fluctuate within a wide range, and a fund could lose money investing in an ETF if the prices of the securities owned by the ETF go down. In addition, ETFs are subject to the following risks that do not apply to conventional funds: (1) the market price of the ETF's shares may trade at a discount to their net asset value; (2) an active trading market for an ETF's shares may not develop or be maintained; or (3) trading of an ETF's shares may be halted if the listing exchange's officials deem such action appropriate, the shares are de-listed from the exchange, or the activation of market-wide "circuit breakers" (which are tied to large decreases in stock prices) halts stock trading generally. Funds may repurchase VIPER/(R) /Shares, which are exchange-traded shares that represent an interest in a portfolio of stocks held by certain Vanguard index funds. "VIPER" stands for Vanguard Index Participation Equity Receipts. Any fund that issues VIPER Shares may repurchase those shares on the open market at the current market price if doing so would be advantageous for the fund. A repurchase might be advantageous, for example, because the VIPER Shares are more cost-effective than alternative investments, are selling at a discount to net asset value, will cause the fund to more closely track its index than alternative investments, or some combination of the three. Each fund that repurchases its VIPER Shares also may lend those shares to qualified institutional borrowers as part of the fund's securities lending activities. Each fund's investments in VIPER Shares are also subject to the descriptions, limitations and risks described above under the headings "Exchange-Traded Funds" and "Other Investment Companies." FOREIGN SECURITIES. Foreign securities are equity or debt securities issued by entities organized, domiciled, or with a principal place of business outside the United States, such as foreign corporations and governments. Foreign securities may trade in U.S. or foreign securities markets. A fund may make foreign investments either directly by purchasing foreign securities or indirectly by purchasing depositary receipts or depositary shares of similar instruments (depositary receipts) for foreign securities (see discussion above). Depositary receipts are securities that are listed on exchanges or quoted in OTC markets in one country but represent shares of issuers domiciled in another country. Direct investments in foreign securities may be made either on foreign securities exchanges or in the OTC markets. Investing in foreign securities involves certain special risk considerations that are not typically associated with investing in securities of U.S. companies or governments. Because foreign issuers are not generally subject to uniform accounting, auditing, and financial reporting standards and practices comparable to those applicable to U.S. issuers, there may be less publicly available information about certain foreign issuers than about U.S. issuers. Evidence of securities ownership may be uncertain in many foreign countries. As a result, there is a risk that a fund's trade details could be incorrectly or fraudulently entered at the time of the transaction, resulting in a loss to the fund. Securities of foreign issuers are generally less liquid than securities of comparable U.S. issuers. In certain countries, there is less government supervision and regulation of stock exchanges, brokers, and listed companies than in the U.S. In addition, with respect to certain foreign countries, there is the possibility of expropriation or confiscatory taxation, political or social instability, war, terrorism, nationalization, limitations on the removal of funds or other assets, or diplomatic developments which could affect U.S. investments in those countries. Although an advisor will endeavor to achieve most favorable execution costs for a fund's portfolio transactions in foreign securities under the circumstances, commissions (and other transaction costs) are generally higher than those on U.S. securities. In addition, it is expected that the expenses for custodian arrangements of the fund's foreign securities will be somewhat greater than the expenses for a fund that invests primarily in domestic securities. Certain foreign governments levy withholding taxes against dividend and interest income from foreign securities. Although in some countries a portion of these taxes is recoverable by the fund, the non-recovered portion of foreign withholding taxes will reduce the income received from the companies making up a fund. The value of the foreign securities held by a fund that are not U.S. dollar-denominated may be significantly affected by changes in currency exchange rates. The U.S. dollar value of a foreign security generally decreases when the value of the U.S. dollar rises against the foreign currency in which the security is denominated and tends to increase when the value of the U.S. dollar falls against such currency (as discussed below, a fund may attempt to hedge its currency risks). In addition, the value of fund assets may be affected by losses and other expenses incurred in converting between various currencies in order to purchase and sell foreign securities, and by currency restrictions, exchange control regulation, currency devaluations, and political and economic developments. FOREIGN SECURITIES -- EMERGING MARKET RISK. Investing in emerging market countries involves certain risks not typically associated with investing in the United States, and imposes risks greater than, or in addition to, risks of investing in more developed foreign countries. These risks include, but are not limited to, the following: greater risks of nationalization or expropriation of assets or confiscatory taxation; currency devaluations and other currency exchange rate fluctuations; greater social, economic, and political uncertainty and instability (including amplified risk of war and B-8 terrorism); more substantial government involvement in the economy; less government supervision and regulation of the securities markets and participants in those markets; controls on foreign investment and limitations on repatriation of invested capital and on the fund's ability to exchange local currencies for U.S. dollars; unavailability of currency hedging techniques in certain emerging market countries; the fact that companies in emerging market countries may be smaller, less seasoned, and newly organized companies; the difference in, or lack of, auditing and financial reporting standards, which may result in unavailability of material information about issuers; the risk that it may be more difficult to obtain and/or enforce a judgment in a court outside the United States; and greater price volatility, substantially less liquidity, and significantly smaller market capitalization of securities markets. Also, any change in the leadership or politics of emerging market countries, or the countries that exercise a significant influence over those countries, may halt the expansion of or reverse the liberalization of foreign investment policies now occurring and adversely affect existing investment opportunities. Furthermore, high rates of inflation and rapid fluctuations in inflation rates have had, and may continue to have, negative effects on the economies and securities markets of certain emerging market countries. FOREIGN SECURITIES -- FOREIGN CURRENCY TRANSACTIONS. The value in U.S. dollars of a fund's non-dollar-denominated foreign securities may be affected favorably or unfavorably by changes in foreign currency exchange rates and exchange control regulations, and the fund may incur costs in connection with conversions between various currencies. To seek to minimize the impact of such factors on net asset values, a fund may engage in foreign currency transactions in connection with its investments in foreign securities. A fund will not speculate in foreign currency exchange and will enter into foreign currency transactions only to attempt to "hedge" the currency risk associated with investing in foreign securities. Although such transactions tend to minimize the risk of loss that would result from a decline in the value of the hedged currency, they also may limit any potential gain that might result should the value of such currency increase. Currency exchange transactions may be conducted either on a spot (i.e., cash) basis at the rate prevailing in the currency exchange market, or through forward contracts to purchase or sell foreign currencies. A forward currency contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract agreed upon by the parties, at a price set at the time of the contract. These contracts are entered into with large commercial banks or other currency traders who are participants in the interbank market. Currency exchange transactions also may be effected through the use of swap agreements or other derivatives. Currency exchange transactions may be considered borrowings. A currency exchange transaction will not be considered to constitute the issuance of a "senior security" by a fund for purposes of the 1940 Act, and therefore such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." By entering into a forward contract for the purchase or sale of foreign currency involved in underlying security transactions, a fund may be able to protect itself against part or all of the possible loss between trade and settlement dates for that purchase or sale resulting from an adverse change in the relationship between the U.S. dollar and such foreign currency. This practice is sometimes referred to as "transaction hedging." In addition, when the advisor reasonably believes that a particular foreign currency may suffer a substantial decline against the U.S. dollar, a fund may enter into a forward contract to sell an amount of foreign currency approximating the value of some or all of its portfolio securities denominated in such foreign currency. This practice is sometimes referred to as "portfolio hedging." Similarly, when the advisor reasonably believes that the U.S. dollar may suffer a substantial decline against a foreign currency, a fund may enter into a forward contract to buy that foreign currency for a fixed dollar amount. A fund may also attempt to hedge its foreign currency exchange rate risk by engaging in currency futures, options, and "cross-hedge" transactions. In cross-hedge transactions, a fund holding securities denominated in one foreign currency will enter into a forward currency contract to buy or sell a different foreign currency (one that the advisor reasonably believes generally tracks the currency being hedged with regard to price movements). The advisor may select the tracking (or substitute) currency rather than the currency in which the security is denominated for various reasons, including in order to take advantage of pricing or other opportunities presented by the tracking currency or because the market for the tracking currency is more liquid or more efficient. Such cross-hedges are expected to help protect a fund against an increase or decrease in the value of the U.S. dollar against certain foreign currencies. A fund may hold a portion of its assets in bank deposits denominated in foreign currencies, so as to facilitate investment in foreign securities as well as protect against currency fluctuations and the need to convert such assets into U.S. dollars (thereby also reducing transaction costs). To the extent these monies are converted back into U.S. dollars, the value of the assets so maintained will be affected favorably or unfavorably by changes in foreign currency exchange rates and exchange control regulations. B-9 The forecasting of currency market movement is extremely difficult, and whether any hedging strategy will be successful is highly uncertain. Moreover, it is impossible to forecast with precision the market value of portfolio securities at the expiration of a foreign currency forward contract. Accordingly, a fund may be required to buy or sell additional currency on the spot market (and bear the expense of such transaction) if its advisor's predictions regarding the movement of foreign currency or securities markets prove inaccurate. In addition, the use of cross-hedging transactions may involve special risks, and may leave a fund in a less advantageous position than if such a hedge had not been established. Because foreign currency forward contracts are privately negotiated transactions, there can be no assurance that a fund will have flexibility to roll-over a foreign currency forward contract upon its expiration if it desires to do so. Additionally, there can be no assurance that the other party to the contract will perform its services thereunder. FOREIGN SECURITIES -- FOREIGN INVESTMENT COMPANIES. Some of the countries in which a fund may invest may not permit, or may place economic restrictions on, direct investment by outside investors. Fund investments in such countries may be permitted only through foreign government-approved or authorized investment vehicles, which may include other investment companies. Such investments may be made through registered or unregistered closed-end investment companies that invest in foreign securities. Investing through such vehicles may involve frequent or layered fees or expenses and may also be subject to the limitations on, and the risks of, a fund's investments in other investment companies, which are described below under the heading "Other Investment Companies." FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. Each Fund's obligations under futures contracts will not exceed 20% of its total assets. To the extent that the REIT Index Fund invests in futures contracts, it will not have 98% of its assets invested in REIT stocks. Futures contracts and options on futures contracts are derivatives (see additional discussion above). A futures contract is a standardized agreement between two parties to buy or sell at a specific time in the future a specific quantity of a commodity at a specific price. The commodity may consist of an asset, a reference rate, or an index. A security futures contract relates to the sale of a specific quantity of shares of a single equity security or a narrow-based securities index. The value of a futures contract tends to increase and decrease in tandem with the value of the underlying commodity. The buyer of a futures contract enters into an agreement to purchase the underlying commodity on the settlement date and is said to be "long" the contract. The seller of a futures contract enters into an agreement to sell the underlying commodity on the settlement date and is said to be "short" the contract. The price at which a futures contract is entered into is established either in the electronic marketplace or by open outcry on the floor of an exchange between exchange members acting as traders or brokers. Open futures contracts can be liquidated or closed out by physical delivery of the underlying commodity or payment of the cash settlement amount on the settlement date, depending on the terms of the particular contract. Some financial futures contracts (such as security futures) provide for physical settlement at maturity. Other financial futures contracts (such as those relating to interest rates, foreign currencies and broad-based securities indexes) generally provide for cash settlement at maturity. In the case of cash settled futures contracts, the cash settlement amount is equal to the difference between the final settlement price on the last trading day of the contract and the price at which the contract was entered into. Most futures contracts, however, are not held until maturity but instead are "offset" before the settlement date through the establishment of an opposite and equal futures position. The purchaser or seller of a futures contract is not required to deliver or pay for the underlying commodity unless the contract is held until the settlement date. However, both the purchaser and seller are required to deposit "initial margin" with a futures commission merchant (FCM) when the futures contract is entered into. Initial margin deposits are typically calculated as a percentage of the contract's market value. If the value of either party's position declines, that party will be required to make additional "variation margin" payments to settle the change in value on a daily basis. This process is known as "marking-to-market." A futures transaction will not be considered to constitute the issuance of a "senior security" by a fund for purposes of the 1940 Act, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." An option on a futures contract (or futures option) conveys the right, but not the obligation, to purchase (in the case of a call option) or sell (in the case of a put option) a specific futures contract at a specific price (called the "exercise" or "strike" price) any time before the option expires. The seller of an option is called an option writer. The purchase price of an option is called the premium. The potential loss to an option buyer is limited to the amount of the premium plus transaction costs. This will be the case, for example, if the option is held and not exercised prior to its expiration date. Generally, an option writer sells options with the goal of obtaining the premium paid by the option buyer. If an option sold B-10 by an option writer expires without being exercised, the writer retains the full amount of the premium. The option writer, however, has unlimited economic risk because its potential loss, except to the extent offset by the premium received when the option was written, is equal to the amount the option is "in-the-money" at the expiration date. A call option is in-the-money if the value of the underlying futures contract exceeds the exercise price of the option. A put option is in-the-money if the exercise price of the option exceeds the value of the underlying futures contract. Generally, any profit realized by an option buyer represents a loss for the option writer. A fund that takes the position of a writer of a futures option is required to deposit and maintain initial and variation margin with respect to the option, as described above in the case of futures contracts. A futures option transaction will not be considered to constitute the issuance of a "senior security" by a fund for purposes of the 1940 Act, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements and subject to the risks described above under the heading "Borrowing." Each fund intends to comply with Rule 4.5 of the Commodity Futures Trading Commission, under which a mutual fund is conditionally excluded from the definition of the term "commodity pool operator." A fund will only enter into futures contracts and futures options that are standardized and traded on a U.S. or foreign exchange, board of trade, or similar entity, or quoted on an automated quotation system. FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS -- RISKS. The risk of loss in trading futures contracts and in writing futures options can be substantial, because of the low margin deposits required, the extremely high degree of leverage involved in futures and options pricing, and the potential high volatility of the futures markets. As a result, a relatively small price movement in a futures position may result in immediate and substantial loss (or gain) to the investor. For example, if at the time of purchase, 10% of the value of the futures contract is deposited as margin, a subsequent 10% decrease in the value of the futures contract would result in a total loss of the margin deposit, before any deduction for the transaction costs, if the account were then closed out. A 15% decrease would result in a loss equal to 150% of the original margin deposit if the contract were closed out. Thus, a purchase or sale of a futures contract, and the writing of a futures option, may result in losses in excess of the amount invested in the position. In the event of adverse price movements, a fund would continue to be required to make daily cash payments to maintain its required margin. In such situations, if the fund has insufficient cash, it may have to sell portfolio securities to meet daily margin requirements (and segregation requirements, if applicable) at a time when it may be disadvantageous to do so. In addition, on the settlement date, a fund may be required to make delivery of the instruments underlying the futures positions it holds. A fund could suffer losses if it is unable to close out a futures contract or a futures option because of an illiquid secondary market. Futures contracts and futures options may be closed out only on an exchange which provides a secondary market for such products. However, there can be no assurance that a liquid secondary market will exist for any particular futures product at any specific time. Thus, it may not be possible to close a futures or option position. Moreover, most futures exchanges limit the amount of fluctuation permitted in futures contract prices during a single trading day. The daily limit establishes the maximum amount that the price of a futures contract may vary either up or down from the previous day's settlement price at the end of a trading session. Once the daily limit has been reached in a particular type of contract, no trades may be made on that day at a price beyond that limit. The daily limit governs only price movement during a particular trading day and therefore does not limit potential losses, because the limit may prevent the liquidation of unfavorable positions. Futures contract prices have occasionally moved to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of future positions and subjecting some futures traders to substantial losses. The inability to close futures and options positions also could have an adverse impact on the ability to hedge a portfolio investment or to establish a substitute for a portfolio investment. Treasury futures are generally not subject to such daily limits. A fund bears the risk that its advisor will incorrectly predict future market trends. If the advisor attempts to use a futures contract or a futures option as a hedge against, or as a substitute for, a portfolio investment, the fund will be exposed to the risk that the futures position will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the fund. While hedging strategies involving futures products can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other fund investments. B-11 A fund could lose margin payments it has deposited with its FCM, if, for example, the FCM breaches its agreement with the fund or becomes insolvent or goes into bankruptcy. In that event, the fund may be entitled to return of margin owed to it only in proportion to the amount received by the FCM's other customers, potentially resulting in losses to the fund. INTERFUND BORROWING AND LENDING. The SEC has granted an exemption permitting the Vanguard funds to participate in Vanguard's interfund lending program. This program allows the Vanguard funds to borrow money from and lend money to each other for temporary or emergency purposes. The program is subject to a number of conditions, including the requirement that no fund may borrow or lend money through the program unless it receives a more favorable interest rate than is typically available from a bank for a comparable transaction. In addition, a Vanguard fund may participate in the program only if and to the extent that such participation is consistent with the fund's investment objective and other investment policies. The boards of trustees of the Vanguard funds are responsible for overseeing the interfund lending program. OPTIONS. An option is a derivative (see additional discussion above). An option on a security (or index) is a contract that gives the holder of the option, in return for the payment of a "premium," the right, but not the obligation, to buy from (in the case of a call option) or sell to (in the case of a put option) the writer of the option the security underlying the option (or the cash value of the index) at a specified exercise price prior to the expiration date of the option. The writer of an option on a security has the obligation upon exercise of the option (1) to deliver the underlying security upon payment of the exercise price prior to the expiration date of the option. The writer of an option on a security has the obligation upon exercise of the option (1) to deliver the underlying security upon payment of the exercise price (in the case of a call option) or (2) to pay the exercise price upon delivery of the underlying security (in the case of a put option). The writer of an option on an index has the obligation upon exercise of the option to pay an amount equal to the cash value of the index minus the exercise price, multiplied by the specified multiplier for the index option. The multiplier for an index option determines the size of the investment position the option represents. Unlike exchange-traded options, which are standardized with respect to the underlying instrument, expiration date, contract size, and strike price, the terms of OTC options (options not traded on exchanges) generally are established through negotiation with the other party to the option contract. While this type of arrangement allows the purchaser or writer greater flexibility to tailor an option to its needs, OTC options generally involve greater credit risk than exchange-traded options, which are guaranteed by the clearing organization of the exchanges where they are traded. The buyer (or holder) of an option is said to be "long" the option, while the seller (or writer) of an option is said to be "short" the option. A call option grants to the holder the right to buy (and obligates the writer to sell) the underlying security at the strike price. A put options grants to the holder the right to sell (and obligates the writer to buy) the underlying security at the strike price. The purchase price of an option is called the "premium." The potential loss to an option buyer is limited to the amount of the premium plus transaction costs. This will be the case if the option is held and not exercised prior to its expiration date. Generally, an option writer sells options with the goal of obtaining the premium paid by the option buyer, but that person could also seek to profit from an anticipated rise or decline in option prices. If an option sold by an option writer expires without being exercised, the writer retains the full amount of the premium. The option writer, however, has unlimited economic risk because its potential loss, except to the extent offset by the premium received when the option was written, is equal to the amount the option is "in-the-money" at the expiration date. A call option is in-the-money if the value of the underlying position exceeds the exercise price of the option. A put option is in-the-money if the exercise price of the option exceeds the value of the underlying position. Generally, any profit realized by an option buyer represents a loss for the option writer. The writing of an option will not be considered to constitute the issuance of a "senior security" by a fund for purposes of the 1940 Act, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." If a trading market in particular options were to become unavailable, investors in those options (such as the funds) would be unable to close out their positions until trading resumes, and they may be faced with substantial losses if the value of the underlying interest moves adversely during that time. Even if the market were to remain available, there may be times when options prices will not maintain their customary or anticipated relationships to the prices of the underlying interests and related interests. Lack of investor interest, changes in volatility, or other factors or conditions might adversely affect the liquidity, efficiency, continuity, or even the orderliness of the market for particular options. A fund bears the risk that its advisor will not accurately predict future market trends. If the advisor attempts to use an option as a hedge against, or as a substitute for, a portfolio investment, the fund will be exposed to the risk that the B-12 option will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the fund. While hedging strategies involving options can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other fund investments. Many options, in particular OTC options, are complex and often valued based on subjective factors. Improper valuations can result in increased cash payment requirements to counterparties or a loss of value to a fund. OTHER INVESTMENT COMPANIES. A fund may invest in other investment companies to the extent permitted by applicable law or SEC exemption. Under the 1940 Act, a fund generally may invest up to 10% of its assets in shares of investment companies and up to 5% of its assets in any one investment company, as long as the investment does not represent more than 3% of the voting stock of the acquired investment company. The 1940 Act provides an exemption from these restrictions for a fund-of-funds where the acquiring fund and any acquired funds are part of the same group of investment companies and comply with various conditions set forth in the Act. If a fund invests in other investment companies, shareholders will bear not only their proportionate share of the fund's expenses (including operating expenses and the fees of the advisor), but also, indirectly, the similar expenses of the underlying investment companies. Shareholders would also be exposed to the risks associated not only to the investments of the fund but also to the portfolio investments of the underlying investment companies. Certain types of investment companies, such as closed-end investment companies, issue a fixed number of shares that typically trade on a stock exchange or over-the-counter at a premium or discount to their net asset value. Others are continuously offered at net asset value but also may be traded in the secondary market. PREFERRED STOCK. Preferred stock represents an equity or ownership interest in an issuer. Preferred stock normally pays dividends at a specified rate and has precedence over common stock in the event the issuer is liquidated or declares bankruptcy. However, in the event an issuer is liquidated or declares bankruptcy, the claims of owners of bonds take precedence over the claims of those who own preferred and common stock. Preferred stock, unlike common stock, often has a stated dividend rate payable from the corporation's earnings. Preferred stock dividends may be cumulative or non-cumulative, participating, or auction rate. "Cumulative" dividend provisions require all or a portion of prior unpaid dividends to be paid before dividends can be paid to the issuer's common stock. "Participating" preferred stock may be entitled to a dividend exceeding the stated dividend in certain cases. If interest rates rise, the fixed dividend on preferred stocks may be less attractive, causing the price of such stocks to decline. Preferred stock may have mandatory sinking fund provisions, as well as provisions allowing the stock to be called or redeemed, which can limit the benefit of a decline in interest rates. Preferred stock is subject to many of the risks to which common stock and debt securities are subject. REPURCHASE AGREEMENTS. A repurchase agreement is an agreement under which a fund acquires a fixed income security (generally a security issued by the U.S. government or an agency thereof, a banker's acceptance, or a certificate of deposit) from a commercial bank, broker, or dealer, and simultaneously agrees to resell such security to the seller at an agreed upon price and date (normally, the next business day). Because the security purchased constitutes collateral for the repurchase obligation, a repurchase agreement may be considered a loan that is collateralized by the security purchased. The resale price reflects an agreed upon interest rate effective for the period the instrument is held by a fund and is unrelated to the interest rate on the underlying instrument. In these transactions, the securities acquired by a fund (including accrued interest earned thereon) must have a total value in excess of the value of the repurchase agreement and be held by a custodian bank until repurchased. In addition, the investment advisor will monitor a fund's repurchase agreement transactions generally and will evaluate the creditworthiness of any bank, broker, or dealer party to a repurchase agreement relating to a fund. The use of repurchase agreements involves certain risks. One risk is the seller's ability to pay the agreed-upon repurchase price on the repurchase date. If the seller defaults, the fund may incur costs in disposing of the collateral, which would reduce the amount realized thereon. If the seller seeks relief under the bankruptcy laws, the disposition of the collateral may be delayed or limited. For example, if the other party to the agreement becomes insolvent and subject to liquidation or reorganization under the bankruptcy or other laws, a court may determine that the underlying security is collateral for a loan by the fund not within its control and therefore the realization by the fund on such collateral may be automatically stayed. Finally, it is possible that the fund may not be able to substantiate its interest in the underlying security and may be deemed an unsecured creditor of the other party to the agreement. RESTRICTED AND ILLIQUID SECURITIES. Illiquid securities are securities that cannot be sold or disposed of in the ordinary course of business within seven business days at approximately the value at which they are being carried on a fund's books. Illiquid securities may include a wide variety of investments, such as: (1) repurchase agreements maturing in more than seven days; (2) OTC options contracts and certain other derivatives (including certain swap agreements); B-13 (3) fixed time deposits that are not subject to prepayment or do not provide for withdrawal penalties upon prepayment (other than overnight deposits); (4) participation interests in loans; (5) municipal lease obligations; (6) commercial paper issued pursuant to Section 4(2) of the Securities Act of 1933 (the 1933 Act); and (7) securities whose disposition is restricted under the federal securities laws. Illiquid securities include restricted, privately placed securities that, under the federal securities laws, generally may be resold only to qualified institutional buyers. If a substantial market develops for a restricted security (or other illiquid investment) held by a fund, it may be treated as a liquid security, in accordance with procedures and guidelines approved by the board of trustees. This generally includes securities that are unregistered, that can be sold to qualified institutional buyers in accordance with Rule 144A under the 1933 Act, or that are exempt from registration under the 1933 Act, such as commercial paper. While a fund's advisor monitors the liquidity of restricted securities on a daily basis, the board of trustees oversees and retains ultimate responsibility for the advisor's liquidity determinations. Several factors that the trustees consider in monitoring these decisions include the valuation of a security, the availability of qualified institutional buyers, brokers, and dealers that trade in the security, and the availability of information about the security's issuer. REVERSE REPURCHASE AGREEMENTS. In a reverse repurchase agreement, a fund sells a security to another party, such as a bank or broker-dealer, in return for cash and agrees to repurchase that security at an agreed-upon price and time. Under a reverse repurchase agreement, the fund continues to receive any principal and interest payments on the underlying security during the term of the agreement. Reverse repurchase agreements involve the risk that the market value of securities retained by the fund may decline below the repurchase price of the securities sold by the fund which it is obligated to repurchase. A reverse repurchase agreement may be considered a borrowing transaction for purposes of the 1940 Act. A reverse repurchase agreement transaction will not be considered to constitute the issuance of a "senior security" by a fund, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." A fund will enter into reverse repurchase agreements only with parties whose creditworthiness has been reviewed and found satisfactory by the advisor. SECURITIES LENDING. A fund may lend its investment securities to qualified institutional investors (typically brokers, dealers, banks, or other financial institutions) who may need to borrow securities in order to complete certain transactions, such as covering short sales, avoiding failures to deliver securities, or completing arbitrage operations. By lending its investment securities, a fund attempts to increase its net investment income through the receipt of interest on the securities lent. Any gain or loss in the market price of the securities lent that might occur during the term of the loan would be for the account of the fund. If the borrower defaults on its obligation to return the securities lent because of insolvency or other reasons, a fund could experience delays and costs in recovering the securities lent or in gaining access to the collateral. These delays and costs could be greater for foreign securities. If a fund is not able to recover the securities lent, a fund may sell the collateral and purchase a replacement investment in the market. The value of the collateral could decrease below the value of the replacement investment by the time the replacement investment is purchased. Cash received as collateral through loan transactions may be invested in other eligible securities. Investing this cash subjects that investment to market appreciation or depreciation. The terms and the structure and the aggregate amount of securities loans must be consistent with the 1940 Act, and the rules or interpretations of the SEC thereunder. These provisions limit the amount of securities a fund may lend to 33 1/3% of the fund's total assets, and require that (1) the borrower pledge and maintain with the fund collateral consisting of cash, an irrevocable letter of credit or securities issued or guaranteed by the U.S. government having at all times not less than 100% of the value of the securities lent, (2) the borrower add to such collateral whenever the price of the securities lent rises (i.e., the borrower "marks-to-market" on a daily basis), (3) the loan be made subject to termination by the fund at any time, and (4) the fund receive reasonable interest on the loan (which may include the fund's investing any cash collateral in interest bearing short-term investments), any distribution on the lent securities, and any increase in their market value. Loan arrangements made by each fund will comply with all other applicable regulatory requirements, including the rules of the New York Stock Exchange, which presently require the borrower, after notice, to redeliver the securities within the normal settlement time of three business days. The advisor will consider the creditworthiness of the borrower, among other things, in making decisions with respect to the lending of securities, subject to oversight by the board of trustees. At the present time, the SEC does not object if an investment company pays reasonable negotiated fees in connection with lent securities, so long as such fees are set forth in a written contract and approved by the investment company's trustees. In addition, voting rights pass with the lent securities, but if a material event occurs affecting an investment on loan, the loan must be called and the securities voted. B-14 SWAP AGREEMENTS. A swap agreement is a derivative (see additional discussion above). A swap agreement is an agreement between two parties (counterparties) to exchange payments at specified dates (periodic payment dates) on the basis of a specified amount (notional amount) with the payments calculated with reference to a specified asset, reference rate, or index. Examples of swap agreements include, but are not limited to, interest rate swaps, credit default swaps, equity swaps, commodity swaps, foreign currency swaps, index swaps, and total return swaps. Most swap agreements provide that when the periodic payment dates for both parties are the same, payments are netted, and only the net amount is paid to the counterparty entitled to receive the net payment. Consequently, a fund's current obligations (or rights) under a swap agreement will generally be equal only to the net amount to be paid or received under the agreement, based on the relative values of the positions held by each counterparty. Swap agreements allow for a wide variety of transactions. For example, fixed rate payments may be exchanged for floating rate payments; U.S. dollar-denominated payments may be exchanged for payments denominated in a different currency; and payments tied to the price of one asset, reference rate, or index may be exchanged for payments tied to the price of another asset, reference rate, or index. An option on a swap agreement, also called a "swaption," is an option that gives the buyer the right, but not the obligation, to enter into a swap on a future date in exchange for paying a market-based "premium." A receiver swaption gives the owner the right to receive the total return of a specified asset, reference rate, or index. A payer swaption gives the owner the right to pay the total return of a specified asset, reference rate, or index. Swaptions also include options that allow an existing swap to be terminated or extended by one of the counterparties. The use of swap agreements by a fund entails certain risks, which may be different from, or possibly greater than, the risks associated with investing directly in the securities and other investments that are the referenced asset for the swap agreement. Swaps are highly specialized instruments that require investment techniques, risk analyses, and tax planning different from those associated with stocks, bonds, and other traditional investments. The use of a swap requires an understanding not only of the referenced asset, reference rate, or index but also of the swap itself, without the benefit of observing the performance of the swap under all possible market conditions. Swap agreements may be subject to liquidity risk, which exists when a particular swap is difficult to purchase or sell. If a swap transaction is particularly large or if the relevant market is illiquid (as is the case with many OTC swaps), it may not be possible to initiate a transaction or liquidate a position at an advantageous time or price, which may result in significant losses. In addition, swap transaction may be subject to a fund's limitation on investments in illiquid securities. Swap agreements may be subject to pricing risk, which exists when a particular swap becomes extraordinarily expensive (or cheap) relative to historical prices or the prices of corresponding cash market instruments. Under certain market conditions, it may not be economically feasible to initiate a transaction or liquidate a position in time to avoid a loss or take advantage of an opportunity or to realize the intrinsic value of the swap agreement. Because some swap agreements have a leverage component, adverse changes in the value or level of the underlying asset, reference rate, or index can result in a loss substantially greater than the amount invested in the swap itself. Certain swaps have the potential for unlimited loss, regardless of the size of the initial investment. A leveraged swap transaction will not be considered to constitute the issuance of a "senior security" by a fund, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." Like most other investments, swap agreements are subject to the risk that the market value of the instrument will change in a way detrimental to a fund's interest. A fund bears the risk that its advisor will not accurately forecast future market trends or the values of assets, reference rates, indexes, or other economic factors in establishing swap positions for the fund. If the advisor attempts to use a swap as a hedge against, or as a substitute for, a portfolio investment, the fund will be exposed to the risk that the swap will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the fund. While hedging strategies involving swap instruments can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other fund investments. Many swaps, in particular OTC swaps, are complex and often valued subjectively. Improper valuations can result in increased cash payment requirements to counterparties or a loss of value to a fund. The use of a swap agreement also involves the risk that a loss may be sustained as a result of the insolvency or bankruptcy of the counterparty or the failure of the counterparty to make required payments or otherwise comply with the terms of the agreement. Additionally, the use of credit default swaps can result in losses if a fund's advisor does not correctly evaluate the creditworthiness of the issuer on which the credit swap is based. B-15 The swaps market is a relatively new market and is largely unregulated. It is possible that developments in the swaps market, including potential government regulation, could adversely affect a fund's ability to terminate existing swap agreements or to realize amounts to be received under such agreements. TAX MATTERS -- FEDERAL TAX TREATMENT OF FUTURES CONTRACTS. A fund is required for federal income tax purposes to recognize as income for each taxable year its net unrealized gains and losses on certain futures contracts as of the end of the year as well as those actually realized during the year. In these cases, any gain or loss recognized with respect to a futures contract is considered to be 60% long-term capital gain or loss and 40% short-term capital gain or loss, without regard to the holding period of the contract. Gains and losses on certain other futures contracts (primarily non-U.S. futures contracts) are not recognized until the contracts are closed and are treated as long-term or short-term, depending on the holding period of the contract. Sales of futures contracts that are intended to hedge against a change in the value of securities held by a fund may affect the holding period of such securities and, consequently, the nature of the gain or loss on such securities upon disposition. A fund may be required to defer the recognition of losses on one position, such as futures contracts, to the extent of any unrecognized gains on a related offsetting position held by the fund. In order for a fund to continue to qualify for federal income tax treatment as a regulated investment company, at least 90% of its gross income for a taxable year must be derived from qualifying income; i.e., dividends, interest, income derived from loans of securities, gains from the sale of securities or of foreign currencies, or other income derived with respect to the fund's business of investing in securities or currencies. It is anticipated that any net gain recognized on futures contracts will be considered qualifying income for purposes of the 90% requirement. A fund will distribute to shareholders annually any net capital gains which have been recognized for federal income tax purposes on futures transactions. Such distributions will be combined with distributions of capital gains realized on the fund's other investments and shareholders will be advised on the nature of the distributions. TAX MATTERS -- FEDERAL TAX TREATMENT OF NON-U.S. TRANSACTIONS. Special rules govern the Federal income tax treatment of certain transactions denominated in a currency other than the U.S. dollar or determined by reference to the value of one or more currencies other than the U.S. dollar. The types of transactions covered by the special rules include the following: (1) the acquisition of, or becoming the obligor under, a bond or other debt instrument (including, to the extent provided in Treasury regulations, preferred stock); (2) the accruing of certain trade receivables and payables; and (3) the entering into or acquisition of any forward contract, futures contract, option, or similar financial instrument if such instrument is not marked to market. The disposition of a currency other than the U.S. dollar by a taxpayer whose functional currency is the U.S. dollar is also treated as a transaction subject to the special currency rules. However, foreign currency-related regulated futures contracts and non-equity options are generally not subject to the special currency rules if they are or would be treated as sold for their fair market value at year-end under the marking-to-market rules applicable to other futures contracts unless an election is made to have such currency rules apply. With respect to transactions covered by the special rules, foreign currency gain or loss is calculated separately from any gain or loss on the underlying transaction and is normally taxable as ordinary income or loss. A taxpayer may elect to treat as capital gain or loss foreign currency gain or loss arising from certain identified forward contracts, futures contracts, and options that are capital assets in the hands of the taxpayer and which are not part of a straddle. The Treasury Department issued regulations under which certain transactions subject to the special currency rules that are part of a "section 988 hedging transaction" (as defined in the IRC and the Treasury regulations) will be integrated and treated as a single transaction or otherwise treated consistently for purposes of the IRC. Any gain or loss attributable to the foreign currency component of a transaction engaged in by a fund which is not subject to the special currency rules (such as foreign equity investments other than certain preferred stocks) will be treated as capital gain or loss and will not be segregated from the gain or loss on the underlying transaction. It is anticipated that some of the non-U.S. dollar-denominated investments and foreign currency contracts a fund may make or enter into will be subject to the special currency rules described above. TAX MATTERS -- FOREIGN TAX CREDIT. Foreign governments may withhold taxes on dividends and interest paid with respect to foreign securities held by a fund. Foreign governments may also impose taxes on other payments or gains with respect to foreign securities. If, at the close of its fiscal year, more than 50% of a fund's total assets are invested in securities of foreign issuers, the fund may elect to pass through foreign taxes paid, and thereby allow shareholders to take a deduction or, if they meet certain holding period requirements, a tax credit on their tax returns. If shareholders do not meet the holding period requirements, they may still be entitled to a deduction for certain gains that were actually distributed by the fund, but will also show the amount of the available offsetting credit or deduction. B-16 TEMPORARY INVESTMENTS. A fund may take temporary defensive measures that are inconsistent with the fund's normal fundamental or non-fundamental investment policies and strategies in response to adverse market, economic, political, or other conditions as determined by the advisor. Such measures could include, but are not limited to, investments in (1) highly liquid short-term fixed income securities issued by or on behalf of municipal or corporate issuers, obligations of the U.S. government and its agencies, commercial paper, and bank certificates of deposit; (2) shares of other investment companies which have investment objectives consistent with those of the fund; (3) repurchase agreements involving any such securities; and (4) other money market instruments. There is no limit on the extent to which the fund may take temporary defensive measures. In taking such measures, the fund may fail to achieve its investment objective. WARRANTS. Warrants are instruments that give the holder the right, but not the obligation, to buy an equity security at a specific price for a specific period of time. Changes in the value of a warrant do not necessarily correspond to changes in the value of its underlying security. The price of a warrant may be more volatile than the price of its underlying security, and a warrant may offer greater potential for capital appreciation as well as capital loss. Warrants do not entitle a holder to dividends or voting rights with respect to the underlying security and do not represent any rights in the assets of the issuing company. A warrant ceases to have value if it is not exercised prior to its expiration date. These factors can make warrants more speculative than other types of investments. WHEN-ISSUED, DELAYED-DELIVERY, AND FORWARD-COMMITMENT TRANSACTIONS. When-issued, delayed-delivery, and forward-commitment transactions involve a commitment to purchase or sell specific securities at a predetermined price or yield in which payment and delivery take place after the customary settlement period for that type of security. Typically, no interest accrues to the purchaser until the security is delivered. When purchasing securities pursuant to one of these transactions, payment for the securities is not required until the delivery date. However, the purchaser assumes the rights and risks of ownership, including the risks of price and yield fluctuations and the risk that the security will not be issued as anticipated. When a fund has sold a security pursuant to one of these transactions, the fund does not participate in further gains or losses with respect to the security. If the other party to a delayed-delivery transaction fails to deliver or pay for the securities, the fund could miss a favorable price or yield opportunity or suffer a loss. A fund may renegotiate a when-issued or forward-commitment transaction and may sell the underlying securities before delivery, which may result in capital gains or losses for the fund. When-issued, delayed-delivery, and forward-commitment transactions will not be considered to constitute the issuance of a "senior security" by a fund, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by the fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." INVESTMENT LIMITATIONS Each Fund is subject to the following fundamental investment limitations, which cannot be changed in any material way without the approval of the holders of a majority of the Fund's shares. For these purposes, a "majority" of shares means shares representing the lesser of: (1) 67% or more of the Fund's net assets voted, so long as shares representing more than 50% of the Fund's net assets are present or represented by proxy; or (2) more than 50% of the Fund's net assets. BORROWING. Each Fund may borrow money for temporary or emergency purposes only in an amount not to exceed 15% of the Fund's net assets. The Fund may borrow money through banks, reverse repurchase agreements, or Vanguard's interfund lending program only, and must comply with all applicable regulatory conditions. The Fund may not make any additional investments whenever its outstanding borrowings exceed 5% of net assets. COMMODITIES. Each Fund may not invest in commodities or commodity contracts, except that it may invest in forward foreign currency exchange transaction, and each Fund may invest in futures contracts and options on futures and securities. No more than 5% of each Fund's total assets may be used as initial margin deposit for futures contracts, and no more than 20% of each Fund's total assets may be obligated under stock futures contracts or options at any time. The Precious Metals and Mining Fund may also invest in bullion as described in the prospectus. DIVERSIFICATION. With respect to 75% of its total assets, each Fund (except for the Precious Metals and Mining and REIT Index Funds) may not: (1) purchase more than 10% of the outstanding voting securities of any one issuer; or (2) purchase securities of any issuer if, as a result, more than 5% of the Fund's total assets would be invested in that issuer's securities. This limitation does not apply to obligations of the U.S. government, its agencies, or instrumentalities. For the Precious Metals and Mining and REIT Index Funds, each Fund will limit the aggregate value of its holdings (except U.S. government securities, cash, and cash items, as defined under subchapter M of the IRC, each of which B-17 exceeds 5% of the Fund's total assets or 10% of the issuer's outstanding voting securities, to an aggregate of 50% of the Fund's total assets as of the end of each quarter of the taxable year. Additionally, each Fund will limit the aggregate value of holdings of a single issuer (except U.S. government securities, cash, and cash items, as defined in the IRC) to a maximum of 25% of the Fund's total assets as of the end of each quarter of the taxable year. ILLIQUID SECURITIES. Each Fund may not acquire any security if, as a result, more than 15% of its net assets would be invested in securities that are illiquid. INDUSTRY CONCENTRATION. Each Fund (with the exception of the Dividend Growth Fund) will concentrate its assets in securities of issuers in a particular industry or group of industries denoted by the Fund's name. That is, Vanguard Energy Fund will concentrate in energy-industry securities, Vanguard Health Care Fund will concentrate in health care-industry securities, Vanguard Precious Metals and Mining Fund will concentrate in precious metals-industry securities, and Vanguard REIT Index Fund will concentrate in REIT securities. The Dividend Growth Fund will concentrate no more than 25% of its assets in any single industry. INVESTING FOR CONTROL. Each Fund may not invest in a company for purposes of controlling its management. INVESTMENT OBJECTIVE. Unless stated otherwise in the "More on the Fund)" section of the prospectuses, the investment objective of each Fund may not be materially changed without a shareholder vote. LOANS. Each Fund may not lend money to any person except by purchasing fixed income securities that are publicly distributed or customarily purchased by institutional investors, by lending its portfolio securities, or through Vanguard's interfund lending program. MARGIN. Each Fund may not purchase securities on margin or sell securities short (unless by virtue of its ownership of other securities it has a right to obtain, at no added cost, securities equivalent in kind and amount to the securities sold), except as permitted by the Fund's investment policies relating to commodities. PLEDGING ASSETS. Each Fund may not pledge, mortgage, or hypothecate more than 15% of its net assets. PUTS AND CALLS. Each Fund may not invest in puts or calls or combinations thereof, except as permitted by the Fund's investment policies relating to commodities. REAL ESTATE. Each Fund (with the exception of the REIT Index Fund, which may invest 100% of its assets in real estate investment trusts) may not invest directly in real estate, although it may invest in securities of companies that deal in real estate, or interests therein. SENIOR SECURITIES. Each Fund may not issue senior securities, except in compliance with the 1940 Act. UNDERWRITING. Each Fund may not engage in the business of underwriting securities issued by other persons. A Fund will not be considered an underwriter when disposing of its investment securities. Compliance with the investment limitations set forth above is measured at the time the securities are purchased. If a percentage restriction is adhered to at the time the investment is made, a later change in percentage resulting from a change in the market value of assets will not constitute a violation of such restriction. None of these limitations prevents a Fund from having an ownership interest in Vanguard. As part owner of Vanguard, each Fund may own securities issued by Vanguard, make loans to Vanguard, and contribute to Vanguard's costs or other financial requirements. See "Management of the Funds" for more information. SHARE PRICE Each Fund's share price, called its net asset value, or NAV, is calculated each business day after the close of regular trading on the New York Stock Exchange (the Exchange), generally 4 p.m., Eastern time. NAV per share for the Energy, Health Care, and REIT Index Funds is computed by dividing the net assets allocated to each share class by the number of Fund shares outstanding for that class. NAV per share for the Dividend Growth and Precious Metals and Mining Funds is computed by dividing the net assets of the Fund by the number of Fund shares outstanding. The Exchange typically observes the following holidays: New Year's Day, Martin Luther King Jr. Day, President's Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. Although each Fund expects the same holidays to be observed in the future, the Exchange may modify its holiday schedule or hours of operation at any time. B-18 PURCHASE AND REDEMPTION OF SHARES PURCHASE OF SHARES The purchase price of shares of each Fund is the NAV per share next determined after the purchase request is received in good order, as defined in the Funds' prospectuses. The NAV per share is calculated as of the close of regular trading on the Exchange on each day the Exchange is open for business. A purchase order received before the close of regular trading on the Exchange will be executed at the NAV computed on the date of receipt; a purchase order received after the close of regular trading on the Exchange will be executed at the NAV computed on the first business day following the date of receipt. EXCHANGE OF SECURITIES FOR SHARES OF A FUND (OTHER THAN VIPER SHARES). In certain circumstances, shares of a fund may be purchased "in kind" (i.e., in exchange for securities, rather than for cash). The securities tendered as part of an in-kind purchase must be included in the index tracked by an index fund and must have a total market value of $1 million or more. In addition, each position must have a market value of $10,000 or more. Such securities also must be liquid securities that are not restricted as to transfer and have a value that is readily ascertainable as evidenced by a listing on the American Stock Exchange, the New York Stock Exchange, or Nasdaq. Securities accepted by the fund will be valued, as set forth in the fund's prospectus, as of the time of the next determination of NAV after such acceptance. Shares of each fund are issued at the NAV determined as of the same time. All dividend, subscription, or other rights that are reflected in the market price of accepted securities at the time of valuation become the property of the fund and must be delivered to the fund by the investor upon receipt from the issuer. A gain or loss for federal income tax purposes would be realized by the investor upon the exchange, depending upon the cost of the securities tendered. A fund will not accept securities in exchange for its shares unless: (1) such securities are, at the time of the exchange, eligible to be held by the fund; (2) the transaction will not cause the fund's weightings to become imbalanced with respect to the weightings of the securities included in the target index for the index fund; (3) the investor represents and agrees that all securities offered to the fund are not subject to any restrictions upon their sale by the fund under the 1933 Act, or otherwise; (4) such securities are traded in an unrelated transaction with a quoted sales price on the same day the exchange valuation is made; (5) the quoted sales price used as a basis of valuation is representative (e.g., one that does not involve a trade of substantial size that artificially influences the price of the security); and (6) the value of any such security being exchanged will not exceed 5% of the fund's net assets immediately prior to the transaction. Investors interested in purchasing fund shares in kind should contact Vanguard. REDEMPTION OF SHARES (OTHER THAN VIPER SHARES) Each Fund may suspend redemption privileges or postpone the date of payment for redeemed shares (1) during any period that the Exchange is closed or trading on the Exchange is restricted as determined by the SEC, (2) during any period when an emergency exists, as defined by the SEC, as a result of which it is not reasonably practicable for the Fund to dispose of securities it owns or to fairly determine the value of its assets, and (3) for such other periods as the SEC may permit. Each Fund has filed a notice of election with the SEC to pay in cash all redemptions requested by any shareholder of record limited in amount during any 90-day period to the lesser of $250,000 or 1% of the net assets of the Fund at the beginning of such period. If Vanguard determines that it would be detrimental to the best interests of the remaining shareholders of a Fund to make payment wholly or partly in cash, the Fund may pay the redemption price in whole or in part by a distribution in kind of readily marketable securities held by the Fund in lieu of cash in conformity with applicable rules of the SEC. Investors may incur brokerage charges on the sale of such securities received in payment of redemptions. The Dividend Growth Fund does not charge a redemption fee. The Energy, Health Care, Precious Metals and Mining, and REIT Index Funds charge a redemption fee of 1% of the value of shares that were held for less than one year. The fee is withheld from redemption proceeds and retained by the Funds. Shares redeemed may be worth more or less than what was paid for them, depending on the market value of the securities held by the Funds. We will redeem your oldest shares first. In addition, in the event that you transfer your Energy, Health Care, Precious Metals and Mining, and REIT Index Funds shares to a different account registration, or convert them to a different share B-19 class, the shares will retain their redemption fee status. If you transfer or convert less than 100% of these shares, the redemption fee status of your shares will be carried over on a proportionate basis. RIGHT TO CHANGE POLICIES Vanguard reserves the right to (1) alter, add, or discontinue any conditions of purchase, service, or privilege at any time without notice; (2) accept initial purchases by telephone; (3) freeze any account and suspend account services when Vanguard has received reasonable notice of a dispute between the registered or beneficial account owners or when we reasonably believe a fraudulent transaction may occur or has occurred; (4) alter, impose, discontinue, or waive any redemption, low-balance account, account maintenance, or other fees charged to a group of shareholders; and (5) redeem an account, without the owner's permission to do so, in cases of threatening conduct or suspicious, fraudulent or illegal activity. Changes may affect all investors or only those in certain classes or groups. These actions will be taken when, in the sole discretion of Vanguard management, we reasonably believe they are deemed to be in the best interest of a fund. INVESTING WITH VANGUARD THROUGH OTHER FIRMS Each Fund has authorized certain agents to accept on its behalf purchase and redemption orders, and those agents are authorized to designate other intermediaries to accept purchase and redemption orders on the Fund's behalf (collectively, Authorized Agents). A Fund will be deemed to have received a purchase or redemption order when an Authorized Agent accepts the order in accordance with the Fund's instructions. In most instances, a customer order that is properly transmitted to an Authorized Agent will be priced at the Fund's NAV next determined after the order is received by the Authorized Agent. If you invest with Vanguard through another firm, you should review that firm's policies relating to trading in the Vanguard funds. MANAGEMENT OF THE FUNDS VANGUARD Each Fund is a member of Vanguard, which consists of more than 130 funds. Through their jointly-owned subsidiary, Vanguard, the funds obtain at cost virtually all of their corporate management, administrative, and distribution services. Vanguard also provides investment advisory services on an at-cost basis to several of the Vanguard funds, including the Funds. Vanguard employs a supporting staff of management and administrative personnel needed to provide the requisite services to the funds and also furnishes the funds with necessary office space, furnishings, and equipment. Each fund pays its share of Vanguard's total expenses, which are allocated among the funds under methods approved by the board of trustees of each fund. In addition, each fund bears its own direct expenses, such as legal, auditing, and custodian fees. The funds' officers are also officers and employees of Vanguard. Vanguard, Vanguard Marketing Corporation, the funds' advisors, and the funds have adopted Codes of Ethics designed to prevent employees who may have access to nonpublic information about the trading activities of the funds (access persons) from profiting from that information. The Codes permit access persons to invest in securities for their own accounts, including securities that may be held by a fund, but place substantive and procedural restrictions on the trading activities of access persons. For example, the Codes require that access persons receive advance approval for most securities trades to ensure that there is no conflict with the trading activities of the funds. The Codes also limit the ability of Vanguard employees to engage in short-term trading of Vanguard funds. Vanguard was established and operates under an Amended and Restated Funds' Service Agreement, which was approved by the shareholders of each of the funds. The Amended and Restated Funds' Service Agreement provides as follows: (1) each Vanguard fund may be called upon to invest up to 0.40% of its current net assets in Vanguard, and (2) there is no other limitation on the dollar amount that each Vanguard fund may contribute to Vanguard's capitalization. The amounts that each fund has invested are adjusted from time to time in order to maintain the proportionate relationship between each fund's relative net assets and its contribution to Vanguard's capital. As of January 31, 2005, the Funds contributed $3,955,000 to Vanguard, which represented 0.01% of each Fund's net assets and was 4.65% of Vanguard's capitalization. B-20 MANAGEMENT. Corporate management and administrative services include: (1) executive staff; (2) accounting and financial; (3) legal and regulatory; (4) shareholder account maintenance; (5) monitoring and control of custodian relationships; (6) shareholder reporting; and (7) review and evaluation of advisory and other services provided to the funds by third parties. DISTRIBUTION. Vanguard Marketing Corporation, a wholly-owned subsidiary of Vanguard, provides all distribution and marketing activities for the funds. The principal distribution expenses are for advertising, promotional materials, and marketing personnel. Distribution services may also include organizing and offering to the public, from time to time, one or more new investment companies. The funds' trustees review and approve the amount to be spent annually on distribution activities, as well as the manner and amount to be spent on each fund. The trustees also determine whether to organize new investment companies. One half of the distribution expenses of a marketing and promotional nature is allocated among the funds based upon their relative net assets. The remaining half of those expenses is allocated among the funds based upon each fund's sales for the preceding 24 months relative to the total sales of the funds as a group, provided, however, that no fund's aggregate quarterly rate of contribution for distribution expenses of a marketing and promotional nature shall exceed 125% of the average distribution expense rate for Vanguard, and that no fund shall incur annual distribution expenses in excess of 0.20 of 1% of its average month-end net assets. During the fiscal years ended January 31, 2003, 2004, and 2005, the Funds incurred the following approximate amounts of Vanguard's management and administrative (including transfer agency), distribution, and marketing expenses:
FUND 2003 2004 2005 ---- ---- ---- ---- Vanguard Dividend Growth Fund $ 1,651,000 $ 1,799,000 $ 2,040,000 Vanguard Energy Fund 4,708,000 5,678,000 10,347,000 Vanguard Health Care Fund 35,546,000 34,985,000 32,086,000 Vanguard Precious Metals and Mining Fund 2,014,000 1,870,000 1,899 ,000 Vanguard REIT Index Fund 4,612,000 6,328,000 9,289,000
INVESTMENT ADVISORY SERVICES. Vanguard provides investment advisory services to the Funds and several other Vanguard funds. These services are provided on an at-cost basis from an experienced investment management staff employed directly by Vanguard. OFFICERS AND TRUSTEES The officers of the Funds manage the day-to-day operations of the Funds under the direction of the Funds' board of trustees. The trustees set broad policies for the Funds; select investment advisors; monitor fund operations, performance, and costs; nominate and select new trustees; and elect fund officers. Each trustee serves a Fund until its termination; until the trustee's retirement, resignation, or death; or as otherwise specified in the Trust's organizational documents. Any trustee may be removed at a meeting of shareholders by a vote representing two-thirds of the total net asset value of all shares of the Funds. Each trustee also serves as a director of Vanguard. B-21 The following chart shows information for each trustee and executive officer of the Funds. The mailing address of the trustees and officers is P.O. Box 876, Valley Forge, PA 19482.
VANGUARD POSITION(S) FUNDS' TRUSTEE/ PRINCIPAL OCCUPATION(S) NUMBER OF VANGUARD FUNDS NAME, YEAR OF BIRTH HELD WITH FUNDS OFFICER SINCE DURING THE PAST FIVE YEARS OVERSEEN BY TRUSTEE/OFFICER - ------------------- --------------- -------------- -------------------------- --------------------------- INTERESTED TRUSTEE John J. Brennan* President, Chairman May 1987 President, 132 (1954) of the Board, Chief Officer, and Director (Trustee) of Executive Officer, Vanguard and each of the and Trustee investment companies served by Vanguard. - ------------------------------------------------------------------------------------------------------------------------------------ INDEPENDENT TRUSTEES Charles D. Ellis Trustee January 2001 The Partners of '63 (pro bono ventures in 132 (1937) education); Senior Advisor to Greenwich Associates (international business strategy consulting); Successor Trustee of Yale University; Overseer of the Stern School of Business at New York University; Trustee of the Whitehead Institute for Biomedical Research. Rajiv L. Gupta Trustee December 2001 Chairman and Chief Executive Officer 132 (1945) of Rohm and Haas Co.(chemicals) since October 1999; Board Member of American Chemistry Council; Director of Tyco International, Ltd. (diversified manufacturing and services( since 2005; Trustee of Drexel University and Chemical Heritage Foundation. JoAnn Heffernan Heisen Trustee July 1998 Vice President, Chief Information Officer, and 132 (1950) Member of the Executive Committee of Johnson & Johnson (pharmaceuticals/ consumer products); Director of the University Medical Center at Princeton and Women's Research and Education Institute. Burton G. Malkiel Trustee May 1977 Chemical Bank Chairman's Professor of Economics, 129 (1932) Princeton University; Director of Vanguard Investment Series plc (Irish investment fund) since November 2001, Vanguard Group (Ireland) Limited (investment management) since November 2001, Prudential Insurance Co. of America, BKF Capital (investment management), The Jeffrey Co. (holding company), and CareGain, Inc. (health care management). Andre F. Perold Trustee December 2004 George Gund Professor of Funance and Banking, Harvard 132 (1952) Business School since 2000; Senior Associate Dean: Director of Faculty Recruiting, and Chair of Finance Faculty, Harvard Business School: Director and Chairman of Unx, Inc. (equities trading firm)since 2003; Director of registered investment companies advised by Merrill Lynch Investment Managers and affiliates (1985-2004); Genbel Securities Limited (South African financial services firm) (1999-2003), Gensec Bank (1999 through 2003), Sanlam Investment Management (1999-2001), Sanlam, Ltd, (South African insurance company) (200-2003), Stockbank, Inc. (credit card firm) (2000-2002), Bulldogresearch.com (investment research) (1999-2001); and Trustee of Commonfund (investment management) (1989-2001). *Officers of the Funds are "interested persons" as defined in the 1940 Act.
B-22
VANGUARD POSITION(S) FUNDS' TRUSTEE/ PRINCIPAL OCCUPATION(S) NUMBER OF VANGUARD FUNDS NAME, YEAR OF BIRTH HELD WITH FUNDS OFFICER SINCE DURING THE PAST FIVE YEARS OVERSEEN BY TRUSTEE/OFFICER - ------------------- --------------- -------------- -------------------------- --------------------------- Alfred M. Rankin, Jr. Trustee January 1993 Chairman, President, Chief Executive Officer, 132 (1941) and Director of NACCO Industries, Inc.(forklift trucks/housewares/lignite); Director of Goodrich Corporation (industrial products/ aircraft systems and services). Director of the Standard Products Company (supplier for automotive industry) until 1998. J. Lawrence Wilson Trustee April 1985 Retired Chairman and Chief Executive Officer 132 (1936) of Rohm and Haas Co. (chemicals); Director of Cummins Inc. (diesel engines), The MeadWestvaco Corp. (packaging products), and Amerisource Bergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University and Culver E ducational Foundation. - ----------------------------------------------------------------------------------------------------------------------------------- EXECUTIVE OFFICERS R. Gregory Barton* Secretary June 2001 Managing Director and General Counsel of 132 (1951) Vanguard since September 1997; Secretary of Vanguard and of each of the investment companies served by Vanguard (since June 2001) Thomas J. Higgins* Treasurer July 1998 Principal of The Vanguard Group, Inc.; 132 (1957) Treasurer of each of the investment companies served by since July 1998.
*Officers of the Funds are "interested persons" as defined in the 1940 Act. Mr. Ellis is a Senior Advisor to Greenwich Associates, a firm that consults on business strategy to professional financial services organizations in markets around the world. A large number of financial service providers, including Vanguard, subscribe to programs of research-based consulting. During 2003 and 2004, Vanguard paid Greenwich subscription fees amounting to less than $350,000. Vanguard's subscription rates are similar to those of other subscribers. Board Committees: Each Fund's board has the following committees: - - Audit Committee: This committee oversees the accounting and financial reporting policies, the systems of internal controls, and the independent audits of each Fund and Vanguard. All independent trustees serve as members of the committee. The committee held three meetings during each Fund's last fiscal year. - - Compensation Committee: This committee oversees the compensation programs established by each Fund and Vanguard for the benefit of their employees, officers, and trustees/directors. All independent trustees serve as members of the committee. The committee held three meetings during each Fund's last fiscal year. - - Nominating Committee: This committee nominates candidates for election to Vanguard's board of directors and the board of trustees of each fund (collectively, the Vanguard boards). The committee also has the authority to recommend the removal of any director or trustee from the Vanguard boards. All independent trustees serve as members of the committee. The committee held four meetings during each Fund's last fiscal year. The Nominating Committee will consider shareholder recommendations for trustee nominees. Shareholders may send recommendations to Mr. Wilson, Chairman of the Committee. B-23 TRUSTEES' OWNERSHIP OF FUND SHARES All trustees allocate their investments among the various Vanguard funds based on their own investment needs. The following table shows each trustee's ownership of shares of each Fund and of all Vanguard funds served by the trustee as of December 31, 2004. As a group, the funds' trustees and officers own less than 1% of the outstanding shares of each class of each fund.
AGGREGATE DOLLAR DOLLAR RANGE OF RANGE OF VANGUARD FUND SHARES FUND SHARES FUND TRUSTEE OWNED BY TRUSTEE OWNED BY TRUSTEE - ---- ------- ---------------- ----------------- VANGUARD DIVIDEND GROWTH FUND John J. Brennan None Over $100,000 Charles D. Ellis None Over $100,000 Rajiv L. Gupta None Over $100,000 JoAnn Heffernan Heisen None Over $100,000 Burton G. Malkiel None Over $100,000 Alfred M. Rankin, Jr. None Over $100,000 Andre F. Perold None Over $100,000 J. Lawrence Wilson None Over $100,000 VANGUARD ENERGY FUND John J. Brennan None Over $100,000 Charles D. Ellis None Over $100,000 Rajiv L. Gupta None Over $100,000 JoAnn Heffernan Heisen None Over $100,000 Burton G. Malkiel None Over $100,000 Andre F. Perold None Over $100,000 Alfred M. Rankin, Jr. None Over $100,000 J. Lawrence Wilson Over $100,000 Over $100,000 VANGUARD HEALTH CARE FUND John J. Brennan None Over $100,000 Charles D. Ellis None Over $100,000 Rajiv L. Gupta None Over $100,000 JoAnn Heffernan Heisen $10,001- $50,000 Over $100,000 Burton G. Malkiel None Over $100,000 Andre F. Perold None Over $100,000 Alfred M. Rankin, Jr. $50,001- $100,000 Over $100,000 J. Lawrence Wilson Over $100,000 Over $100,000 VANGUARD PRECIOUS METALS AND MINING FUND John J. Brennan None Over $100,000 Charles D. Ellis None Over $100,000 Rajiv L. Gupta None Over $100,000 JoAnn Heffernan Heisen None Over $100,000 Burton G. Malkiel None Over $100,000 Andre F. Perold None Over $100,000 Alfred M. Rankin, Jr. None Over $100,000 J. Lawrence Wilson Over $100,000 Over $100,000
B-24
AGGREGATE DOLLAR DOLLAR RANGE OF RANGE OF VANGUARD FUND SHARES FUND SHARES FUND TRUSTEE OWNED BY TRUSTEE OWNED BY TRUSTEE - ---- ------- ---------------- ----------------- VANGUARD REIT INDEX FUND John J. Brennan None Over $100,000 Charles D. Ellis None Over $100,000 Rajiv L. Gupta None Over $100,000 JoAnn Heffernan Heisen None Over $100,000 Burton G. Malkiel $10,001- $50,000 Over $100,000 Alfred M. Rankin, Jr. None Over $100,000 Andre F. Perold None Over $100,000 J. Lawrence Wilson None Over $100,000
TRUSTEE COMPENSATION The same individuals serve as trustees of all Vanguard funds (with one exception, which is noted in the table on page B-23), and each fund pays a proportionate share of the trustees' compensation. The funds also employ their officers on a shared basis; however, officers are compensated by Vanguard, not the funds. INDEPENDENT TRUSTEES. The funds compensate their independent trustees (i.e., the ones who are not also officers of the funds) in three ways: - - The independent trustees receive an annual fee for their service to the funds, which is subject to reduction based on absences from scheduled board meetings. - - The independent trustees are reimbursed for the travel and other expenses that they incur in attending board meetings. - - Upon retirement (after attaining age 65 and completing five years of service), the independent trustees who began their service prior to January 1, 2001, receive a retirement benefit under a separate account arrangement. As of January 1, 2001, the opening balance of each eligible trustee's separate account was generally equal to the net present value of the benefits he or she had accrued under the trustees' former retirement plan. Each eligible trustee's separate account will be credited annually with interest at a rate of 7.5% until the trustee receives his or her final distribution. Those independent trustees who began their service on or after January 1, 2001, are not eligible to participate in the plan. "INTERESTED" TRUSTEE. Mr. Brennan serves as a trustee, but is not paid in this capacity. He is, however, paid in his role as officer of Vanguard. COMPENSATION TABLE. The following table provides compensation details for each of the trustees. We list the amounts paid as compensation and accrued as retirement benefits by the Funds for each trustee. In addition, the table shows the total amount of benefits that we expect each trustee to receive from all Vanguard funds upon retirement, and the total amount of compensation paid to each trustee by all Vanguard funds. B-25 VANGUARD SPECIALIZED FUNDS TRUSTEES' COMPENSATION TABLE
PENSION OR RETIREMENT AGGREGATE BENEFITS ACCRUED ACCRUED ANNUAL TOTAL COMPENSATION COMPENSATION AS PART OF THESE RETIREMENT BENEFITS FROM ALL VANGUARD NAME OF TRUSTEE FROM THESE FUNDS(1) FUNDS' EXPENSES(1) AT JANUARY 1, 2004(2) FUNDS PAID TO TRUSTEE(3) - ------------------------------------------------------------------------------------------------------------------------------ John J. Brennan None None None None Charles D. Ellis $6,578 N/A N/A $112,700 Rajiv L. Gupta 6,578 N/A N/A 112,700 JoAnn Heffernan Heisen 6,578 $212 $ 3,900 112,700 Burton G. Malkiel 6,578 348 11,200 112,700 Andre F. Perold/(//4)/ 1,121 N/A N/A 19,200 Alfred M. Rankin, Jr. 6,578 256 6,070 112,700 J. Lawrence Wilson 7,590 270 8,400 130,000 /(1)/The amounts shown in this column are based on the Funds' fiscal year ended January 31, 2005. Each Fund within the Trust is responsible for a proportionate share of these amounts. /(2)/ Each trustee is eligible to receive retirement benefits only after completing at least 5 years (60 consecutive months) of service as a trustee for the Vanguard funds. The annual retirement benefit will be paid in monthly installments, beginning with the month following the trustee's retirement from service, and will cease after 10 years of payments (120 monthly installments). Trustees who began their service on or after January 1, 2001, are not eligible to participate in the retirement benefit plan. /(3)/ The amounts reported in this column reflect the total compensation paid to each trustee for his or her service as trustee of 132 Vanguard funds (129 in the case of Mr. Malkiel) for the 2004 calendar year. /(4)/ Mr. Perold became a trustee effective December 2004.
PORTFOLIO HOLDINGS DISCLOSURE POLICIES AND PROCEDURES INTRODUCTION Vanguard and the Boards of Trustees of the Vanguard funds (the Boards) have adopted Portfolio Holdings Disclosure Policies and Procedures (Polices and Procedures) to govern the disclosure of the portfolio holdings of a Vanguard fund. Vanguard and the Boards considered each of the circumstances under which Vanguard fund portfolio holdings may be disclosed to different categories of persons under the Policies and Procedures. Vanguard and the Boards also considered actual and potential material conflicts that could arise in such circumstances between the interests of Vanguard fund shareholders, on the one hand, and those of the fund's investment advisor, distributor, or any affiliated person of the fund, its investment advisor, or its distributor, on the other. After giving due consideration to such matters and after the exercise of their fiduciary duties and reasonable business judgment, Vanguard and the Boards determined that the Vanguard funds have a legitimate business purpose for disclosing portfolio holdings to the persons described in each of the circumstances set forth in the Policies and Procedures and that the Policies and Procedures are reasonably designed to ensure that disclosure of portfolio holdings and information about portfolio holdings is in the best interests of fund shareholders and appropriately address the potential for material conflicts of interest. The Boards exercise continuing oversight of the disclosure of Vanguard fund portfolio holdings by (1) overseeing the implementation and enforcement of the Policies and Procedures, the Code of Ethics, and the Policies and Procedures Designed to Prevent the Misuse of Inside Information (collectively, the portfolio holdings governing policies) by the Chief Compliance Officer of Vanguard and the Vanguard funds, (2) considering reports and recommendations by the Chief Compliance Officer concerning any material compliance matters (as defined in Rule 38a-1 under the 1940 Act and Rule 206(4)-7 under the Investment Advisers Act of 1940) that may arise in connection with any portfolio holdings governing policies, and (3) considering whether to approve or ratify any amendment to any portfolio holdings governing policies. Vanguard and the Boards reserve the right to amend the Policies and Procedures at any time and from time to time without prior notice in their sole discretion. For purposes of the Policies and Procedures, the term "portfolio holdings" means the equity and debt securities (e.g., stocks and bonds) held by a Vanguard fund and does not mean the cash investments, derivatives, and other investment positions (collectively, other investment positions) held by the fund. B-26 ONLINE DISCLOSURE OF TEN LARGEST STOCK HOLDINGS Each of the Vanguard equity funds and Vanguard balanced funds generally will seek to disclose their ten largest stock portfolio holdings and the percentages that each of these ten largest stock portfolio holdings represent of the fund's total assets (collectively, ten largest stock holdings) as of the most recent calendar-quarter end online at www.vanguard.com in the "Holdings" section of the fund's Profile page, 15 calendar days after the end of the calendar quarter. Online disclosure of the ten largest stock holdings is made to all categories of persons, including individual investors, institutional investors, intermediaries, third-party service providers, rating and ranking organizations, affiliated persons of a Vanguard fund, and all other persons. ONLINE DISCLOSURE OF COMPLETE PORTFOLIO HOLDINGS Each of the Vanguard funds, excluding Vanguard money market funds, will seek to disclose their complete portfolio holdings as of the most recent calendar-quarter end online at www.vanguard.com in the "Holdings" section of the fund's Profile page, 30 calendar days after the end of the calendar quarter. Online disclosure of complete portfolio holdings is made to all categories of persons, including individual investors, institutional investors, intermediaries, third-party service providers, rating and ranking organizations, affiliated persons of a Vanguard fund, and all other persons. A Principal or Senior Analyst in Vanguard's Portfolio Review Department will review complete portfolio holdings before online disclosure is made as described above and, after consultation with a Vanguard fund's investment advisor, may withhold any portion of the fund's complete portfolio holdings from online disclosure as described above when deemed to be in the best interest of the fund. DISCLOSURE OF COMPLETE PORTFOLIO HOLDINGS TO SERVICE PROVIDERS SUBJECT TO CONFIDENTIALITY AND TRADING RESTRICTIONS Vanguard, for legitimate business purposes, may disclose Vanguard fund complete portfolio holdings at times it deems necessary and appropriate to rating and ranking organizations, financial printers, proxy voting service providers, pricing information vendors, third-parties that deliver analytical, statistical, or consulting services, and other third parties that provide services (collectively, Service Providers) to Vanguard, Vanguard subsidiaries, and/or the Vanguard funds. Disclosure of complete portfolio holdings to a Service Provider is conditioned on the Service Provider being subject to a written agreement imposing a duty of confidentiality, including a duty not to trade on the basis of any material nonpublic information. The frequency with which complete portfolio holdings may be disclosed to a Service Provider, and the length of the lag, if any, between the date of the information and the date on which the information is disclosed to the Service Provider, is determined based on the facts and circumstances, including, without limitation, the nature of the portfolio holdings information to be disclosed, the risk of harm to the funds and their shareholders, and the legitimate business purposes served by such disclosure. The frequency of disclosure to a Service Provider varies and may be as frequent as daily, with no lag. Disclosure of Vanguard fund complete portfolio holdings by Vanguard to a Service Provider must be authorized by a Vanguard fund officer or a Principal in Vanguard's Portfolio Review or Legal Departments. Any disclosure of Vanguard fund complete portfolio holdings to a Service Provider as described above may also include a list of the other investment positions comprising the fund, such as cash investments and derivatives. As of December 31, 2004, Vanguard fund complete portfolio holdings are disclosed to the following Service Providers as part of ongoing arrangements that serve legitimate business purposes: Alcom Printing Group Inc., Apple Press Automatic Data Processing, Inc., Intelligencer Printing Company, McMunn Associates Inc., Moore Wallace Inc., Pitney Bowes Management Services, Reuters America Inc., Triune Color Corporation, and Tursack Printing Inc. DISCLOSURE OF COMPLETE PORTFOLIO HOLDINGS TO VANGUARD AFFILIATES AND CERTAIN FIDUCIARIES SUBJECT TO CONFIDENTIALITY AND TRADING RESTRICTIONS Vanguard fund complete portfolio holdings may be disclosed between and among the following persons (collectively, (Affiliates and Fiduciaries) for legitimate business purposes within the scope of their official duties and responsibilities, subject to such persons' continuing legal duty of confidentiality and legal duty not to trade on the basis of any material nonpublic information, as such duties are imposed under the Code of Ethics, the Policies and Procedures Designed to Prevent the Misuse of Inside Information, by agreement, or under applicable laws, rules, and regulations: (1) persons who are subject to the Code of Ethics or the Policies and Procedures Designed to Prevent the Misuse of Inside Information; (2) an investment advisor, distributor, administrator, transfer agent, or custodian to a Vanguard fund; (3) an accounting firm, an auditing firm, or outside legal counsel retained by Vanguard, a Vanguard subsidiary, or a Vanguard B-27 fund; (4) an investment advisor to whom complete portfolio holdings are disclosed for due diligence purposes when the advisor is in merger or acquisition talks with a Vanguard fund's current advisor; and (5) a newly hired investment advisor or sub-advisor to whom complete portfolio holdings are disclosed prior to the time it commences its duties. The frequency with which complete portfolio holdings may be disclosed between and among Affiliates and Fiduciaries, and the length of the lag, if any, between the date of the information and the date on which the information is disclosed between and among the Affiliates and Fiduciaries, is determined by such Affiliates and Fiduciaries based on the facts and circumstances, including, without limitation, the nature of the portfolio holdings information to be disclosed, and the risk of harm to the funds and their shareholders, and the legitimate business purposes served by such disclosure. The frequency of disclosure between and among Affiliates and Fiduciaries varies and may be as frequent as daily, with no lag. Any disclosure of Vanguard fund complete portfolio holdings to any Affiliates and Fiduciaries as described in the preceding text may also include a list of the other investment positions comprising the fund, such as cash investments and derivatives. Disclosure of Vanguard fund complete portfolio holdings or investment positions by Vanguard, Vanguard Marketing Corporation, or a Vanguard fund to Affiliates and Fiduciaries must be authorized by a Vanguard fund officer or a Principal of Vanguard. As of December 31, 2004, Vanguard fund complete portfolio holdings are disclosed to the following Affiliates and Fiduciaries as part of ongoing arrangements that serve legitimate business purposes: Vanguard and each investment advisor, custodian, and independent registered public accounting firm identified in this Statement of Additional Information. DISCLOSURE OF PORTFOLIO HOLDINGS AS REQUIRED BY APPLICABLE LAW Vanguard fund portfolio holdings (whether partial portfolio holdings or complete portfolio holdings) and other investment positions comprising a fund shall be disclosed to any person as required by applicable laws, rules, and regulations. Examples of such required disclosure include, but are not limited to, disclosure of Vanguard fund portfolio holdings (1) in a filing or submission with the SEC or another regulatory body, (2) in connection with seeking recovery on defaulted bonds in a federal bankruptcy case, (3) in connection with a lawsuit, or (4) as required by court order. Disclosure of portfolio holdings or other investment positions by Vanguard, Vanguard Marketing Corporation, or a Vanguard fund as required by applicable laws, rules, and regulations must be authorized by a Vanguard fund officer or a Principal of Vanguard. DISCLOSURE OF PORTFOLIO HOLDINGS IN ACCORDANCE WITH SEC EXEMPTIVE ORDERS Vanguard's Fund Financial Services unit may disclose to the National Securities Clearing Corporation (NSCC) the daily portfolio composition files (PCFs) that identify a basket of specified securities which may overlap with the actual or expected portfolio holdings of the Vanguard index funds (VIPER Funds) that offer a class of shares known as Vanguard Index Participation Equity Receipts (VIPER) Shares in accordance with the terms and conditions of related exemptive orders (the VIPER Exemptive Orders) issued by the SEC, as described further below. Unlike the conventional classes of shares issued by VIPER Funds, the VIPER Shares are listed for trading on the American Stock Exchange (AMEX). Each VIPER Fund issues VIPER Shares in large blocks, known as "Creation Units." To purchase or redeem a Creation Unit, an investor must be an "Authorized Participant" or it must do so through a broker-dealer that is an Authorized Participant. An Authorized Participant is a participant in the Depository Trust Company (DTC) that has executed a Participant Agreement with Vanguard Marketing Corporation. Each VIPER Fund issues Creation Units in exchange for a "portfolio deposit" consisting of a basket of specified securities (Deposit Securities) and a cash payment (the Balancing Amount). Each VIPER Fund also redeems Creation Units in kind; an investor who tenders a Creation Unit will receive, as redemption proceeds, a basket of specified securities together with a Balancing Amount. In connection with the creation and redemption process, and in accordance with the terms and conditions of the VIPER Exemptive Orders, Vanguard makes available to the NSCC, for dissemination to NSCC participants on each business day prior to the opening of trading on the AMEX, a PCF containing a list of the names and the required number of shares of each Deposit Security for each VIPER Fund. (The NSCC is a clearing agency registered with the SEC and affiliated with DTC.) In addition, the AMEX disseminates (1) continuously throughout the trading day, through the facilities of the consolidated tape, the market value of a VIPER Share, and (2) every 15 seconds throughout the trading day, separately from the consolidated tape, a calculation of the estimated net asset value (NAV) of a VIPER Share (which estimate is expected to be accurate to within a few basis points). Comparing these two figures allows an investor to determine whether, and to what extent, VIPER Shares are selling at a premium or a discount to NAV. VIPER Shares are B-28 listed on the AMEX and traded in the secondary market in the same manner as other equity securities. The price of VIPER Shares trading on the secondary market is based on a current bid/offer market. As contemplated by the VIPER Exemptive Orders, Vanguard and the VIPER Funds expect that only institutional arbitrageurs and institutional investors with large indexed portfolios will buy and sell VIPER Shares in Creation Unit-sized aggregations because Creation Units can be purchased only in exchange for securities likely to cost millions of dollars. An AMEX specialist, in providing for a fair and orderly secondary market for VIPER Shares, also may purchase Creation Units for use in its market-making activities on the AMEX. Vanguard and the VIPER Funds expect secondary market purchasers of VIPER Shares will include both institutional and retail investors. Vanguard and the VIPER Funds believe that arbitrageurs will purchase or redeem Creation Units to take advantage of discrepancies between the VIPER Shares' market price and the VIPER Shares' underlying NAV. Vanguard and the VIPER Funds expect that this arbitrage activity will provide a market "discipline" that will result in a close correspondence between the price at which the VIPER Shares trade and their NAV. In other words, Vanguard and the VIPER Funds do not expect the VIPER Shares to trade at a significant premium or discount to their NAV. In addition to making PCFs available to NSCC as described above, Vanguard's Fund Financial Services unit may disclose the PCF for any VIPER Fund to any person, or online at www.vanguard.com to all categories of persons, if (1) such disclosure serves a legitimate business purpose and (2) such disclosure does not constitute material nonpublic information. Vanguard's Fund Financial Services unit must make a good faith determination whether the PCF for any VIPER Fund constitutes material nonpublic information, which involves an assessment of the particular facts and circumstances. Vanguard believes that in most cases the PCF for any VIPER Fund would be immaterial and would not convey any advantage to the recipient in making an investment decision concerning the VIPER Fund if sufficient time has passed between the date of the PCF and the date on which the PCF is disclosed. Vanguard's Fund Financial Services unit may in its sole discretion determine whether to deny any request for the PCF for any VIPER Fund made by any person, and may do so for any reason or no reason. Disclosure of a PCF must be authorized by a Vanguard fund officer or a Principal in Vanguard's Fund Financial Services unit. DISCLOSURE OF PORTFOLIO HOLDINGS TO BROKER-DEALERS IN THE NORMAL COURSE OF MANAGING A FUND'S ASSETS An investment advisor, administrator, or custodian for a Vanguard fund may, for legitimate business purposes within the scope of their official duties and responsibilities, disclose portfolio holdings (whether partial portfolio holdings or complete portfolio holdings) and other investment positions comprising the fund to one or more broker-dealers during the course of, or in connection with, normal day-to-day securities and derivatives transactions with or through such broker-dealers subject to the broker-dealer's legal obligation not to use or disclose material nonpublic information concerning the funds' portfolio holdings, other investment positions, securities transactions, or derivatives transactions without the consent of the funds or their agents. The Vanguard funds have not given their consent to any such use or disclosure and no person or agent of Vanguard is authorized to give such consent except as approved in writing by the fund Boards. Disclosure of portfolio holdings or other investment positions by Vanguard to broker-dealers must be authorized by a Vanguard fund officer or a Principal of Vanguard. DISCLOSURE OF NON-MATERIAL INFORMATION The Policies and Procedures permit Approved Vanguard Representatives to disclose any views, opinions, judgments, advice or commentary, or any analytical, statistical, performance, or other information, in connection with or relating to a Vanguard fund or its portfolio holdings and/or other investment positions (collectively, commentary and analysis) or any changes in the portfolio holdings of a Vanguard fund that occurred after the most recent calendar-quarter end (recent portfolio changes) to any person if (1) such disclosure serves a legitimate business purpose, (2) such disclosure does not effectively result in the disclosure of the complete portfolio holdings of any Vanguard fund (which can be disclosed only in accordance with the Policies and Procedures), and (3) such information does not constitute material nonpublic information. Disclosure of commentary and analysis or recent portfolio changes by Vanguard, Vanguard Marketing Corporation, or a Vanguard fund must be authorized by a Vanguard fund officer or a Principal of Vanguard. An Approved Vanguard Representative must make a good faith determination whether the information constitutes material nonpublic information, which involves an assessment of the particular facts and circumstances. Vanguard believes that in most cases recent portfolio changes that involve a few or even several securities in a diversified portfolio or commentary and analysis would be immaterial and would not convey any advantage to a recipient in making an B-29 investment decision concerning a Vanguard fund. Nonexclusive examples of commentary and analysis about a Vanguard fund include (1) the allocation of the fund's portfolio holdings and other investment positions among various asset classes, sectors, industries, and countries, (2) the characteristics of the stock and bond components of the fund's portfolio holdings and other investment positions, (3) the attribution of fund returns by asset class, sector, industry, and country, and (4) the volatility characteristics of the fund. An Approved Vanguard Representative may in its sole discretion determine whether to deny any request for information made by any person, and may do so for any reason or no reason. "Approved Vanguard Representatives" include Vanguard fund officers, Vanguard fund portfolio managers and other individuals employed by or associated with Vanguard or a subsidiary of Vanguard who have been authorized by a Principal in Vanguard's Portfolio Review Department to disclose recent portfolio changes and/or commentary and analysis in accordance with the Policies and Procedures. PROHIBITIONS ON DISCLOSURE OF PORTFOLIO HOLDINGS No person is authorized to disclose Vanguard fund portfolio holdings or other investment positions (whether online at www.vanguard.com, in writing, by fax, by e-mail, orally, or by other means) except in accordance with the Policies and Procedures. In addition, no person is authorized to make disclosure pursuant to the Policies and Procedures if such disclosure is otherwise unlawful under the antifraud provisions of the federal securities laws (as defined in Rule 38a-1 under the 1940 Act). Furthermore, Vanguard's management, in its sole discretion, may determine not to disclose portfolio holdings or other investment positions comprising a Vanguard fund to any person who would otherwise be eligible to receive such information under the Policies and Procedures, or may determine to make such disclosures publicly as provided by the Policies and Procedures. PROHIBITIONS ON RECEIPT OF COMPENSATION OR OTHER CONSIDERATION The Policies and Procedures prohibit a Vanguard fund, its investment advisor, and any other person to pay or receive any compensation or other consideration of any type for the purpose of obtaining disclosure of Vanguard fund portfolio holdings or other investment positions. "Consideration" includes any agreement to maintain assets in the fund or in other investment companies or accounts managed by the investment advisor or by any affiliated person of the investment advisor. INVESTMENT ADVISORY SERVICES The Trust currently has three investment advisors: - - Vanguard, 100 Vanguard Boulevard, Malvern, PA 19355, provides investment advisory services for the REIT Index Fund and a portion of the assets of the Energy Fund. - - M&G Investment Management Limited (M&G), Laurence Pountney Hill, London EC4H OHH, England, provides investment advisory services for the Precious Metals and Mining Fund. - - Wellington Management Company, LLP (Wellington Management), 75 State Street, Boston, MA 02109, provides investment advisory services for the Dividend Growth and Health Care Funds, and a portion of the assets of the Energy Fund. VANGUARD REIT INDEX FUND An experienced investment management staff employed directly by Vanguard provides investment advisory services to Vanguard REIT Index Fund on an at-cost basis. During the fiscal years ended January 31, 2003, 2004, and 2005, the Fund incurred expenses for investment advisory services of approximately $104,000, $114,000, and $83,000, respectively. VANGUARD ENERGY FUND Vanguard Energy Fund uses multiple investment advisors. The Fund's advisors discharge their responsibilities subject to the supervision and oversight of the trustees and officers of the Fund. The proportion of the net assets of the Fund managed by each advisor was established by the board of trustees and may be changed in the future by the board of trustees as circumstances warrant. Vanguard, through its Quantitative Equity Group, provides investment advisory services on an "internalized," at-cost basis for a portion of the Fund's assets. During the fiscal years ended January 31, 2003, 2004, and 2005, the Fund incurred advisory fees of $837,000, $1,103,000, and $2,335,000, respectively. B-30 DISCLOSURE REGARDING OTHER ACCOUNTS MANAGED Gerard C. O'Reilly managed the REIT Index Fund, which, as of January 31, 2005, held assets of $5,744,000,000. As of January 31, 2005, Mr. O'Reilly also managed six other registered investment companies with total assets of $73,975,500,000, and one other pooled investment vehicle with total assets of $256,000,000. Joel M. Dickson managed a portion of the Energy Fund; the Fund, as of April 30, 2005, held assets of $5,943,200,000. As of April 30, 2005, Mr. Dickson also managed $9,866,000,000 in assets of three other registered investment companies, and $447,000,000 in assets of two other pooled investment vehicles, including one where the advisory firm's fee was based on account performance with assets of $272,300,000. MATERIAL CONFLICTS OF INTEREST At Vanguard, individual portfolio managers may manage multiple accounts for multiple clients. In addition to mutual funds, these other accounts may include separate accounts, collective trusts, or offshore funds. Vanguard manages potential conflicts between funds or with other types of accounts through allocation policies and procedures, internal review processes and oversight by directors and independent third parties. Vanguard has developed trade allocation procedures and controls to ensure that no one client, regardless of type, is intentionally favored at the expense of another. Allocation policies are designed to address potential conflicts in situations where two or more funds or accounts participate in investment decisions involving the same securities. DESCRIPTION OF COMPENSATION As of January 31, 2005, a Vanguard portfolio manager's compensation generally consists of base salary, bonus, and payments under Vanguard's long-term incentive compensation program. In addition, portfolio managers are eligible for the standard retirement benefits and health and welfare benefits available to all Vanguard employees. Also, certain portfolio managers may be eligible for additional retirement benefits under several supplemental retirement plans that Vanguard adopted in the 1980's to restore dollar-for-dollar the benefits of management employees that had been cut back solely as a result of tax law changes. These plans are structured to provide the same retirement benefits as the standard retirement benefits. In the case of portfolio managers responsible for managing multiple Vanguard funds or accounts, the method used to determine their compensation is the same for all funds and investment accounts. A portfolio manager's base salary is determined by the manager's experience and performance in the role, taking into account the ongoing compensation benchmark analyses performed by the Vanguard Human Resources Department. A portfolio manager's base salary is generally a fixed amount that may change as a result of an annual review, upon assumption of new duties, or when a market adjustment of the position occurs. A portfolio manager's bonus is determined by a number of factors. One factor is gross, pre-tax performance of the fund relative to expectations for how the fund should have performed, given its objectives and policies and the market environment during the measurement period. This performance factor is not based on the value of assets held in the fund's portfolio. For the REIT Index Fund, the performance factor depends on how closely the portfolio manager tracks the fund's benchmark index over a one-year period. Additional factors include the portfolio manager's contributions to the investment management functions within the sub-asset class, contributions to the development of other investment professionals and supporting staff, and overall contributions to strategic planning and decisions for the investment group. The target bonus is expressed as a percentage of base salary. The actual bonus paid may be more or less than the target bonus, based on how well the manager satisfies the objectives stated above. The bonus is paid on an annual basis. Under the long-term incentive compensation program, all full-time employees receive a payment from Vanguard's long term incentive compensation plan based on their years of service, job level and, if applicable, management responsibilities. Each year, Vanguard's independent directors determine the amount of the long term incentive compensation award for that year based on the investment performance of the Vanguard funds relative to competitors and Vanguard's operating efficiencies in providing services to the Vanguard funds. THIRD-PARTY INVESTMENT ADVISORS For funds that are advised by independent third-party advisory firms unaffiliated with Vanguard, Vanguard hires investment advisory firm, not individual portfolio managers, to provide investment advisory services to such funds. Vanguard negotiates each advisory agreement, which contains advisory fee arrangements, on an arms-length basis with B-31 the advisory firm. Each advisory agreement is reviewed annually by each fund's board of trustees, taking into account numerous factors, which include, without limitation, the nature, extent, and quality of the services provided, investment performance, and fair market value of services provided. Each advisory agreement is between the fund and the advisory firm, not between the fund and the portfolio manager. The structure of the advisory fee paid to each unaffiliated investment advisory firm is described in detail in the following sections. In addition, each firm has established policies and procedures designed to address the potential for conflicts of interest. Each firm's compensation structure and management of potential conflicts of interest is summarized by the advisory firm in the following sections for the period ended January 31, 2005. M&G M&G is a wholly-owned subsidiary of Prudential plc (an English insurance company not related to The Prudential Insurance Company of America). INVESTMENT ADVISORY ARRANGEMENTS The Precious Metals and Mining Fund has entered into an investment advisory agreement with M&G to manage its assets. Under this agreement M&G manages the investment and reinvestment of the assets of the Precious Metals and Mining Fund and continuously reviews, supervises, and administers the Fund's investment program. M&G discharges its responsibilities subject to the supervision and oversight of the officers and trustees of the Fund. The Precious Metals and Mining Fund pays M&G a fee at the end of each fiscal quarter, calculated by applying a quarterly rate, based on the following annual percentage rates, to the aggregate average month-end net assets of the Fund for the quarter: NET ASSETS RATE ---------- ----- First $100 million 0.30% Next $150 million 0.20% Next $250 million 0.15% Next $500 million 0.10% During the fiscal years ended January 31, 2003, 2004, and 2005, the Precious Metals and Mining Fund incurred advisory fees of $1,003,000, $1,025,000, and $1,146,000, respectively, to M&G. DISCLOSURE REGARDING OTHER ACCOUNTS MANAGED Graham French managed the Precious Metals and Mining Fund, which, as of January 31, 2005, held assets of $921,000,000. Mr. French also managed three other pooled investment vehicles with total assets of $700,000,000, as of January 31, 2005. MATERIAL CONFLICTS OF INTEREST At M&G, individual portfolio managers may manage multiple accounts for multiple clients. In addition to mutual funds, these other accounts may include non-US collective investment schemes, insurance companies, and segregated pension funds. M&G manages potential conflicts between funds or with other types of accounts through allocation policies and procedures, internal review processes and oversight by directors. M&G has developed trade allocation procedures and controls to ensure that no one client, regardless of type, is intentionally favored at the expense of another. Allocation policies are designed to address potential conflicts in situations where two or more funds participate in investment decisions involving the same securities. DESCRIPTION OF COMPENSATION Graham French is compensated in line with standard M&G practice, which is: M&G has a strong and integrated set of compensation practices designed to reflect the logic, internally within M&G, of people's value as well as their outputs. Each component of the remuneration package has a role to play in the effective and appropriate reward of individuals in order to attract, retain and motivate. M&G believes it is also important to ensure B-32 that in total the components are coherent and relate appropriately to each other, delivering the reward levels that M&G wants to make available for different levels of performance. The components are as follows: - - Base pay is used to reward inputs, reflecting the values of people's knowledge, skills, aptitudes and track records. It progresses in line with personal growth, general contribution and potential. - - Bonus payment levels are closely aligned with 'outputs', chiefly investment performance but also other results. Bonuses are discretionary, variable year on year and reflect personal, team and company performance. Depending on the fund's objective, M&G uses either a representative index or a representative group of competitor funds as a benchmark against which to measure performance. In the case of Vanguard Precious Metals and Mining Fund, the performance factor of the fund manager's bonus is dependent on the Fund's performance over one- and three-year periods compared with a representative group of competitor funds. The actual bonus, which is paid on an annual basis, may be up to a multiple of base salary depending on the achieved percentile ranking in this peer group over these time periods. - - M&G's long-term incentive plan, combining phantom equity and options over phantom equity in M&G is designed to provide a meaningful stake in the future growth of the value of the company to those who have a significant role to play in its growth. - - The method used to determine the compensation for portfolio managers who are responsible for the management of multiple accounts, is the same for all funds. In addition, the portfolio manager is eligible for the standard retirement benefits and health benefits generally available to all M&G employees. M&G's remuneration package is regularly reviewed by outside consultants to ensure that it is competitive in the London investment management market. WELLINGTON MANAGEMENT Wellington Management is a Massachusetts partnership owned by its 87 partners, all of whom are active members of the firm. The managing partners of the firm are Laurie A. Gabriel, John R. Ryan, and Perry M. Traquina. VANGUARD ENERGY FUND Vanguard Energy Fund has entered into a new Investment Advisory Agreement with Wellington Management Company, LLP (Wellington Management or Advisor). Under the investment advisory agreement, Wellington Management manages the investment and reinvestment of a portion of the Fund's assets that the board of trustees assigns to Wellington Management (the WM Portfolio). In this capacity, Wellington Management continuously reviews, supervises, and administers the WM Portfolio. For each fiscal quarter after the first fiscal quarter in which the agreement is in effect, the Fund shall pay to the Advisor, at the end of the quarter, a fee calculated by applying the following annual percentage rates to the average month-end net assets of the WM Portfolio, then dividing the result by four. For purposes of calculating this compensation, average month-end net assets consist of Fund assets that are managed by the Advisor (including any cash that may be directed to Vanguard for cash management purposes). NET ASSETS ANNUAL RATES ---------- ------------ First $100 million 0.150% Next $300 million 0.125% Next $500 million 0.100% Next $1 billion 0.075% Over $1.9 billion 0.050% In the event of termination of the agreement, the fee shall be computed on the basis of the period ending on the last business day on which the agreement is in effect subject to a pro rata adjustment based on the number of days elapsed in the current fiscal quarter as a percentage of the total number of days in such quarter. The fee for the first fiscal quarter in which the agreement is in effect (May 1 through July 31, 2005) shall be the sum of the amounts calculated in paragraphs (a) and (b) below: B-33 (a) The following annual percentage rates shall be applied to the average month-end net assets of the WM Portfolio. The result shall then be divided by four (for one fiscal quarter), and then multiplied by 0.717 (a factor representing 66/92 of the fiscal quarter). NET ASSETS ANNUAL RATES ---------- ------------ First $100 million 0.150% Next $300 million 0.125% Next $500 million 0.100% Next $1 billion 0.075% Over $1.9 billion 0.050% (b) The following annual percentage rates shall be applied to the combined average month-end net assets of Vanguard Energy Fund and Vanguard Health Care Fund. The result shall then be allocated to each Fund based on the relative net assets of each. The amount of the fee allocated to Vanguard Energy Fund shall then be divided by four (for one fiscal quarter), and then multiplied by 0.283 (a factor representing 26/92 of the fiscal quarter). NET ASSETS ANNUAL RATES ---------- ------------ First $500 million 0.150% Next $500 million 0.125% Next $1 billion 0.100% Next $1 billion 0.075% Over $3 billion 0.050% The agreement became effective on May 27, 2005, and shall continue in effect for successive twelve-month periods, only so long as the agreement is approved at least annually by votes of the Fund's board of trustees who are not parties to such agreement or "interested persons" (as defined in the 1940 Act) of any such party, cast in person at a meeting called for the purpose of voting on such approval. In addition, the question of continuance of the agreement may be presented to the shareholders of the Fund; in such event, such continuance will be effected only if approved by the affirmative vote of a majority of the outstanding voting securities of the Fund. Notwithstanding the foregoing, however, (1) the agreement may at any time be terminated without payment of any penalty either by vote of the Fund's board of trustees or by vote of a majority of the outstanding voting securities of the Fund, on thirty (30) days' written notice to the Advisor; (2) the agreement will automatically terminate in the event of its assignment; and (3) the agreement may be terminated by the Advisor on ninety (90) days' written notice to the Fund. VANGUARD HEALTH CARE FUND Vanguard Health Care Fund has entered into a new investment advisory agreement with Wellington Management. Under the investment advisory agreement, Wellington Management manages the investment of the Fund's assets and continuously reviews, supervises, and administers the Fund's investment program. Wellington Management, which has advised the Fund since 1984, advises the Fund subject to the supervision and oversight of the officers and trustees of the Fund. For each fiscal quarter after the first fiscal quarter in which the agreement is in effect, the Fund shall pay to the advisor, at the end of the quarter, a fee calculated by applying the following annual percentage rates to the average month-end net assets of the Fund, then dividing the result by four. For purposes of calculating this compensation, average month-end net assets consist of Fund assets that are managed by the advisor (including any cash that may be directed to Vanguard for cash management purposes). B-34 NET ASSETS ANNUAL RATES ---------- ------------ First $500 million 0.150% Next $500 million 0.125% Next $1 billion 0.100% Next $10 billion 0.075% Over $12 billion 0.050% In the event of termination of the agreement, the fee shall be computed on the basis of the period ending on the last business day on which the agreement is in effect subject to a pro rata adjustment based on the number of days elapsed in the current fiscal quarter as a percentage of the total number of days in such quarter. The fee for the first fiscal quarter in which the agreement is in effect (May 1 through July 31, 2005) shall be the sum of the amounts calculated in paragraphs (a) and (b) below: (a) The following annual percentage rates shall be applied to the average month-end net assets of the Fund. The result shall then be divided by four (for one fiscal quarter), and then multiplied by 0.717 (a factor representing 66/92 of the fiscal quarter). NET ASSETS ANNUAL RATES ---------- ------------ First $500 million 0.150% Next $500 million 0.125% Next $1 billion 0.100% Next $10 billion 0.075% Over $12 billion 0.050% (b) The following annual percentage rates shall be applied to the combined average month-end net assets of Vanguard Energy Fund and Vanguard Health Care Fund. The result shall then be allocated to each Fund based on the relative net assets of each. The amount of the fee allocated to Vanguard Health Care Fund shall then be divided by four (for one fiscal quarter), and then multiplied by 0.283 (a factor representing 26/92 of the fiscal quarter). NET ASSETS ANNUAL RATES ---------- ------------ First $500 million 0.150% Next $500 million 0.125% Next $1 billion 0.100% Next $1 billion 0.075% Over $3 billion 0.050% During the fiscal years ended January 31, 2003, 2004, and 2005, the Fund incurred advisory fees of $9,585,000, $10,298,000, and $12,014,000, respectively. The agreement will become effective on May 27, 2005, and shall continue in effect for successive twelve-month periods, only so long as the agreement is approved at least annually by votes of the Fund's board of trustees who are not parties to such agreement or "interested persons" (as defined in the 1940 Act) of any such party, cast in person at a meeting called for the purpose of voting on such approval. In addition, the question of continuance of the agreement may be presented to the shareholders of the Fund; in such event, such continuance will be effected only if approved by the affirmative vote of a majority of the outstanding voting securities of the Fund. Notwithstanding the foregoing, however, (1) the agreement may at any time be terminated without payment of any penalty either by vote of the Fund's board of trustees or by vote of a majority of the outstanding voting securities of the Fund, on thirty (30) days' written notice to the advisor; (2) the agreement will automatically terminate in the event of its assignment; and (3) the agreement may be terminated by the advisor on ninety (90) days' written notice to the Fund. B-35 VANGUARD DIVIDEND GROWTH FUND The Dividend Growth Fund employs Wellington Management under an investment advisory agreement to manage the investment and reinvestment of a portion of the assets of the Fund that the Fund's board of trustees determines in its sole discretion to assign to the advisor from time to time (currently the entire Fund), and to continuously review, supervise, and administer the Fund's investment program. Wellington Management discharges its responsibilities subject to the supervision and oversight of the officers and trustees of the Fund. (A) TOTAL QUARTERLY FEE PAYABLE. For services rendered by Wellington Management, the Fund will pay to Wellington Management at the end of each fiscal quarter an amount (the adjusted fee) equal to a basic fee plus a performance adjustment amount, which may be negative, reflecting the investment performance of the Fund relative to the total return of the Russell 1000 Index. The Russell 1000 Index is prepared by the Frank Russell Company (which is not affiliated with the Fund or any of the Fund's affiliates). The Russell 1000 Index is composed of the 1,000 largest U.S. companies (as measured by market capitalization). For purposes of the calculations, both the Basic Fee and the adjustment amount will incorporate an asset-based fee (the asset fee) that is determined by applying a quarterly rate, calculated based on the following annual percentage rate schedule (shown in (b) below), to the average month-end net assets of the Fund over the applicable time period. (B) BASIC FEE FOR THE QUARTER. The Basic Fee for each quarter is calculated by applying a quarterly rate based on the following annual percentage rates to the average month-end net assets of the Wellington Management Portfolio for the quarter. NET ASSETS RATE - ---------- ----- First $1 billion 0.125% Next $4 billion 0.100% Over $5 billion 0.080% (C) PERFORMANCE ADJUSTMENT. The adjustment amount is based on the cumulative investment performance of the Wellington Management Portfolio over a trailing 36-month period relative to that of the Russell 1000 Index over the same period. Subject to the transition rules described below, the adjustment amount is equal to the product of an adjustment percentage and the asset fee as computed over the 36-month period ending with the relevant fiscal quarter (the Relevant 36-Month Period). The adjustment percentage will vary based on the investment performance of the Wellington Management Portfolio relative to the investment performance of the Russell 1000 Index as determined for the relevant 36-month period. The adjustment percentage applies as follows: CUMULATIVE PERFORMANCE OF THE WELLINGTON MANAGEMENT ADJUSTMENT PORTFOLIO VS. THE INDEX OVERRELEVANT 36-MONTH PERIOD PERCENTAGE* - ---------------------------------------------------- ------------- Less than -6% -0.50 X Basic Fee From -6% up to and including -3% -0.25 X Basic Fee Between -3% and +3% 0 X Basic Fee From +3% up to and including +6% +0.25 X Basic Fee More than +6% +0.50 X Basic Fee *For purposes of applying the adjustment, the basic fee will be calculated based on average month-end net assets over the same time period for which performance is measured. (D) PERFORMANCE ADJUSTMENT TRANSITION RULES. The adjustment amount will not be fully incorporated into the determination of the adjusted fee until the close of the quarter ending July 31, 2006. Until that date, the following transition rules will apply: 1. MAY 31, 2003, THROUGH JANUARY 31, 2004. Wellington Management's compensation was the basic fee. No adjustment amount was applied during this period. 2. FEBRUARY 1, 2004, THROUGH JULY 31, 2006. Beginning February 1, 2004, the adjustment amount will take effect on a progressive basis with regards to the number of months elapsed between May 31, 2003, and the end of the quarter for which the adviser's fee is being computed. During the period, the adjustment amount will be calculated using cumulative performance of the Wellington Management Portfolio and the Index from May 31, 2003, through the end of the applicable quarter. For these purposes, the endpoints and size of the range over which a positive or negative B-36 adjustment amount applies and the corresponding adjustment amount will be multiplied by a fractional time-elapsed adjustment. The fraction will equal the number of months elapsed since May 31, 2003, divided by thirty-six. Example: Assume that the adviser's compensation is being calculated for the quarter ended July 31, 2005, and that the cumulative performance of the Wellington Management Portfolio versus the Index for the applicable period is +5.0%. In this case, an adjustment percentage of +36.11% would apply. The following demonstrates the calculation: Calculate the fractional time-elapsed adjustment by dividing 26 months by 36 months (equals 72.22%), then multiply by the endpoints for the range over which the positive or negative adjustment amount applies [(26/36) x 3.0% to (26/36) x 6.0% = 2.16% to 4.33%]. Given the Portfolio's cumulative performance of +5.0% is greater than the time-elapsed adjusted range of +2.16% to +4.33%, multiply the fractional time-elapsed adjustment of 72.22% by the corresponding maximum adjustment for the time-elapsed adjusted range of greater than +4.33% or (72.22%)(50.0%) = +36.11%. 3. ON AND AFTER AUGUST 1, 2006. The adjustment amount will be fully operable. During the fiscal years ended January 31, 2003, 2004, and 2005, the Dividend Growth Fund incurred advisory fees of: $456,000, $361,000, and $1,098,000 (before a performance-based increase of $111,000), respectively, to Wellington Management. DISCLOSURE REGARDING OTHER ACCOUNTS MANAGED Minerva Butler managed the Dividend Growth Fund, which, as of January 31, 2005, held assets of $965,000,000. Ms. Butler also managed nine other accounts with total assets of $34,300,000, as of January 31, 2005. Karl Bandtel managed a portion of the Energy Fund; the Fund, as of January 31, 2005, held assets of $5,371,000,000. As of January 31, 2005, Mr. Bandtel managed three other registered investment companies with total assets of $821,800,000, and 17 other pooled investment vehicles with total assets of $4,647,200,000, including nine where the advisory firm's fee was based on account performance with total assets of $3,193,100,000. As of January 31, 2005, Mr. Bandtel also managed 23 other accounts with total assets of $811,500,000. James Bevilacqua managed a portion of the Energy Fund; the Fund, as of January 31, 2005, held assets of $5,371,000,000. As of January 31, 2005, Mr. Bevilacqua managed three other registered investment companies with total assets of $821,800,000, and 17 other pooled investment vehicles with total assets of $4,647,200,000, including nine where the advisory firm's fee was based on account performance with total assets of $3,193,100,000. As of January 31, 2005, Mr. Bevilacqua also managed 19 other accounts with total assets of $797,200,000. Edward P. Owens managed the Health Care Fund, which, as of January 31, 2005, held assets of $21,906,000,000. As of January 31, 2005, Mr. Owens managed 32 other pooled investment vehicles with total assets of $3,834,400,000, including six where the advisory firm's fee was based on account performance with total assets of $2,169,500,000. As of January 31, 2005, Mr. Owens also managed 172 other accounts with total assets of $1,693,700,000, including 17 where the advisory firm's fee was based on account performance with total assets of $178,700,000. MATERIAL CONFLICTS OF INTEREST Individual investment professionals at Wellington Management manage multiple portfolios for multiple clients. These accounts may include mutual funds, separate accounts (assets managed on behalf of institutions such as pension funds, insurance companies, foundations), bank common trust accounts, and hedge funds. The investment professionals primarily responsible for the day-to-day management of each Fund (Portfolio Managers) generally manage portfolios in several different investment styles. These portfolios may have investment objectives, strategies, time horizons, tax considerations and risk profiles that differ from those of the relevant Fund. The Portfolio Managers make investment decisions for the relevant Fund based on the investment objectives, policies, practices, benchmarks, cash flows, tax, and other relevant investment considerations applicable to that portfolio. Consequently, the Portfolio Managers may purchase or sell securities, including IPOs, for one portfolio and not another portfolio, and the performance of securities purchased for one portfolio may vary from the performance of securities purchased for other portfolios. The Portfolio Managers or other investment professionals at Wellington Management may place transactions on behalf of other accounts that are directly or indirectly contrary to investment decisions made on behalf of the relevant Fund, or make investment decisions that are similar to those made for the relevant Fund, both of which have the potential to adversely impact the Fund depending on market conditions. For example, the Portfolio Managers may purchase a security in one portfolio while appropriately selling that same security in another portfolio. In addition, some of these portfolios have fee structures, including performance fees, that are or have the potential to be higher, in some cases significantly higher, B-37 than the fees paid by the relevant Fund to Wellington Management. Messrs. Bandtel, Bevilacqua, and Owens manage hedge funds, which pay performance allocations to Wellington Management or its affiliates. Because incentive payments are tied to revenues earned by Wellington Management, and where noted, to the performance achieved by the manager in each account, the incentives associated with any given fund may be significantly higher or lower than those associated with other accounts managed by a given Portfolio Manager. Wellington Management's goal is to meet its fiduciary obligation to treat all clients fairly and provide high quality investment services to all of its clients. Wellington Management has adopted and implemented policies and procedures, including brokerage and trade allocation policies and procedures that it believes address the conflicts associated with managing multiple accounts for multiple clients. In addition, Wellington Management monitors a variety of areas, including compliance with primary fund guidelines, the allocation of IPOs, and compliance with the firm's Code of Ethics, and places additional investment restrictions on Portfolio Managers who manage hedge funds and certain other accounts. Furthermore, senior investment and business personnel at Wellington Management periodically review the performance of Wellington Management's Portfolio Managers. Although Wellington Management does not track the time a Portfolio Manager spends on a single portfolio, Wellington Management does periodically assess whether a Portfolio Manager has adequate time and resources to effectively manage the Portfolio Manager's various client mandates. DESCRIPTION OF COMPENSATION Each Fund pays Wellington Management a fee based on the assets under management of each Fund as set forth in the Investment Advisory Agreement between Wellington Management and Vanguard Specialized Funds with respect to each Fund. Wellington Management pays its investment professionals out of its total revenues and other resources, including the advisory fees earned with respect to each Fund. The following information relates to the period ended January 31, 2005. Wellington Management's compensation structure is designed to attract and retain high-caliber investment professionals necessary to deliver high quality investment management services to its clients. Wellington Management's compensation of its Portfolio Managers includes a base salary and incentive components. The base salary for each Portfolio Manager who is a partner of Wellington Management is determined by the Managing Partners of the firm. A partner's base salary is generally a fixed amount that may change as a result of an annual review. The base salaries for all other Portfolio Managers are determined by the Portfolio Manager's experience and performance in their role as a Portfolio Manager. Base salaries for non-partners are reviewed annually and may be adjusted based on the recommendation of the Portfolio Manager's business manager, using guidelines established by Wellington Management's Compensation Committee, which has final oversight responsibility for base salaries for non-partners. Each Portfolio Manager is eligible to receive an incentive payment based on the revenues earned by Wellington Management from the relevant Fund managed by that Portfolio Manager and generally each other portfolio managed by such Portfolio Manager. For the Energy Fund and the Health Care Fund, each Portfolio Manager's incentive payment relating to the relevant Fund is linked to the revenues received by Wellington Management Company on the relevant Fund. The incentives are additionally linked to the performance of the Fund compared to the benchmark identified below over two-year periods and to the performance of the Fund compared to the peer group identified below over one-year periods. For the Dividend Growth Fund, overall revenues to Wellington Management vary with the performance of the Fund relative to a specified benchmark (see "Vanguard Dividend Growth Fund" in this section). Incentive payments made to the Fund's Portfolio Manager relating to the Dividend Growth Fund are additionally linked to the performance of the Fund compared to the benchmark identified below over one- and three-year periods, with an emphasis on three-year results. Wellington Management applies similar incentive structures (although the benchmarks or peer groups, time periods, and rates may differ) to other portfolios managed by these Portfolio Managers, including portfolios with performance fees.
PORTFOLIO BENCHMARK AND/OR PEER GROUP - --------- ---------------------------- Energy Portfolio S&P Energy Sector and peer group average* Health Care Portfolio S&P 500 Health Care Sector and peer group average** Dividend Growth Portfolio Russell 1000 Index *Average of five open-end mutual funds selected by Vanguard. **Average of three open-end mutual funds selected by Vanguard
B-38 The incentive compensation component across all portfolios managed by a Portfolio Manager can, and typically does, represent a significant portion of a Portfolio Manager's overall compensation; incentive compensation varies significantly by individual and can vary significantly from year to year. Some Portfolio Managers are also eligible for bonus payments based on their overall contribution to Wellington Management's business operations. Senior management at Wellington Management may reward individuals as it deems appropriate based on factors other than performance. Each partner of Wellington Management is also eligible to participate in a partner-funded retirement plan. Messrs. Bandtel, Bevilacqua and Owens are partners of the firm. OWNERSHIP OF SECURITIES Vanguard employees, including portfolio managers, allocate their investments among the various Vanguard funds based on their own individual investment needs and goals. Vanguard employees as a group invest a sizeable portion of their personal assets in Vanguard funds. As of December 31, 2004, Vanguard employees collectively invested $1.27 billion in Vanguard funds. John. J. Brennan, Chairman and Chief Executive Officer of Vanguard and the Vanguard funds. and George U. Sauter, Managing Director and Chief Investment Officer, invest substantially all of their personal financial assets in Vanguard funds. As of January 31, 2005, Ms. Butler owned shares of the Dividend Growth Fund within the $100,001-$500,000 range, Mr. Bandtel owned shares of the Energy Fund within the $100,001-$500,000 range, and Mr. Owens owned shares of the Health Care Fund within the over $1,000,000 range. Except as noted in the previous sentence, as of January 31, 2005, the portfolio managers did not own any shares of the Specialized Funds they managed. As of April 30, 2005, Mr. Dickson did not own any shares of the Energy Fund. DURATION AND TERMINATION OF INVESTMENT ADVISORY AGREEMENTS Each Fund's current agreement with each adviser is renewable for successive one-year periods, only if (1) each renewal is specifically approved by a vote of the Fund's board of trustees, including the affirmative votes of a majority of the trustees who are not parties to the agreement or "interested persons" (as defined in the 1940 Act) of any such party cast in person at a meeting called for the purpose of considering such approval, or (2) each renewal is specifically approved by a vote of a majority of the Fund's outstanding voting securities. An agreement is automatically terminated if assigned, and may be terminated by the Fund without penalty, at any time, (1) either by vote of the board of trustees on sixty (60) days' written notice to the adviser, (2) by a vote of a majority of the Fund's outstanding voting securities, or (3) by the adviser upon ninety (90) days' written notice to the Fund. BOARD REVIEW OF INVESTMENT ADVISORY ARRANGEMENTS Each Fund's board of trustees oversees the Fund's management and each advisor's performance on a regular basis. For Vanguard Dividend Growth, Health Care, and Precious Metals and Mining Funds, and the portion of Vanguard Energy Fund that is managed by Wellington Management, which are advised by independent third-party advisory firms unaffiliated with Vanguard (collectively, the Externally-Advised Funds), the board determines annually whether to renew the Funds' investment advisory agreements. For Vanguard REIT Index Fund and the portion of Vanguard Energy Fund that is managed by Vanguard (collectively, the Vanguard-Advised Funds), the board considers annually whether the Funds and their shareholders continue to benefit from the internalized management structure whereby the Funds receive investment management services at cost from Vanguard's Quantitative Equity Group. Vanguard provides the board with monthly, quarterly, and annual analyses of each advisor's performance. In addition, each advisor provides the board with quarterly self-evaluations and certain other information that the board deems important for its evaluation of the short- and long-term performance of the advisor of each Fund, and the internalized management services provided by Vanguard. Each Fund's portfolio managers meet with the board periodically to discuss the management and performance of the Fund. The board receives additional information detailing other sources of revenue to the advisor or its affiliates from its relationship with the Fund and intangible or "fall-out" benefits that accrue to the advisor and its affiliates, if relevant. Also, the board receives information about the advisor's control of Fund investment expenses, such as transaction costs, including ways in which portfolio transactions for the Fund are conducted and brokers are selected. When considering whether to continue a Fund's investment advisory arrangement, the board examines several factors, but does not identify any particular factor as controlling its decision. B-39 DIVIDEND GROWTH FUND (WELLINGTON MANAGEMENT) The board considered performance and advisory fee information when determining whether to a continue the Dividend Growth Fund's investment advisory arrangement with Wellington Management. Recent performance and advisory fee information follows:
AVERAGE ANNUAL RETURN (BEFORE TAXES)FOR PERIODS ENDED JANUARY 31, 2005 ---------------------------------------- ADVISORY FEES EXPRESSED AS AN ANNUAL EFFECTIVE EXPENSE RATE OF THE FUND'S One Year Five years Ten Years RATIO AVERAGE NET ASSETS --------- ---------- --------- ----- ------------------ VANGUARD DIVIDEND GROWTH FUND 6.92% -0.19% 7.46% 0.37% 0.125% (Investor Shares) Average Large-Cap Core Fund* 3.71 N/A+ N/A+ 1.45 0.61 Dividend Growth Spliced Index** 6.57 -2.16 7.03 N/A N/A Russell 1000 Index 6.57 -1.43 11.59 N/A N/A *Derived from data provided by Lipper Inc. **The Dividend Growth Spliced Index is based on the Fund's current and former benchmark indexes. Effective December 6, 2002, the Vanguard Utilities Income Fund changed its investment objective and its name to the Vanguard Dividend Growth Fund. The Dividend Growth Spliced Index consists of the former benchmark, a composite of utilities indexes (from the Fund's inception through December 5, 2002) and the Russell 1000 Index (beginning December 6, 2002). +It is not relevant to compare the Fund's 5 and 10 year performance record to the Average Large-Cap Core Fund because prior to December 6, 2002, the Fund had a different investment objective and different investment strategies.
- - The board considered the Fund's short- and long-term performance records, which are disclosed in the table above. The board noted that the Fund outperformed its average peer group fund (derived from data provided by Lipper Inc.) and other appropriate benchmarks. - - The board assessed the advisory fee paid by the Fund and compared it to the average advisory fee for the Fund's peer group. The board took into account the nature of the fee arrangements, which include breakpoints that decrease the fee rate as the size of the advisor's portfolio increases. The board noted that the advisory fee paid to Wellington Management was significantly less than the average advisory fee paid by others in the Fund's Lipper peer group. - - The board evaluated the advisor's investment staff and portfolio management process, and reviewed the composition and overall performance of the advisor's portfolio on both a short-term and long-term basis. The board found that the portfolio management team had depth and stability, and concluded that the advisor's investment staff and portfolio management process were suitable for the Fund. - - Finally, the board considered whether the Fund should obtain alternative portfolio management services and concluded that, under all the circumstances and based on its informed business judgment, the most appropriate course of action in the best interest of the Fund's shareholders was to renew the agreement with Wellington Management. ENERGY FUND WELLINGTON MANAGEMENT The board's decision to revise the current advisory fee schedule was based upon its most recent evaluation of the Advisor's investment staff, portfolio management process, and performance results. In considering whether to approve the new agreement, the board engaged in arm's-length discussions with Wellington Management and considered the following factors, among others. - - The board considered the benefits to shareholders of continuing to retain Wellington Management as the advisor to the fund, particularly in light of the nature, extent, and quality of services provided by Wellington Management. The board considered the quality of investment management of the Fund over both the short and long term and the organizational depth and stability of the firm. The trustees concluded that the existing advisory fee schedule has been in place for many years and should be adjusted to reflect the need to hire and retain specialized investment talent for this large sector-specific fund. The new fee arrangement will enable Wellington Management to enhance the organizational depth and stability of the Fund's portfolio management team by retaining top investment talent and by hiring new investment professionals on an as-needed basis. B-40 The board considered the investment performance of the Fund and compared the results with those of the Fund's peer group and relevant benchmarks. The trustees concluded that under Wellington Management the Fund has consistently outperformed both the Standard & Poor's Energy Sector Index and the Fund's peer group. Among other comparative data, the board considered the following performance information about the Fund.
AVERAGE ANNUAL RETURN (BEFORE TAXES) FOR PERIODS ENDED JANUARY 31, 2005 ------------------------------ ONE YEAR FIVE YEARS TEN YEARS VANGUARD ENERGY FUND 38.90% 20.55% 16.82% (INVESTOR SHARES)* Average Natural Resources Fund** 32.17 14.82 11.86 S&P Energy Sector Index 33.46 10.45 14.60 *Information about the Fund's Admiral Shares may be found elsewhere in this Statement of Additional Information. **Derived from data provided by Lipper Inc.
- - The board considered the cost of services to be provided, including consideration of competitive fee rates and the fact that, after the adjustment of the fee schedule, the Fund's advisory fee remains significantly below that of most of its peers. Among other comparative data, the board considered the following expense information.
ADVISORY FEES EXPRESSED AS AN ANNUAL EFFECTIVE RATE OF THE FUNDS' ESTIMATED ADVISORY AVERAGE NET ASSETS FEE RATE AFTER BEFORE IMPLEMENTATION IMPLEMENTATION OF OF NEW FEE NEW ADVISORY EXPENSE RATIO+ ARRANGEMENT++ FEE SCHEDULE -------------- ------------- ------------ VANGUARD ENERGY FUND (INVESTOR SHARES)* 0.32% 0.06% 0.07% Average Natural Resources Fund** 1.59 0.64 N/A *Information about the Fund's Admiral Shares may be found elsewhere in this Statement of Additional Information. **Derived from data provided by Lipper Inc. +As of January 31, 2005. ++Advisory fee rates are expressed as an annual effective rate of the Energy Fund's average net assets, as of January 31, 2005.
- - The board considered the extent to which economies of scale would be realized as the Fund grows, including a consideration of appropriate breakpoints in the fee schedule. By including asset-based breakpoints in the fee schedule, the Fund's trustees ensure that if the Fund continues to grow, investors will benefit by realizing economies of scale in the form of a lower advisory fee rate. - - The board considered all of the circumstances and information provided by both Wellington Management and Vanguard regarding the performance of the Fund, and concluded that approval of the Amended and Restated Investment Advisory Agreement is in the best interest of the Fund and its shareholders. VANGUARD - - The board's decision to add Vanguard as a second advisor to the Fund, was based upon the board's most recent evaluation of the nature, extent, and quality of services to be provided by Vanguard. The board decided that a multimanager arrangement provides the Fund's shareholders with the best combination of investment approaches, expertise, and resources, and ensures that the Fund will maintain its character as a globally diversified, value-oriented, multi-cap energy-sector fund. The Fund will have a mix of differentiated active managers, who each have the opportunity to generate superior returns for shareholders over the long term. - - In evaluating the internalized management services to be provided by Vanguard, the board analyzed the performance of other funds and accounts managed by the firm. The board concluded that Vanguard's other investment portfolios generally have strong investment returns and have posted competitive results. - - The board considered the at-cost advisory expenses to be paid by the Fund to Vanguard and the estimated expense ratio of the Fund and compared them with the average advisory fee and expense ratio for funds in the Fund's peer group. The board concluded that, after the addition of Vanguard, the Fund's advisory expenses and expense ratio are expected to remain significantly below the advisory fee rates and expense ratios of the Fund's peers. Among other B-41 comparative data, the board considered the expense information shown in the table captioned "Average Annual Return (Before Taxes)" in the section above entitled "Energy Fund: Wellington." - - The board evaluated Vanguard's business strength, organizational depth, and stability by observing such characteristics in Vanguard's service to the other funds it manages. The board concluded that Vanguard has provided high-quality investment management to the funds over both the short and long term, as demonstrated by the funds' performance records relative to those of their peers and other appropriate benchmarks. The board considered all of the circumstances and information provided by Vanguard, and concluded that the addition of Vanguard as a second advisor would provide an appropriate complement to the Fund's other current advisor and is in the best interests of the Fund and its shareholders. VANGUARD HEALTH CARE FUND (WELLINGTON MANAGEMENT) The board's decision to revise the current advisory fee schedule was based upon its most recent evaluation of the advisor's investment staff, portfolio management process, and performance results. In considering whether to approve the new agreement, the board engaged in arm's-length discussions with Wellington Management and considered the following factors, among others. - - The board considered the benefits to shareholders of continuing to retain Wellington Management as the advisor of the Fund, particularly in light of the nature, extent, and quality of services provided by Wellington Management. The board considered the quality of investment management of the Fund over both the short and long term and the organizational depth and stability of the firm. The board noted that Wellington Management has been the Fund's advisor since the Fund's inception in 1984, and that the firm has over 75 years of investment management experience. The board found that the new advisory fee schedule should benefit the Fund and its shareholders because it will help Wellington Management retain and build on a stable, talented, and competitive portfolio management team that manages the industry's largest health care fund. - - The board considered the investment performance of the Fund and compared the results with those of the Fund's peer group and relevant benchmarks. The trustees concluded that under Wellington Management the Fund has consistently outperformed both the S&P Health Sector Index and the Fund's peer group. Among other comparative data, the board considered the following performance information about the Fund.
AVERAGE ANNUAL RETURN (BEFORE TAXES) FOR PERIODS ENDED JANUARY 31, 2005 ------------------------------ ONE YEAR FIVE YEARS TEN YEARS -------- ---------- --------- VANGUARD HEALTH CARE (INVESTOR SHARES)* 2.76%** 11.57% 19.36% Average Health/Biotechnology Fund+ 0.82 3.59 13.49 S&P Health Sector Index -4.17 0.62 14.03 *Information about the Fund's Admiral Shares may be found elsewhere in this Statement of Additional Information. **Reflects the 1% fee assessed on redemptions of Fund shares held for less than five years. After March 23, 2005, the Fund's 1% fee will be assessed on redemptions of shares held for less than one year. +Derived from data provided by Lipper Inc.
- - The board considered the cost of services to be provided, including consideration of competitive fee rates and the fact that, after the adjustment of the fee schedule, the Fund's advisory fee remains significantly below that of most of its peers. Among other comparative data, the board considered the following expense information. B-42
ADVISORY FEES EXPRESSED AS AN ANNUAL EFFECTIVE RATE OF THE FUNDS' ESTIMATED ADVISORY AVERAGE NET ASSETS FEE RATE AFTER BEFORE IMPLEMENTATION IMPLEMENTATION OF OF NEW FEE NEW ADVISORY EXPENSE RATIO+ ARRANGEMENT++ FEE SCHEDULE -------------- ------------- ------------ VANGUARD HEALTH CARE FUND (INVESTOR SHARES)* 0.22% 0.06% 0.07% Average Health/Biotechnology Fund** 1.88 0.67 N/A *Information about the Fund's Admiral Shares may be found elsewhere in this Statement of Additional Information. **Derived from data provided by Lipper Inc. +As of January 31, 2005. ++Advisory fee rates are expressed as an annual effective rate of the Health Care Fund's average net assets, as of January 31, 2005.
- - The board considered the extent to which economies of scale would be realized as the Fund grows, including a consideration of appropriate breakpoints in the fee schedule. By including asset-based breakpoints in the fee schedule, the Fund's trustees ensure that if the Fund continues to grow, investors will benefit by realizing economies of scale in the form of a lower advisory fee rate. - - The board considered all of the circumstances and information provided by both Wellington Management and Vanguard regarding the performance of the Fund, and concluded that approval of the Amended and Restated Investment Advisory Agreement is in the best interest of the Fund and its shareholders. VANGUARD PRECIOUS METALS AND MINING FUND (M&G) The board considered the following performance and advisory fee information when determining whether to a continue the Fund's investment advisory arrangement with M&G Investment Management Limited:
AVERAGE ANNUAL RETURN (BEFORE TAXES)FOR PERIODS ENDED JANUARY 31, 2005 ----------------------------- ADVISORY FEES EXPRESSED AS AN ANNUAL EFFECTIVE EXPENSE RATE OF THE FUND'S One Year Five years Ten Years RATIO AVERAGE NET ASSETS --------- ---------- --------- ----- ------------------ VANGUARD PRECIOUS METALS AND MINING FUND 14.20% 22.20% 7.78% 0.48% 0.17% Average Gold Oriented Fund* -4.30 19.49 3.87 1.76 0.70 S&P/Citigroup World Equity Gold Index** -1.95 17.02 4.76 N/A N/A S&P 500 Index 6.23 -1.77 11.51 N/A N/A *Derived from data provided by Lipper Inc. **The Salomon Smith Barney World Equity Gold Index became known as the Citigroup World Equity Gold Index on April 7, 2003, and then known as the S&P/Citigroup World Equity Gold Index on November 12, 2003.
- - The board considered the Fund's short- and long-term performance records, which are disclosed in the table above. The board observed that the performance results show that the Fund outperformed (for short- and long-term periods) relevant performance standards, including the performance results of the average gold-oriented fund (derived from data provided by Lipper Inc.) and other appropriate market indexes. - - The board assessed the advisory fee paid by the Fund and compared it to the average advisory fee for the Fund's Lipper peer group. The board also took into account the nature of the fee arrangements, which include breakpoints that decrease the fee rate as the size of the advisor's portfolio increases. The board noted that the advisory fee paid to M&G was significantly less that the average advisory fee paid by others in the Fund's Lipper peer group. - - The board evaluated the advisor's investment staff and portfolio management process, and reviewed the composition and overall performance of the advisor's portfolio on both a short-term and long-term basis. The board noted the portfolio management team's experience and educational background, and concluded that the advisor's investment staff and portfolio management process were suitable for the Fund. - - Finally, the board considered whether the Fund should obtain alternative portfolio management services and concluded that, under all the circumstances and based on its informed business judgment, the most appropriate course of action in the best interest of the Fund's shareholders was to renew the agreement with Wellington Management. B-43 VANGUARD REIT INDEX FUND (THE VANGUARD GROUP, INC.) The board considered performance and advisory expense information when determining whether Vanguard should continue providing internalized investment management services at cost to the Fund. The specific Fund performance and advisory fee information considered by the board included the following:
AVERAGE ANNUAL RETURN (BEFORE TAXES)FOR PERIODS ENDED JANUARY 31, 2005 ---------------------------------------- ADVISORY FEES EXPRESSED AS AN ANNUAL EFFECTIVE SINCE EXPENSE RATE OF THE FUND'S One Year Five years INCEPTION RATIO AVERAGE NET ASSETS --------- ---------- --------- ----- ------------------ VANGUARD REIT INDEX FUND (INVESTOR SHARES)* 14.78% 18.91% 13.29% 0.21% 0.002% Average Real Estate Fund** 17.68 19.20 13.22 1.62 0.67 Morgan Stanley REIT Index 15.13 19.35 13.40 N/A N/A Target REIT Composite Index+ 14.88 19.01 13.24 N/A N/A Dow Jones Wilshire 5000 Composite Index 7.24 -1.12 8.31 N/A N/A *Information about the Fund's other share classes may be found elsewhere in this Statement of Additional Information. **Derived from data provided by Lipper Inc. +The Target REIT Composite Index consists of the Morgan Stanley REIT Index adjusted to include a 2% cash position (Lipper Money Market Average). ++Since inception--May 13, 1996--of the REIT Index Fund's Investor Shares.
- - The board also considered the Fund's short- and long-term investment performance, which is disclosed in the table above. The board noted that the performance results for the Fund were within expectations as the Fund's performance closely tracked that of its target index. - - The board concluded that, in the aggregate, the nature, extent, and quality of services provided by Vanguard to the Fund are appropriate and should continue. - - The board considered the advisory expenses incurred by the Fund and assessed the fair market value of the services provided in light of the expenses incurred. The board noted that the expenses incurred to Vanguard was extraordinarily low. - - Based upon its most recent evaluation of the investment staff, the portfolio management process, the short- and long-term performance, and the at-cost, internalized management arrangements, the board of the Fund determined that it would be in the best interests of the Fund's shareholders to continue its internalized management arrangement. - - Finally, the board considered whether the Fund should obtain alternative portfolio management services and concluded that, under all the circumstances and based on its informed business judgment, the most appropriate course of action in the best interests of the Fund's shareholders to continue the investment management arrangement with Vanguard. PORTFOLIO TRANSACTIONS The advisor decides which securities to buy and sell on behalf of a Fund and then selects the brokers or dealers that will execute the trades on an agency basis or the dealers with whom the trades will be effected on a principal basis. For each trade, the advisor must select a broker-dealer that it believes will provide "best execution." Best execution does not mean the lowest possible spread or commission rate. In seeking best execution, the SEC has said that an adviser should consider the full range of a broker-dealer's services. The factors considered by the advisor in seeking best execution include, but are not limited to, the broker-dealer's execution capability, clearance and settlement services, commission rate, trading expertise, willingness and ability to commit capital, ability to provide anonymity, financial responsibility, reputation and integrity, responsiveness, access to underwritten offerings and secondary markets, and access to company management, as well as the value of any research provided by the broker-dealer. In assessing which broker-dealer can provide best execution for a particular trade, the advisor also may consider the timing and size of the order and available liquidity and current market conditions. B-44 During the fiscal years ended January 31, 2003, 2004, and 2005, the Funds paid brokerage commissions in the following amounts:
FUND 2003 2004 2005 ---- ---- ---- ---- Vanguard Dividend Growth Fund $ 2,120,000 $ 413,000 $ 236,000 Vanguard Energy Fund 680,000 2,100,000 1,544,000 Vanguard Health Care Fund 10,803,000 7,297,000 4,981,000 Vanguard Precious Metals and Mining Fund 1,161,000 853,000 1,509,000 Vanguard REIT Index Fund 591,000 762,000 764,000
Some securities that are considered for investment by a Fund may also be appropriate for other Vanguard funds or for other clients served by the advisors. If such securities are compatible with the investment policies of a Fund and one or more of an advisor's other clients, and are considered for purchase or sale at or about the same time, then transactions in such securities will be aggregated by the advisor and the purchased securities or sale proceeds will be allocated among the participating Vanguard funds and the other participating clients of the advisor in a manner deemed equitable by the advisor. Although there may be no specified formula for allocating such transactions, the allocation methods used, and the results of such allocations, will be subject to periodic review by the Funds' board of trustees. PROXY VOTING GUIDELINES The Board of Trustees (the Board) of each Vanguard fund that invests in stocks has adopted proxy voting procedures and guidelines to govern proxy voting by the fund. The Board has delegated day-to-day oversight of proxy voting to the Proxy Oversight Committee (the Committee), comprised of senior Vanguard officers and subject to the operating procedures and guidelines described below. The Committee reports directly to the Board. Our overarching objective in voting is simple: to support proposals and director nominees that maximize the value of a fund's investments--and those of our fund shareholders--over the long term. While our goal is simple, the proposals we receive are varied and frequently complex. The guidelines adopted by the Board provide a rigorous framework for assessing each proposal. The Board has designed the guidelines to stress Vanguard's role as a fiduciary with responsibility for evaluating each proposal on its merits, based on the particular facts and circumstances as presented. For most proxy proposals, particularly those involving corporate governance, the evaluation will result in the funds voting as a block. In some cases, however, funds may vote differently, depending upon the nature and objective of the funds, the composition of their portfolios and other factors. The guidelines do not permit Vanguard to delegate voting responsibility to a third party that does not serve as a fiduciary for the funds. Because many factors bear on each decision, the guidelines incorporate factors the Committee should consider in each voting decision. A fund may refrain from voting if refraining from voting would be in the fund's and its shareholders' best interests. These circumstances may arise, for example, when the expected cost of voting exceeds the expected benefits of voting, or exercising the vote results in the imposition of trading or other restrictions. In evaluating proxy proposals, we consider information from many sources, including the portfolio manager for the fund, management or shareholders of a company presenting a proposal, and independent proxy research services. We will give substantial weight to the recommendations of the company's board, absent guidelines or other specific facts that would support a vote against management. In all cases, however, the ultimate decision rests with the members of the Proxy Oversight Committee, who are accountable to the fund's Board. While serving as a framework, the following guidelines cannot contemplate all possible proposals with which a fund may be presented. In the absence of a specific guideline for a particular proposal (e.g., in the case of a transactional issue or contested proxy), the Committee will evaluate the issue and cast the fund's vote in a manner that, in the Committee's view, will maximize the value of the fund's investment. B-45 I. THE BOARD OF DIRECTORS A. ELECTION OF DIRECTORS We believe that good governance starts with a majority-independent board, whose key committees are comprised entirely of independent directors. Companies should attest to the independence of directors who serve on the Compensation, Nominating, and Audit committees. In any instance in which a director is not categorically independent, the basis for the independence determination should be clearly explained in the proxy statement. While we will generally support the board's nominees, we will take the following factors into account in determining our vote:
FACTORS FOR APPROVAL FACTORS AGAINST APPROVAL - -------------------- ------------------------ Nominated slate results in board Nominated slate results in board comprised of a majority of non- comprised of a majority of independent directors. independent directors. All members of Audit, Nominating,and Compensation Audit, Nominating, and/or Compensation committees include committees are independent of management. non-independent members. Incumbent board member failed to attend at least 75% of meetings in the previous year. Actions of committee(s) on which nominee serves are inconsistent with other guidelines (e.g., excessive option grants, substantial non-audit fees, lack of board independence).
B. CONTESTED DIRECTOR ELECTIONS In the case of contested board elections, we will evaluate the nominees' qualifications, the performance of the incumbent board, as well as the rationale behind the dissidents' campaign, to determine the outcome that we believe will maximize shareholder value. C. CLASSIFIED BOARDS We will generally support proposals to declassify existing boards (whether proposed by management or shareholders), and will block efforts by companies to adopt classified board structures, in which only part of the board is elected each year. II. APPROVAL OF INDEPENDENT AUDITORS We believe that the relationship between the company and its auditors should be limited primarily to the audit, although it may include certain closely related activities that do not, in the aggregate, raise any appearance of impaired independence. We will generally support management's recommendation for the ratification of the auditor, except in instances where audit and audit-related fees make up less than 50% of the total fees paid by the company to the audit firm. We will evaluate on a case-by-case basis instances in which the audit firm has a substantial non-audit relationship with the company (regardless of its size relative to the audit fee) to determine whether we believe independence has been compromised. III. COMPENSATION ISSUES A. STOCK-BASED COMPENSATION PLANS We believe that appropriately designed stock-based compensation plans, administered by an independent committee of the board and approved by shareholders, can be an effective way to align the interests of long-term shareholders and the interests of management, employees, and directors. Conversely, we oppose plans that substantially dilute our ownership interest in the company, provide participants with excessive awards, or have inherently objectionable structural features. An independent compensation committee should have significant latitude to deliver varied compensation to motivate the company's employees. However, we will evaluate compensation proposals in the context of several factors (a company's industry, market capitalization, competitors for talent, etc.) to determine whether a particular plan or proposal B-46 balances the perspectives of employees and the company's other shareholders. We will evaluate each proposal on a case-by-case basis, taking all material facts and circumstances into account. The following factors will be among those considered in evaluating these proposals.
FACTORS FOR APPROVAL FACTORS AGAINST APPROVAL - -------------------- ------------------------- Company requires senior executives to hold a minimum Total potential dilution (including all stock-based plans) exceeds 15% of amount of company stock(frequently expressed shares outstanding. as a multiple of salary). Company requires stock acquired through option Annual option grants have exceeded 2% of shares outstanding. exercise to be held for a certain period of time. Compensation program includes performance-vesting Plan permits repricing or replacement of options without shareholder awards, indexed options or other performance-linked approval. grants. Concentration of option grants to senior executives Plan provides for the issuance of reload options. is limited (indicating that the plan is very broad-based). Stock-based compensation is clearly used as a Plan contains automatic share replenishment (evergreen) feature. substitute for cash in delivering market-competitive total pay.
B. BONUS PLANS Bonus plans, which must be periodically submitted for shareholder approval to qualify for deductibility under Section 162(m) of the IRC, should have clearly defined performance criteria and maximum awards expressed in dollars. Bonus plans with awards that are excessive, in both absolute terms and relative to a comparative group, generally will not be supported. C. EMPLOYEE STOCK PURCHASE PLANS We will generally support the use of employee stock purchase plans to increase company stock ownership by employees, provided that shares purchased under the plan are acquired for no less than 85% of their market value and that shares reserved under the plan comprise less than 5% of the outstanding shares. D. EXECUTIVE SEVERANCE AGREEMENTS (GOLDEN PARACHUTES) While we believe that executives' incentives for continued employment should be more significant than severance benefits, there are instances--particularly in the event of a change in control--in which severance arrangements may be appropriate. Severance benefits triggered by a change in control that do not exceed three times an executive's salary and bonus may generally be approved by the compensation committee of the board without submission to shareholders. Any such arrangement under which the beneficiary receives more than three times salary and bonus--or where severance is guaranteed absent a change in control--should be submitted for shareholder approval. IV. CORPORATE STRUCTURE AND SHAREHOLDER RIGHTS We believe the exercise of shareholder rights, in proportion to economic ownership, to be a fundamental privilege of stock ownership that should not be unnecessarily limited. Such limits may be placed on shareholders' ability to act by corporate charter or by-law provisions, or by the adoption of certain takeover provisions. We believe that, in general, the market for corporate control should be allowed to function without undue interference from these artificial barriers. Our positions on a number of the most commonly presented issues in this area are as follows: A. SHAREHOLDER RIGHTS PLANS (POISON PILLS) A company's adoption of a so-called poison pill effectively limits a potential acquirer's ability to buy a controlling interest without the approval of the target's board of directors. Such a plan, in conjunction with other takeover defenses, may serve to entrench incumbent management and directors. However, in other cases, a pill may force a suitor to negotiate with the board and result in the payment of a higher acquisition premium. In general, we believe that shareholders should be afforded the opportunity to approve shareholder rights plans within a year of their adoption. This provides the board with the ability to put a poison pill in place for legitimate defensive B-47 purposes, subject to subsequent approval by shareholders. In evaluating the approval of proposed shareholder rights plans, we will consider the following factors:
FACTORS FOR APPROVAL FACTORS AGAINST APPROVAL - -------------------- ------------------------ Plan is relatively short-term (3-5 years). Plan is long term (>5 years). Plan requires shareholder approval for renewal. Renewal of plan is automatic or does not require shareholder approval. Plan incorporates review by a committee of Ownership trigger is less than 15%. independent directors at least every three years (so-called TIDE provisions). Plan includes permitted bid/qualified offer Classified board. feature (chewable pill) that mandates shareholder vote in certain situations. Ownership trigger is reasonable (15-20%). Board with limited independence. Highly independent, non-classified board.
B. CUMULATIVE VOTING We are generally opposed to cumulative voting under the premise that it allows shareholders a voice in director elections that is disproportionate to their economic investment in the corporation. C. SUPERMAJORITY VOTE REQUIREMENTS We support shareholders' ability to approve or reject matters presented for a vote based on a simple majority. Accordingly, we will support proposals to remove supermajority requirements and oppose proposals to impose them. D. RIGHT TO CALL MEETINGS AND ACT BY WRITTEN CONSENT We support shareholders' right to call special meetings of the board (for good cause and with ample representation) and to act by written consent. We will generally vote for proposals to grant these rights to shareholders and against proposals to abridge them. E. CONFIDENTIAL VOTING We believe that the integrity of the voting process is enhanced substantially when shareholders (both institutions and individuals) can vote without fear of coercion or retribution based on their votes. We support proposals to provide confidential voting. F. DUAL CLASSES OF STOCK We are opposed to dual class capitalization structures that provide disparate voting rights to different groups of shareholders with similar economic investments. We will oppose the creation of separate classes with different voting rights and will support the dissolution of such classes. V. CORPORATE AND SOCIAL POLICY ISSUES Proposals in this category, initiated primarily by shareholders, typically request that the company disclose or amend certain business practices. We generally believe that these are "ordinary business matters" that are primarily the responsibility of management and should be evaluated and approved solely by the corporation's board of directors. Often, proposals may address concerns with which we philosophically agree, but absent a compelling economic impact on shareholder value (e.g., proposals to require expensing of stock options), we will typically abstain from voting on these proposals. This reflects our belief that regardless of our philosophical perspective on the issue, these decisions should be the province of company management unless they have a significant, tangible impact on the value of our investment and, we don't view management as responsive to the matter. VI. VOTING IN FOREIGN MARKETS Corporate governance standards, disclosure requirements, and voting mechanics vary greatly among the markets outside the United States in which the funds may invest. We will use our votes, where applicable, to advocate for improvements in governance and disclosure by our portfolio companies. We will evaluate issues presented to shareholders for our foreign holdings in the context with the guidelines described above, as well as local market standards and best practices. We will cast our votes in a manner we believe to be philosophically consistent with our B-48 guidelines, while taking into account differing practices by market. In addition, there may be instances in which we elect not to vote, as described below. Many foreign markets require that securities be "blocked" or reregistered to vote at a company's meeting. Absent an issue of compelling economic importance, we will generally not subject the fund to the loss of liquidity imposed by these requirements. The costs of voting (e.g., custodian fees, vote agency fees) in foreign markets may be substantially higher than for U.S. holdings. As such, the fund may limit its voting on foreign holdings in instances where the issues presented are unlikely to have a material impact on shareholder value. VII. VOTING ON A FUND'S HOLDINGS OF OTHER VANGUARD FUNDS Certain Vanguard funds (owner funds) may, from time to time, own shares of other Vanguard funds (underlying funds). If an underlying fund submits a matter to a vote of its shareholders, votes for and against such matters on behalf of the owner funds will be cast in the same proportion as the votes of the other shareholders in the underlying fund. VIII. THE PROXY VOTING GROUP The Board has delegated the day-to-day function of voting proxies for the funds to the Proxy Voting Group, which the Proxy Oversight Committee oversees. While most votes will be determined through Vanguard's procedures and guidelines, there may be circumstances when the Proxy Voting Group will refer proxy issues to the Committee for consideration. In addition, at any time, the Board has the authority to vote proxies, when, in the Board's or the Committee's discretion, such action is warranted. The Proxy Voting Group performs the following functions: (1) managing proxy voting vendors; (2) reconciling share positions; (3) analyzing proxy proposals using factors described in the guidelines; (4) determining and addressing potential or actual conflicts of interest that may be presented by a particular proxy; and (5) voting proxies. The Proxy Voting Group also prepares periodic and special reports to the Board, and any proposed amendments to the procedures and guidelines. IX. THE PROXY OVERSIGHT COMMITTEE The Board, including a majority of the independent trustees, appoints the members of the Committee who are principals of Vanguard, and who have the requisite expertise to oversee proxy voting for the Vanguard funds. The Committee does not include anyone whose primary duties include external client relationship management or sales. This clear separation between the proxy voting and client relationship functions is intended to eliminate any potential conflict of interest in the proxy voting process. In the unlikely event that a member of the Committee believes he or she might have a conflict of interest regarding a proxy vote, that member must recuse him or herself from the committee meeting at which the matter is addressed, and not participate in the voting decision. The Committee works with the Proxy Voting Group to provide reports and other guidance to the Board regarding proxy voting by the Vanguard funds. The Committee has an obligation to conduct its meetings and exercise its decision-making authority subject to the fiduciary standards of good faith, fairness and Vanguard's Code of Ethics. The Committee shall authorize proxy votes that the Committee determines, in its sole discretion, to be in the best interests of the funds' shareholders. In determining how to apply the Guidelines to a particular factual situation, the Committee may not take into account any interest that would conflict with the interest of fund shareholders in maximizing the value of their investments. The Board may review these procedures and guidelines and modify them from time to time. The procedures and guidelines are available on Vanguard's website at www.vanguard.com. You may obtain a free copy of a report that details how the funds voted the proxies relating to the portfolio securities held by the funds for the prior 12-month period ended June 30 by logging on to Vanguard's internet site, at www.vanguard.com, or the SEC's website at http://www.sec.gov. B-49 YIELD AND TOTAL RETURNS The annualized yields of each Fund for the 30-day period ended January 31, 2005, are set forth below:
SHARE CLASSES ------------- FUND INVESTOR ADMIRAL INSTITUTIONAL - ---- --------- -------- --------------- Vanguard Dividend Growth Fund 1.86% N/A N/A Vanguard Energy Fund 1.53 1.58% N/A Vanguard Health Care Fund 1.05 1.12 N/A Vanguard Precious Metals and Mining Fund N/A N/A N/A Vanguard REIT Index Fund* 4.41 4.46 4.47% *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.
The average annual total returns of each Fund for the one-, five-, and ten-year periods (or since inception) ended January 31, 2005, are set forth below:
10 YEARS(or since 1 YEAR ENDED 5 YEARS ENDED inception) ENDED INVESTOR SHARES 1/31/2005 1/31/2005 1/31/2005 - --------------- --------------- --------------- --------------- VANGUARD DIVIDEND GROWTH FUND Return Before Taxes 6.92% -0.19% 7.46% Return After Taxes on Distributions 6.62 -1.42 5.55 Return After Taxes on Distributions and Sale of Fund Shares 4.88 -0.75 5.49 VANGUARD ENERGY FUND Return Before Taxes 38.90% 20.55% 16.82% Return After Taxes on Distributions 38.34 19.21 15.47 Return After Taxes onDistributions and Sale of Fund Shares 25.59 17.52 14.41 VANGUARD HEALTH CARE FUND** Return Before Taxes 2.76% 11.57% 19.36% Return After Taxes on Distributions 2.06 10.08 17.75 Return After Taxes on Distributions and Sale of Fund Shares 2.54 9.49 16.79 VANGUARD PRECIOUS METALS AND MINING FUND Return Before Taxes 14.20% 22.20% 7.78% Return After Taxes on Distributions 13.22 20.45 6.70 Return After Taxes on Distributions and Sale of Fund Shares 10.54 18.64 6.16 VANGUARD REIT INDEX FUND Return Before Taxes 14.78% 18.91% 13.29% Return After Taxes on Distributions 13.06 16.65 11.05 Return After Taxes on Distributions and Sale of Fund Shares 10.04 15.16 10.23 *Since Inception: the inception date for the REIT Index Fund Investor Shares was May 13, 1996. **Reflects the 1% fee assessed on redemptions of Health Care Fund Investor shares held for less than five years. After March 23, 2005, the Fund's 1% fee will be assessed on redemptions of shares held for less than one year.
B-50
5 YEARS (or since 1 YEAR ENDED inception) ENDED ADMIRAL SHARES* 1/31/2005 1/31/2005 - --------------- ------------- --------------- VANGUARD ENERGY FUND Return Before Taxes 39.02% 22.26% VANGUARD HEALTH CARE FUND Return Before Taxes 2.85** 6.56 VANGUARD REIT INDEX FUND Return Before Taxes 14.82 19.80 *Since Inception: the inception date for the Admiral Shares was November 12, 2001. **Reflects the 1% fee assessed on redemptions of Health Care Fund shares held for less than five years. After March 23, 2005, the Fund's 1% fee will be assessed on redemptions of shares held for less than one year.
SINCE INCEPTION* 1 YEAR ENDED THROUGH INSTITUTIONAL SHARES 1/31/2005 1/31/2005 - -------------------- ------------ --------------- VANGUARD REIT INDEX FUND Return Before Taxes 14.81% 18.84% *December 2, 2003 INFORMATION ABOUT THE VIPER SHARE CLASS The REIT Index Fund (The VIPER Fund) offers and issues an exchange-traded class of shares called VIPER Shares. The VIPER Fund issues VIPER Shares in large blocks, known as "Creation Units." To purchase or redeem a Creation Unit, you must be an Authorized Participant or you must do so through a broker that is an Authorized Participant. An Authorized Participant is a participant in the Depository Trust Company (DTC) that has executed a Participant Agreement with Vanguard Marketing Corporation, the Fund's Distributor. The VIPER Fund issues Creation Units in kind, in exchange for a basket of stocks that are part of--or soon to be part of--its target index (Deposit Securities). The VIPER Fund also redeems Creation Units in kind; an investor who tenders a Creation Unit will receive, as redemption proceeds, a basket of stocks that are part of the Fund's portfolio holdings (Redemption Securities). The Deposit Securities and the Redemption Securities will usually, but may not necessarily always, be the same. As part of any creation or redemption transaction, the investor will either pay or receive some cash in addition to the securities, as described more fully below. The VIPER Fund reserves the right to issue Creation Units for cash, rather than in kind, although each has no current intention of doing so. EXCHANGE LISTING AND TRADING The VIPER shares have been approved for listing on the American Stock Exchange (AMEX) and will trade on the Exchange at market prices that may differ from net asset value. There can be no assurance that, in the future, VIPER Shares will continue to meet all of the AMEX's listing requirements. The AMEX may, but is not required to, delist a Fund's VIPER Shares from listing if: (1) following the initial 12-month period beginning upon the commencement of trading, there are fewer than 50 beneficial owners of the VIPER Shares for 30 or more consecutive trading days; (2) the value of the target index tracked by each Fund is no longer calculated or available; or (3) such other event shall occur or condition exist that, in the opinion of the AMEX, makes further dealings on the AMEX inadvisable. The AMEX will also delist a Fund's VIPER Shares upon termination of the VIPER Share class. As with any stock traded on an exchange, purchases and sales of VIPER Shares will be subject to usual and customary brokerage commissions. CONVERSIONS AND EXCHANGES Owners of conventional shares issued by a VIPER Fund (Investor, Admiral, or Institutional Shares) may convert those shares into VIPER Shares of equivalent value of the same fund. Note: Investors who own conventional shares through a 401(k) plan or other employer-sponsored retirement or benefit plan may not convert those shares into VIPER Shares. B-51 Vanguard will impose a charge on conversion transactions and reserves the right, in the future, to limit or terminate the conversion privilege. VIPER Shares, whether acquired through a conversion or purchased in the secondary market, cannot be converted into shares of another class of the same fund. Investors that are not Authorized Participants must hold VIPER Shares in a brokerage account. Thus, before converting conventional shares into VIPER Shares, an investor must have an existing, or open a new, brokerage account. To initiate a conversion of conventional shares into VIPER Shares, an investor must contact his or her broker. The broker may charge a fee, over and above Vanguard's fee, to process a conversion request. Converting conventional shares into VIPER Shares generally is accomplished as follows. First, after the broker notifies Vanguard of an investor's request to convert, Vanguard will transfer conventional shares from the investor's account with Vanguard to the broker's omnibus account with Vanguard (an account maintained by the broker on behalf of all its customers who hold conventional Vanguard fund shares through the broker). At this point, Vanguard will no longer have any record of the investor; his or her ownership of conventional shares and VIPER Shares will be known only to his or her broker. Next, the broker will instruct Vanguard to convert the appropriate amount of conventional shares in its omnibus account into VIPER Shares of equivalent value. These shares will be held in an account at Vanguard in the name of DTC. (DTC will keep track of which VIPER Shares belong to the broker and the broker, in turn, will keep track of which VIPER Shares belong to its customers.) Because DTC is unable to handle fractional shares, only whole shares will be converted. For example, if the investor owned 300.250 conventional shares, and this was equivalent in value to 90.750 VIPER Shares, the DTC account would receive 90 VIPER Shares. Conventional shares worth 0.750 VIPER Shares (in this example, that would be 2.481 conventional shares) would remain in the broker's omnibus account with Vanguard. The broker then could either (1) take certain internal actions necessary to credit the investor's account with 0.750 VIPER Shares rather than 2.481 conventional shares, or (2) redeem the 2.481 conventional shares at net asset value, in which case the investor would receive cash in lieu of those shares. If the broker chooses to redeem the conventional shares, the investor will realize a gain or loss on the redemption that must be reported on his or her tax return (unless she holds the shares in an IRA or other tax-deferred account). Investors should consult their brokers for information on how the brokers will handle the conversion process, including whether they will impose a fee to process a conversion. The conversion process works differently if the investor opts to hold VIPER Shares through an account at Vanguard Brokerage Services/(R)/ (VBS/(R)/). If the investor converts his or her conventional shares to VIPER Shares through VBS, all conventional shares for which she requests conversion will be converted into the equivalent amount of VIPER Shares. Because no fractional shares will have to be sold, the transaction will be 100% tax-free. Here are some important points to keep in mind when converting conventional shares of a VIPER Fund into VIPER Shares: - - The conversion transaction is nontaxable except, as applicable, to the limited extent described above. - - The conversion process can take anywhere from several days to several weeks, depending on the broker. Vanguard generally will process conversion requests, once received, on the same or next business day, although processing may take up to three business days depending on when the conversion request is received. - - During the conversion process, the investor will remain fully invested in the Fund's conventional shares, and his or her investment will increase or decrease in value in tandem with the net asset value of those shares. - - During the conversion process, the investor will be able to liquidate all or part of his or her investment by instructing Vanguard or his or her broker (depending on whether his or her shares are held in his or her own account or his or her broker's omnibus account) to redeem his or her conventional shares. After the conversion process is complete, the investor will be able to liquidate all or part of his or her investment by instructing his or her broker to sell his or her VIPER Shares. BOOK ENTRY ONLY SYSTEM Vanguard REIT VIPERs/(R)/ are registered in the name of the DTC or its nominee, Cede & Co., and deposited with, or on behalf of, DTC. DTC is a limited-purpose trust company that was created to hold securities of its participants (the DTC Participants) and to facilitate the clearance and settlement of securities transactions among the DTC Participants in such securities through electronic book-entry changes in accounts of the DTC Participants, thereby eliminating the need for physical movement of securities certificates. DTC Participants include securities brokers and dealers, banks, trust companies, clearing corporations and certain other organizations, some of whom (and/or their representatives) own DTC. More specifically, DTC is owned by a number of its DTC Participants and by the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX) and the National Association of Securities Dealers (NASD). Access to the DTC B-52 system is also available to others such as banks, brokers, dealers, and trust companies that clear through or maintain a custodial relationship with a DTC Participant, either directly or indirectly (the Indirect Participants). Beneficial ownership of VIPER Shares is limited to DTC Participants, Indirect Participants, and persons holding interests through DTC Participants and Indirect Participants. Ownership of beneficial interests in VIPER Shares (owners of such beneficial interests are referred to herein as Beneficial Owners) is shown on, and the transfer of ownership is effected only through, records maintained by DTC (with respect to DTC Participants) and on the records of DTC Participants (with respect to Indirect Participants and Beneficial Owners that are not DTC Participants). Beneficial Owners will receive from or through the DTC Participant a written confirmation relating to their purchase of VIPER Shares. The VIPER Fund recognizes DTC or its nominee as the record owner of all VIPER Shares for all purposes. Beneficial Owners of VIPER Shares are not entitled to have VIPER Shares registered in their names, and will not receive or be entitled to physical delivery of share certificates. Each Beneficial Owner must rely on the procedures of DTC and any DTC Participant and/or Indirect Participant through which such Beneficial Owner holds its interests, to exercise any rights of a holder of VIPER Shares. Conveyance of all notices, statements, and other communications to Beneficial Owners is effected as follows. DTC will make available to the Trust upon request and for a fee a listing of the VIPER Shares of the VIPER Fund held by each DTC Participant. The Trust shall obtain from each such DTC Participant the number of Beneficial Owners holding VIPER Shares, directly or indirectly, through such DTC Participant. The Trust shall provide each such DTC Participant with copies of such notice, statement, or other communication, in such form, number and at such place as such DTC Participant may reasonably request, in order that such notice, statement or communication may be transmitted by such DTC Participant, directly or indirectly, to such Beneficial Owners. In addition, the Trust shall pay to each such DTC Participant a fair and reasonable amount as reimbursement for the expenses attendant to such transmittal, all subject to applicable statutory and regulatory requirements. Share distributions shall be made to DTC or its nominee as the registered holder of all VIPER Shares. DTC or its nominee, upon receipt of any such distributions, shall credit immediately DTC Participants' accounts with payments in amounts proportionate to their respective beneficial interests in VIPER Shares of the VIPER Fund as shown on the records of DTC or its nominee. Payments by DTC Participants to Indirect Participants and Beneficial Owners of VIPER Shares held through such DTC Participants will be governed by standing instructions and customary practices, as is now the case with securities held for the accounts of customers in bearer form or registered in a "street name," and will be the responsibility of such DTC Participants. The Trust has no responsibility or liability for any aspects of the records relating to or notices to Beneficial Owners, or payments made on account of beneficial ownership interests in such VIPER Shares, or for maintaining, supervising, or reviewing any records relating to such beneficial ownership interests, or for any other aspect of the relationship between DTC and the DTC Participants or the relationship between such DTC Participants and the Indirect Participants and Beneficial Owners owning through such DTC Participants. DTC may determine to discontinue providing its service with respect to VIPER Shares at any time by giving reasonable notice to the Trust and discharging its responsibilities with respect thereto under applicable law. Under such circumstances, the Trust shall take action either to find a replacement for DTC to perform its functions at a comparable cost or, if such replacement is unavailable, to issue and deliver printed certificates representing ownership of VIPER Shares, unless the Trust makes other arrangements with respect thereto satisfactory to the AMEX (or such other exchange on which VIPER Shares may be listed). PURCHASE AND ISSUANCE OF VIPER SHARES IN CREATION UNITS The VIPER Fund issues and sells VIPER Shares only in Creation Units on a continuous basis through the Distributor, without a sales load, at their net asset value next determined after receipt, on any Business Day, of an order in proper form. The VIPER Fund will not issue fractional Creation Units. A Business Day is any day on which the NYSE is open for business. As of the date of the Prospectus, the NYSE observes the following holidays: New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day (observed), Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. B-53 FUND DEPOSIT The consideration for purchase of a Creation Unit from a VIPER Fund generally consists of the in kind deposit of a designated portfolio of equity securities (the Deposit Securities) and an amount of cash (the Cash Component) consisting of a Balancing Amount (described below) and a Transaction Fee (also described below). Together, the Deposit Securities and the Cash Component constitute the Fund Deposit. The Balancing Amount is an amount equal to the difference between the net asset value (NAV) of a Creation Unit and the market value of the Deposit Securities (the Deposit Amount). It ensures that the NAV of a Fund Deposit (not including the Transaction Fee) is identical to the NAV of the Creation Unit it is used to purchase. If the Balancing Amount is a positive number (i.e., the NAV per Creation Unit exceeds the market value of the Deposit Securities), then that amount will be paid by the purchaser to the VIPER Fund in cash. If the Balancing Amount is a negative number (i.e., the NAV per Creation Unit is less than the market value of the Deposit Securities), then that amount will be paid by the VIPER Fund to the purchaser in cash (except as offset by the Transaction Fee, described below). Vanguard, through the National Securities Clearing Corporation (NSCC) (discussed below), makes available on each Business Day, immediately prior to the opening of business on the AMEX (currently 9:30 a.m., Eastern time), a list of the names and the required number of shares of each Deposit Security to be included in the current Fund Deposit for each VIPER Fund (based on information at the end of the previous Business Day). The Fund Deposit is applicable, subject to any adjustments as described below, in order to effect purchases of Creation Units of a VIPER Fund until such time as the next-announced Fund Deposit composition is made available. Each VIPER Fund reserves the right to accept a nonconforming Fund Deposit. The identity and number of shares of the Deposit Securities required for a Fund Deposit may change to reflect rebalancing adjustments and corporate actions by a Fund, or in response to adjustments to the weighting or composition of the component stocks of the relevant target index. In addition, the Trust reserves the right to permit or require the substitution of an amount of cash--i.e., a "cash in lieu" amount--to be added to the Cash Component to replace any Deposit Security that may not be available in sufficient quantity for delivery, may not be eligible for transfer through the Clearing Process (discussed below), or may not be eligible for trading by an Authorized Participant (as defined below) or the investor for which an Authorized Participant is acting. Brokerage commissions incurred in connection with acquisition of Deposit Securities not eligible for transfer through the systems of DTC and hence not eligible for transfer through the Clearing Process (discussed below) will be an expense of the Fund. However, Vanguard may adjust the Transaction Fee (described below) to protect existing shareholders from this expense. All questions as to the number of shares of each security in the Deposit Securities and the validity, form, eligibility, and acceptance for deposit of any securities to be delivered shall be determined by the appropriate VIPER Fund, and the Fund's determination shall be final and binding. PROCEDURES FOR PURCHASING CREATION UNITS To be eligible to place orders with the Distributor and to purchase Creation Units from a VIPER Fund, you must be an Authorized Participant, i.e., a DTC Participant that has executed an agreement with the Trust's Distributor governing the purchase and redemption of Creation Units (the Participant Agreement). Investors who are not Authorized Participants must make appropriate arrangements with an Authorized Participant in order to purchase or redeem a Creation Unit. If your broker is not a DTC Participant or has not executed a Participant Agreement, it will have to place your order through an Authorized Participant, which may result in additional charges to you. For a current list of Authorized Participants, contact the Distributor. An Authorized Participant may place an order to purchase (or redeem) Creation Units of a VIPER Fund either (1) through the Continuous Net Settlement (CNS) clearing processes of NSCC as such processes have been enhanced to effect purchases (and redemptions) of Creation Units, such processes being referred to herein as the Clearing Process, or (2) outside the Clearing Process. To purchase or redeem through the Clearing Process, an Authorized Participant must be a member of NSCC that is eligible to use the Continuous Net Settlement system. Purchases (and redemptions) of Creation Units cleared through the Clearing Process will be subject to a lower Transaction Fee than those cleared outside the Clearing Process. To initiate a purchase order for a Creation Unit, whether through the Clearing Process or outside the Clearing Process, an Authorized Participant must give notice to the Distributor. The order must be in proper form and must be received by the Distributor prior to the closing time of the regular trading session on the NYSE (Closing Time) (ordinarily 4 p.m., B-54 Eastern time) to receive that day's NAV. The date on which an order to purchase (or redeem) Creation Units is placed is referred to as the Transmittal Date. Orders must be transmitted by an Authorized Participant by a transmission method acceptable to the Distributor pursuant to procedures set forth in the Participation Agreement. Purchase orders effected outside the Clearing Process are likely to require transmittal by the Authorized Participant earlier on the Transmittal Date than orders effected using the Clearing Process. Those persons placing orders outside the Clearing Process should ascertain the deadlines applicable to DTC and the Federal Reserve Bank wire system by contacting the operations department of the broker or depository institution effectuating such transfer of Deposit Securities and Cash Component. Neither the Trust, the Distributor, nor any affiliated party will be liable to an investor who is unable to submit a purchase (or redemption) order by Closing Time, even if the problem is the responsibility of one of those parties (e.g., the Distributor's phone systems or fax machines were not operating properly.) If you are not an Authorized Participant, you must place your purchase order with an Authorized Participant in a form acceptable to such Authorized Participant. In addition, the Authorized Participant may request that you make certain representations or enter into agreements with respect to the order, e.g., to provide for payments of cash when required. You should afford sufficient time to permit proper submission of the order by the Authorized Participant to the Distributor prior to Closing Time on the Transmittal Date. PLACEMENT OF PURCHASE ORDERS USING CLEARING PROCESS For purchase orders placed through the Clearing Process, the Authorized Participant Agreement authorizes the Distributor to transmit through the Transfer Agent or Index Receipt Agent to NSCC, on behalf of an Authorized Participant, such trade instructions as are necessary to effect the Authorized Participant's purchase order. Pursuant to such trade instructions to NSCC, the Authorized Participant agrees to deliver the requisite Deposit Securities and the Cash Component to the appropriate VIPER Fund, together with such additional information as may be required by the Distributor. An order to purchase Creation Units through the Clearing Process is deemed received on the Transmittal Date if (1) such order is received by the Distributor not later than the Closing Time on such Transmittal Date, and (2) all other procedures set forth in the Participant Agreement are properly followed. Such order will be effected based on the NAV of the Fund next determined on that day. An order to purchase Creation Units through the Clearing Process made in proper form but received after Closing Time on the Transmittal Date will be deemed received on the next Business Day immediately following the Transmittal Date and will be effected at the NAV next determined on that day. The Deposit Securities and the Cash Component will be transferred by the third NSCC Business Day following the date on which the purchase request is deemed received. PLACEMENT OF PURCHASE ORDERS OUTSIDE CLEARING PROCESS An Authorized Participant that wishes to place an order to purchase Creation Units outside the Clearing Process must state that it is not using the Clearing Process and that the purchase instead will be effected through a transfer of securities and cash directly through DTC. An order to purchase Creation Units outside the Clearing Process is deemed received by the Distributor on the Transmittal Date if (1) such order is received by the Distributor not later than the Closing Time on such Transmittal Date; and (2) all other procedures set forth in the Participant Agreement are properly followed. If a Fund's custodian does not receive the Deposit Securities and Cash Component by the settlement date (T+3 unless otherwise agreed), the Fund shall be entitled to cancel the purchase order and/or charge the purchaser for any costs (including investment losses, attorney's fees, and interest) sustained by the Fund as a result of the late delivery or failure to deliver. The VIPER Fund may issue Creation Units to a purchaser before receiving some or all of the Deposit Securities if the purchaser deposits, in addition to the available Deposit Securities and the Cash Component, an additional cash deposit in an amount determined by the Fund. REJECTION OF PURCHASE ORDERS The VIPER Fund reserves the absolute right to reject a purchase order transmitted to it by the Distributor. By way of example, and not limitation, the VIPER Fund will reject a purchase order if: - - the order is not in proper form; B-55 - - the investor(s), upon obtaining the VIPER Shares ordered, would own 80% or more of the total combined voting power of all classes of stock issued by the Fund; - - the Deposit Securities delivered are not as disseminated through the facilities of the AMEX for that date by the Custodian, as described above; - - acceptance of the Deposit Securities would have certain adverse tax consequences to the VIPER Fund; - - acceptance of the Fund Deposit would, in the opinion of counsel, be unlawful; - - acceptance of the Fund Deposit would otherwise, in the discretion of the VIPER Fund or Vanguard, have an adverse effect on the Fund or any of its shareholders; or - - circumstances outside the control of the VIPER Fund, the Transfer Agent, the Custodian, the Distributor, and Vanguard make it for all practical purposes impossible to process the order. Examples of such circumstances include acts of God; public service or utility problems such as fires, floods, extreme weather conditions, and power outages resulting in telephone, telecopy, and computer failures; market conditions or activities causing trading halts; systems failures involving computer or other information systems affecting the Trust, Vanguard, the Distributor, DTC, NSCC, or any other participant in the purchase process, and similar extraordinary events. The Distributor shall notify the prospective purchaser of a Creation Unit, and/or the Authorized Participant acting on the purchaser's behalf, of its rejection of the purchaser's order. The VIPER Fund, the Transfer Agent, the Custodian, and the Distributor are under no duty, however, to give notification of any defects or irregularities in the delivery of a Fund Deposit, nor shall any of them incur any liability for the failure to give any such notification. TRANSACTION FEE ON PURCHASES OF CREATION UNITS The VIPER Fund imposes a transaction fee (payable to the Fund) to compensate the Fund for the transfer and other transaction costs associated with the issuance of Creation Units. For purchases effected through the Clearing Process, the transaction fee is $1,000, regardless of how many Creation Units are purchased. An additional charge of up to $1,000 may be imposed for purchases effected outside the Clearing Process. When the VIPER Fund permits a purchaser to substitute cash in lieu of depositing one or more Deposit Securities, the purchaser will be assessed an additional variable charge on the "cash in lieu" portion of its investment. The amount of this variable charge shall be determined by the Fund in its sole discretion, but shall not be more than is reasonably needed to compensate the Fund for the brokerage costs associated with purchasing the relevant Deposit Securities and, if applicable, the estimated market impact costs of purchasing such securities. REDEMPTION OF VIPER SHARES IN CREATION UNITS VIPER Shares may be redeemed only in Creation Units; the VIPER Fund will not redeem VIPER Shares tendered in less than Creation Unit-size aggregations. Investors should expect to incur brokerage and other costs in connection with assembling a sufficient number of VIPER Shares to constitute a redeemable Creation Unit. There can be no assurance, however, that there will be sufficient liquidity in the public trading market at any time to permit assembly of a Creation Unit. Redemption requests in good order will receive the NAV next determined after the request is made. An investor tendering a Creation Unit generally will receive redemption proceeds consisting of (1) a basket of Redemption Securities, plus (2) a Cash Redemption Amount equal to the difference between (x) the NAV of the Creation Unit being redeemed, as next determined after receipt of a request in proper form, and (y) the value of the Redemption Securities, less (3) a Redemption Transaction Fee (described below). If the Redemption Securities have a value greater then the NAV of a Creation Unit, the redeeming investor would pay the Cash Redemption Amount to the Fund, rather than receiving such amount from the Fund. Vanguard, through the NSCC, makes available immediately prior to the opening of business on the AMEX (currently 9:30 a.m., Eastern time) on each Business Day, the identity of the Redemption Securities that will be used (subject to possible amendment or correction) to satisfy redemption requests received in proper form (as defined below) on that day. The basket of Redemption Securities provided to an investor redeeming a Creation Unit may not be identical to the basket of Deposit Securities required of a investor purchasing a Creation Unit. If the VIPER Fund and a redeeming investor mutually agree, the VIPER Fund may provide the investor with a basket of Redemption Securities that differs from the composition of the redemption basket published through NSCC. B-56 TRANSACTION FEES ON REDEMPTIONS OF CREATION UNITS The VIPER Fund imposes a transaction fee (payable to the Fund) to compensate the Funds for the transfer and other transaction costs associated with the redemption of Creation Units. For redemptions effected through the Clearing Process, the transaction fee is $5,500, regardless of how many Creation Units are redeemed. An additional charge of up to $5,500 may be imposed for redemptions effected outside the Clearing Process. When a VIPER Fund permits a redeeming investor to receive cash in lieu of one or more Redemption Securities, the investor will be assessed an additional variable charge on the "cash in lieu" portion of its redemption. The amount of this variable charge shall be determined by the VIPER Fund in its sole discretion, but shall not be more than is reasonably needed to compensate the Fund for the brokerage costs associated with selling portfolio securities to raise the necessary cash and, if applicable, the estimated market impact costs of selling such securities. PLACEMENT OF REDEMPTION ORDERS USING CLEARING PROCESS An order to redeem Creation Units through the Clearing Process is deemed received on the Transmittal Date if (1 such order is received by the Distributor not later than the Closing Time on such Transmittal Date, and (2) all other procedures set forth in the Participant Agreement are properly followed. Such order will be effected based on the NAV of the Fund next determined on that day. An order to redeem Creation Units through the Clearing Process made in proper form but received by a Fund after Closing Time on the Transmittal Date will be deemed received on the next Business Day immediately following the Transmittal Date and will be effected at the NAV next determined on that day. The Redemption Securities and the Cash Redemption Amount will be transferred by the third NSCC Business Day following the date on which the redemption request is deemed received. PLACEMENT OF REDEMPTION ORDERS OUTSIDE CLEARING PROCESS An Authorized Participant that wishes to place an order to redeem a Creation Unit outside the Clearing Process must state that it is not using the Clearing Process and that redemption instead will be effected through a transfer of VIPER Shares directly through DTC. An order to redeem a Creation Unit of a VIPER Fund outside the Clearing Process is deemed received on the Transmittal Date if (1) such order is received by the Fund's Transfer Agent prior to the Closing Time on such Transmittal Date; and (2) all other procedures set forth in the Participant Agreement are properly followed. If the Fund's custodian does not receive the required number of VIPER Shares from the redeeming investor by the settlement date (T+3 unless otherwise agreed), the Fund shall be entitled to charge the redeeming investor for any costs (including investment losses, attorney's fees, and interest) sustained by the Fund as a result of the late delivery or failure to deliver. After the Transfer Agent has deemed an order for redemption outside the Clearing Process received, the Transfer Agent will initiate procedures to transfer the Redemption Securities and the Cash Redemption Amount to the Authorized Participant on behalf of the redeeming Beneficial Owner by the third Business Day following the Transmittal Date on which such redemption order is deemed received by the Transfer Agent. The calculation of the value of the Redemption Securities and the Cash Redemption Amount to be delivered upon redemption will be made by the Custodian according to the procedures set forth under "Calculation of Net Asset Value," computed on the Business Day on which a redemption order is deemed received by the Transfer Agent. Therefore, if a redemption order in proper form is submitted to the Transfer Agent by an Authorized Participant prior to the Closing Time on the Transmittal Date, then the value of the Redemption Securities and the Cash Redemption Amount will be determined by the Custodian on such Transmittal Date. The VIPER Fund reserves the right, in its sole discretion, to require or permit a redeeming investor to receive its redemption proceeds in cash. In such cases, the investor would receive a cash payment equal to the net asset value of its VIPER Shares based on the NAV of those shares next determined after the redemption request is received in proper form (minus a transaction fee, including a charge for cash redemptions, described above). If a redeeming investor (or an Authorized Participant through which it is acting) is subject to a legal restriction with respect to a particular stock included in the basket of Redemption Securities, such investor may be paid an equivalent amount of cash in lieu of the stock. In addition, each VIPER Fund reserves the right to redeem Creation Units partially for cash to the extent that the Fund could not lawfully deliver one or more Redemption Securities or could not do so without first registering such securities under federal or state law. B-57 FINANCIAL STATEMENTS Each Fund's Financial Statements for the fiscal year ended January 31, 2005, appearing in the Funds' 2005 Annual Reports to Shareholders, and the reports thereon of PricewaterhouseCoopers LLP, an independent registered public accounting firm, also appearing therein, are incorporated by reference in this Statement of Additional Information. For a more complete discussion of each Fund's performance, please see the Funds' Annual and Semiannual Reports to Shareholders, which may be obtained without charge. SAI051 082005 B-58 PART C VANGUARD SPECIALIZED FUNDS OTHER INFORMATION ITEM 23. EXHIBITS (a) Declaration of Trust, filed on October 7, 2002, Post-Effective Amendment No. 37, is hereby incorporated by reference. (b) By-Laws, filed on July 3, 2004, Post-Effective Amendment No. 48, is hereby incorporated by reference. (c) Instruments Defining Rights of Security Holders, Reference is made to Articles III and V of the Registrant's Declaration of Trust. (d) Investment Advisory Contracts, for M&G Investment Management Limited (for Vanguard Precious Metals and Mining Fund), filed on December 2, 2002, Post-Effective Amendment No. 39; and for Wellington Management Company, LLP (with respect to Vanguard Dividend Growth Fund), filed on May 20, 2003, Post-Effective Amendment No. 41; are hereby incorporated by reference. For Wellington Management Company (with respect to Vanguard Energy and Health Care Funds), filed on May 31, 2005, Post-Effective Amendment No. 51, are hereby incorporated by reference. The Vanguard Group provides investment advisory services to Vanguard REIT Index Fund and Vanguard Energy Fund at cost pursuant to the Amended and Restated Funds' Service Agreement, refer to Exhibit (h) below. (e) Underwriting Contracts, Not applicable. (f) Bonus or Profit Sharing Contracts, Reference is made to the section entitled "Management of the Funds" in the Registrant's Statement of Additional Information. (g) Custodian Agreements, filed on September 21, 2004, Post-Effective Amendment No. 49, for JPMorgan Chase Bank, Wachovia Bank, N.A., and for Citibank, N.A., filed on December 2, 2002, Post-Effective Amendment No. 39; are hereby incorporated by reference. (h) Other Material Contracts, Amended and Restated Funds' Service Agreement, filed on October 7, 2002, Post-Effective Amendment No. 37, is hereby incorporated by reference. (i) Legal Opinion, Not Applicable. (j) Consent of an Independent Registered Public Accounting Firm, to be filed by Amendment. (k) Omitted Financial Statements, Not Applicable. (l) Initial Capital Agreements, Not Applicable. (m) Rule 12(b)-1 Plan, Not Applicable (n) Rule 18f-3 Plan, filed on May 31, 2005, Post-Effective Amendment No. 51, is hereby incorporated by reference. (o) Reserved. (p) Code of Ethics, for The Vanguard Group, Inc. and Wellington Management Company, filed on March 30, 2005, Post-Effective Amendment No. 50, are hereby incorporated by reference; and for M&G Investment Management Limited, filed on May 31, 2005, Post-Effective Amendment No. 51, is hereby incorporated by reference. ITEM 24. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT Registrant is not controlled by or under common control with any person. ITEM 25. INDEMNIFICATION The Registrant's organizational documents contain provisions indemnifying Trustees and officers against liability incurred in their official capacity. Article VII, Section 2 of the Declaration of Trust provides that the Registrant may indemnify and hold harmless each and every Trustee and officer C-1 from and against any and all claims, demands, costs, losses, expenses, and damages whatsoever arising out of or related to the performance of his or her duties as a Trustee or officer. However, this provision does not cover any liability to which a Trustee or officer would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his or her office. Article VI of the By-Laws generally provides that the Registrant shall indemnify its Trustees and officers from any liability arising out of their past or present service in that capacity. Among other things, this provision excludes any liability arising by reason of willful misfeasance, bad faith, gross negligence, or the reckless disregard of the duties involved in the conduct of the Trustee's or officer's office with the Registrant. ITEM 26. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER Wellington Management Company, LLP (Wellington Management) is an investment adviser registered under the Investment Advisers Act of 1940, as amended (the Advisers Act). The list required by this Item 26 of officers and partners of Wellington Management, together with any information as to any business, profession, vocation or employment of a substantial nature engaged in by such officers and partners during the past two years, is incorporated herein by reference from Schedules B and D of form ADV filed by Wellington Management pursuant to the Advisers Act (SEC File No. 801-15908). M&G Investment Management Limited (M&G) is an investment adviser registered under the Advisers Act. The list required by this Item 26 of officers and directors of M&G, together with any information as to any business, profession, vocation or employment of a substantial nature engaged in by such officers and directors during the past two years, is incorporated herein by reference from Schedules B and D of Form ADV filed by M&G pursuant to the Advisers Act (SEC File No. 801-21981). The Vanguard Group, Inc. (Vanguard) is an investment adviser registered under the Advisers Act. The list required by this Item 26 of officers and directors of Vanguard, together with any information as to any business profession, vocation, or employment of a substantial nature engaged in by such officers and directors during the past two years, is incorporated herein by reference from Schedules B and D of Form ADV filed by Vanguard pursuant to the Advisers Act (SEC File No. 801-11953). ITEM 27. PRINCIPAL UNDERWRITERS (a) Not Applicable (b) Not Applicable (c) Not Applicable ITEM 28. LOCATION OF ACCOUNTS AND RECORDS The books, accounts, and other documents required to be maintained by Section 31 (a) of the Investment Company Act and the rules promulgated thereunder will be maintained at the offices of Registrant; Registrant's Transfer Agent, The Vanguard Group, Inc., 100 Vanguard Boulevard, Malvern, Pennsylvania 19355; and the Registrant's Custodians, Wachovia Bank, N.A., PA4942, 123 S. Broad Street, Philadelphia, Pennsylvania 19109, Citibank, N.A., 111 Wall Street, New York, NY 11245, and JPMorgan Chase Bank, 270 Park Avenue, New York, NY 10017-2070. ITEM 29. MANAGEMENT SERVICES Other than as set forth in the section entitled "Management of the Funds" in Part B of this Registration Statement, the Registrant is not a party to any management-related service contract. ITEM 30. UNDERTAKINGS Not Applicable C-2 SIGNATURES Pursuant to the requirements of the Securities Act of 1933 and the Investment Company Act of 1940, the Registrant hereby certifies that it has duly caused this Post-Effective Amendment to this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the Town of Valley Forge and the Commonwealth of Pennsylvania, on the 6th day of June, 2005. VANGUARD SPECIALIZED FUNDS BY:_____________(signature)________________ ----------- (HEIDI STAM) JOHN J. BRENNAN* CHAIRMAN AND CHIEF EXECUTIVE OFFICER Pursuant to the requirements of the Securities Act of 1933, this Post-Effective Amendment to the Registration Statement has been signed below by the following persons in the capacities and on the date indicated:
SIGNATURE TITLE DATE - ---------------------------------------------------------------------------------------- By: /S/ JOHN J. BRENNAN President, Chairman, Chief June 6, 2005 ---------------------------- Executive Officer, and Trustee (Heidi Stam) John J. Brennan* By: /S/CHARLES D. ELLIS Trustee June 6, 2005 ---------------------------- (Heidi Stam) Charles D. Ellis* By: /S/ RAJIV L. GUPTA Trustee June 6, 2005 ---------------------------- (Heidi Stam) RAJIV L. GUPTA* By: /S/ JOANN HEFFERNAN HEISEN Trustee June 6, 2005 ---------------------------- (Heidi Stam) JoAnn Heffernan Heisen* By: /S/ BURTON G. MALKIEL Trustee June 6, 2005 ---------------------------- (Heidi Stam) Burton G. Malkiel* By: /S/ANDRE F. PEROLD Trustee June 6, 2005 ---------------------------- (Heidi Stam) ANDRE F. PEROLD* By: /S/ ALFRED M. RANKIN, JR. Trustee June 6, 2005 ---------------------------- (Heidi Stam) Alfred M. Rankin, Jr.* By: /S/ J. LAWRENCE WILSON Trustee June 6, 2005 ---------------------------- (Heidi Stam) J. Lawrence Wilson* By: /S/ THOMAS J. HIGGINS Treasurer and Principal June 6, 2005 ------------------------------ Financial Officer and Principal (Heidi Stam) Accounting Officer Thomas J. Higgins*
*By Power of Attorney. Filed on December 20, 2004, see File Number 2-14336. Incorporated by reference. COVER 2 filename2.txt June 6, 2005 U.S. Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 Re: Vanguard Specialized Funds File No. 2-88116 Commissioners: Enclosed is the 52nd Post-Effective Amendment of the registration statement on Form N-1A for the Vanguard Specialized Funds (the "Trust"). The purposes of this Amendment are to: (1) amend Vanguard Energy Fund's investment advisory arrangements (Vanguard Energy Fund is a series of the Trust); and (2) effect a number of non-material changes. Pursuant to the requirements of Rule 485(a), it is hereby requested that this Amendment be declared effective on August 8, 2005. Within the next 60 days, we will also be submitting a Rule 485(b) filing that will include text addressing any SEC staff comments. Pursuant to Rule 485(d)(2), Vanguard will request that the Rule 485(b) filing be declared effective concurrently with this 485(a) filing on August 8, 2005. Please contact me at (610) 503-5804 with any questions or comments that you have concerning the enclosed Amendment. Sincerely, Frances T. Han Associate Counsel The Vanguard Group, Inc. Enclosures cc: Christian Sandoe, Esq. U.S. Securities and Exchange Commission -----END PRIVACY-ENHANCED MESSAGE-----