N-30D 1 convertible072002.txt VANGUARD CONVERTIBLE SECURITIES FUND N-30D FILING Vanguard(R) Convertible Securities Fund Semiannual Report * May 31, 2002 [PICTURE] [THE VANGUARD GROUP LOGO] What You Can Control As an investor, you cannot control how the financial markets perform. But there are vital variables that you can control. You can decide how much to invest. You can limit the risk in your portfolio by diversifying your holdings. And you can control the investment costs you incur. Costs may seem the least dramatic of the three. But costs have a powerful impact on how your wealth accumulates; they reduce, dollar for dollar, the returns that you can derive from an investment. Every mutual fund has operating expenses--to pay for investment managers, telephone support, and so on. These costs appear in the fund's expense ratio, which reflects the percentage of average net assets (your money) consumed each year by operating costs. In 2001, the average mutual fund had an expense ratio of 1.34% (or $13.40 per $1,000 in assets), according to data from Lipper Inc. For Vanguard(R) funds, the average expense ratio was less than one-fourth that amount (0.27%, or $2.70 per $1,000 in assets). Our average expense ratio has been less than the industry average for 25 years, and it's an advantage we aim to maintain. Under our unique corporate structure, shareholders like you own the Vanguard funds, which in turn own The Vanguard Group. No middleman makes a profit from managing the operation. You bear all of the investment risk. It's only right that you reap as much of the potential reward as possible. -------------------------------------------------------------------------------- Contents Letter from the Chairman 1 Report from the Adviser 5 Fund Profile 8 Glossary of Investment Terms 9 Performance Summary 11 Financial Statements 12 Advantages of Vanguard.com 20 Summary * Vanguard Convertible Securities Fund posted a six-month return of -4.4%, falling short of its comparative measures. * Concerns about bankruptcies and corporate accounting practices led to declines in issues from heavily leveraged companies, even those not connected to the accounting scandals. * The poor performance of some holdings in the wireless, cable, and pharmaceutical industries caused your fund to lag its benchmarks. vanguard(R) Admiral(TM) Letter from the Chairman -------------------------------------------------------------------------------- LETTER FROM THE CHAIRMAN [PICTURE] JOHN J. BRENNAN Fellow Shareholder, During the six months ended May 31, 2002, investors' continuing concerns about corporate scandals caused price declines in stock, bond, and convertible issues from companies with high debt loads. In this environment, vanguard(R) convertible securities fund posted a -4.4% return, lagging its comparative measures. The table below shows six-month total returns (capital change plus reinvested dividends) for your fund, the average convertible securities fund, and the unmanaged Credit Suisse First Boston Convertible Securities Index. Per-share components of your fund's return are shown on page 4. ----------------------------------------------- Total Returns Six Months Ended May 31, 2002 ----------------------------------------------- Vanguard Convertible Securities Fund -4.4% Average Convertible Securities Fund* -1.0 CS First Boston Convertibles Index -1.6 ----------------------------------------------- *Derived from data provided by Lipper Inc. The Economy Surged, But Stocks Stayed Weak During the past six months, weak corporate earnings and lingering concern about the integrity of financial statements obscured the good news about the economy's quick rebound from the 2001 recession. U.S. stocks, as represented by the Wilshire 5000 Total Market Index, returned -3.4% as investors focused on the negative. Large, previously top-performing companies, such as Intel and Cisco Systems, were hit especially hard. Corporate America continued to cut back on capital spending, particularly on the big-dollar technology investments that fueled much of the late-1990s boom. As profits shrank, stock valuations pulled back, a pattern that has prevailed since the bursting of the growth-stock bubble in March 2000. Value stocks (those trading at relatively low prices compared with such measures as earnings and book value) held up better, both because these shares had not been priced for the most optimistic scenarios and because many of these stocks represent basic industries, such as commodities producers, that thrive in the early stages of an economic recovery. Natural-resource and basic-processing industries have enjoyed an especially favorable climate in 2002. During the first quarter, more than half of the 6.1% annualized growth in U.S. real gross domestic product derived from additions to inventory, rather than final sales to consumers--a boon to the companies that supply the raw materials for goods to be 1 finished farther up the production line. The strong first quarter followed annualized growth of 1.7% in the fourth quarter of 2001. During the six months ended May 31, the stock market's best performers were small stocks with value characteristics. As a group, these stocks returned 16.4%, as measured by the Russell 2000 Value Index. International equity markets drifted generally lower. -------------------------------------------------------------------------------- MARKET BAROMETER TOTAL RETURNS PERIODS ENDED MAY 31, 2002 ----------------------------------- Six One Five Months Year Years* -------------------------------------------------------------------------------- STOCKS Russell 1000 Index (Large-caps) -4.9% -13.3% 6.4% Russell 2000 Index (Small-caps) 6.5 -0.5 6.4 Wilshire 5000 Index (Entire market) -3.4 -11.8 6.0 MSCI EAFE Index (International) 3.1 -9.6 0.3 -------------------------------------------------------------------------------- BONDS Lehman Aggregate Bond Index 2.3% 8.1% 7.6% (Broad taxable market) Lehman 10 Year Municipal Bond Index 3.0 6.6 6.3 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 0.9 2.6 4.7 ================================================================================ CPI Consumer Price Index 1.4% 1.2% 2.3% -------------------------------------------------------------------------------- *Annualized. CONCERN ABOUT RATES RESTRAINED BOND RETURNS The Federal Reserve Board indicated that an "accommodative" monetary policy, characterized by low short-term interest rates, was appropriate in light of rising unemployment and continuing economic uncertainty. However, the bond market apparently expects that growth will mean higher rates down the road: From November 30, 2001, to May 31, 2002, the yield on the 10-year U.S. Treasury note--a rate controlled by the market, not the Fed--rose 30 basis points (0.30 percentage point) to 5.05%. Bond prices declined when rates rose, but interest income offset the drop, providing investors with modestly positive total returns for the six months. The Lehman Brothers Aggregate Bond Index, a proxy for the broad investment-grade bond market, returned 2.3%. Despite some high-profile blowups in the telecommunications sector, corporate bonds provided modestly higher returns than U.S. Treasury securities with comparable maturities. FIRST MONTHS OF 2002 WERE HARD ON YOUR FUND With a -4.4% return for the semiannual period, the Convertible Securities Fund lagged its benchmark index and the average peer mutual fund by 2.8 and 3.4 percentage points, respectively. Most of the shortfall came during January and February, when the fund returned -6.6%. Though the fund outpaced its average peer and market index during the remainder of the period, it could not offset the earlier decline. -------------------- MOST OF THE FUND'S SHORTFALL CAME DURING JANUARY AND FEBRUARY, THOUGH IT OUTPACED BENCHMARKS DURING THE REST OF THE PERIOD. -------------------- 2 The recent rash of corporate accounting scandals has colored investors' perceptions of many highly leveraged companies, even those unconnected to the scandals. This was especially true for the telecom and cable industries. Compared with its benchmarks, your fund had only a small commitment to telecom, but the sector hurt it nonetheless. Shares in wireless companies and in Charter Communications--a cable company that was among the fund's top ten holdings at the start of the fiscal period--dropped sharply. In addition, some of the fund's pharmaceutical and biotechnology holdings hit significant snags. For example, the Food and Drug Administration's refusal to approve a new drug from Sepracor, the fund's second-biggest holding at the start of the period, resulted in a steep price decline for the company's issues. (Your fund's investment adviser, Oaktree Capital Management, has sold its positions in Sepracor and Charter Communications.) The half-year wasn't all bad news. Your fund's holdings in areas such as defense industries performed relatively well. And, while it may be of cold comfort, convertible issues did fulfill one of their defensive roles: The fund's decline would have been steeper had it owned the common stocks of the same companies. More details about your fund's performance and its individual holdings are in the Report from the Adviser on page 5. We believe that, over the long run, the Convertible Securities Fund will provide competitive returns. Our confidence lies in the investment management skills of the fund's adviser and in Vanguard's cost advantage, which provides an edge in any market environment. The fund's annualized expense ratio (operating expenses as a percentage of average net assets) of 0.92%, or $9.20 per $1,000 invested, is more than one-third less than the 1.49%, or $14.90 per $1,000 invested, charged by the average peer fund. This advantage is one that works to the benefit of our shareholders year in and year out, and is especially powerful over the long run. MAINTAINING PERSPECTIVE IN VOLATILE MARKETS The financial markets have been disappointing over the past two years, particularly for investors who had become accustomed to the stellar returns of the prior 18-year bull market. Through the good times and the bad times, our message never changes: We urge investors to stay the course with a low-cost portfolio diversified across asset classes and market segments in proportions appropriate for your goals, time horizon, and risk tolerance. ------------------------ CONVERTIBLE ISSUES DID FULFILL ONE OF THEIR DEFENSIVE ROLES: THE FUND'S DECLINE WOULD HAVE BEEN STEEPER HAD IT OWNED THE COMMON STOCKS OF THE SAME COMPANIES. ------------------------ 3 Remaining true to such an investment plan can be difficult, given the volatility of the markets and the noise of day-to-day events and commentary. But once you have your plan in place, our recommendation is to stay the course. Thank you for entrusting your hard-earned money to us. Sincerely, /S/ JOHN J. BRENNAN John J. Brennan Chairman and Chief Executive Officer June 13, 2002 John J. Brennan -------------------------------------------------------------------------------- Your Fund's Performance at a Glance: November 30, 2001-May 31, 2002 DISTRIBUTIONS PER SHARE -------------------- STARTING ENDING INCOME CAPITAL SHARE PRICE SHARE PRICE DIVIDENDS GAINS -------------------------------------------------------------------------------- Vanguard Convertible Securities Fund $12.12 $11.33 $0.26 $0.00 -------------------------------------------------------------------------------- 4 REPORT FROM THE ADVISER After producing good absolute and relative performance in fiscal 2001, Vanguard Convertible Securities Fund underperformed its primary index, the CS First Boston Convertibles Index, in the first six months of fiscal 2002. We found the fiscal half-year to be unusually challenging, with several of the common stocks underlying our convertible securities experiencing negative fundamental developments. While there are always disappointments, they were more numerous in this period and led to most of our shortfall relative to the index. THE INVESTMENT ENVIRONMENT Volatility remained extremely high during the six months, and the premiums demanded for bearing credit risk widened across many industry groups. Equity prices were quite weak, as a variety of fundamental concerns negatively affected companies in a number of sectors. Several actual or anticipated corporate bankruptcies also heightened the market's perception of risk. Overall, the stocks underlying the convertible market declined roughly 15% during the period. Investor confidence reversed sharply from the rally in late 2001, producing declines for many asset classes. Despite the overall negativity of the period, new issuance in the convertible market remained steady, though not as strong as in prior periods. For the six months, 97 deals were priced, totaling $48.0 billion, compared with 96 deals and $45.5 billion in the second half of fiscal 2001. The highlights so far in 2002 have been three mega-deals: two from the automobile sector--Ford and General Motors raised $5.0 billion and $3.2 billion, respectively--and a $1.75-billion deal from Lucent Technologies. Without these mega-deals, issuance for the period would have been below expectations. Demand certainly continued to outstrip supply, as a wide variety of investors were attracted to the yields and defensive attributes of convertibles. One very interesting characteristic of the new-issue market in the past few quarters was that many convertible offerings included a feature known as a "short-dated put." This feature, which allows investors to sell securities back to their issuers at preset prices, was meant to induce buyers to accept lower yields and/or higher conversion premiums. However, many of these short-dated puts will come due soon and are likely to be exercised unless conversion values rise enough to motivate investors to retain the securities. It is estimated that approximately $25 billion of convertibles with this feature are now trading below their put prices and have substantial -------------------------------- INVESTMENT PHILOSOPHY THE ADVISER BELIEVES THAT A REASONABLE LEVEL OF CURRENT INCOME AND LONG-TERM GROWTH IN CAPITAL CAN BE ACHIEVED BY INVESTING IN A BROADLY DIVERSIFIED GROUP OF CONVERTIBLE SECURITIES THAT PROVIDE ATTRACTIVE COMBINATIONS OF CURRENT INCOME AND POTENTIAL FOR PRICE APPRECIATION FROM THEIR CONVERTIBILITY INTO COMMON STOCK. -------------------------------- 5 conversion premiums. Although many factors could mitigate the amount of securities that are actually sold back to their issuers, the opportunities and risk associated with these issues bear close monitoring. In general, we expect to see issuers attempt to avert the drain of puts on their resources by offering refinancings at attractive prices, sweetening the terms of the existing issues, or otherwise restructuring the issues. THE FUND'S SUCCESSES AND SHORTFALLS As you would expect given our diverse portfolio, a variety of investments contributed to our underperformance. In contrast to prior periods, however, few holdings had meaningful positive returns to offset our declines. Our positions in the health care sector were particularly troublesome. This industry had been a significant source of return for us in 2001. Our investment in Sepracor was particularly disappointing, as the company was denied approval for a potentially significant new drug. Despite a relatively large 7% coupon, a short maturity of three years, and the fact that the company held about $900 million in cash, the bonds experienced an above-average decline after the release of the news. While this was a disappointment and was damaging to our performance, the convertible provided strong relative downside protection, reflecting less than half of the decline in the company's common shares. Given the resulting high conversion premium of 125% and the expected one-year delay in the new drug's approval, we exited this position. Other decliners in the health care area were Invitrogen, Imclone Systems, and IVAX. We expect positive developments from our other health care investments. We believe that convertibles from the hospital-management industry are particularly attractive. Our holdings in the telecommunications and media industries--though relatively limited--also were hurt by the investment environment. We had decided to emphasize the wireless area, which we believed was the safest portion of the telecom sector. This assumption proved incorrect as Nextel Communications and other associated holdings recorded meaningful declines, due primarily to increased concern over their high debt levels. Of course, many investments in the telecom sector came under pressure due to the severe negative developments among many key players. On a positive note, the fund had no investments in WorldCom, Tyco, Global Crossing, Kmart, or Adelphia Communications. OUR POSITION As always, the fund remains well diversified. We made no significant changes in the fund's general composition and characteristics. Our primary emphasis is on convertible bonds (de-emphasizing preferreds and mandatory convertibles) with intermediate-term maturities, attractive yields, and solid credit quality. In this uncertain economic environment, our focus on credit quality has served us well, and it should continue to do so in the future. 6 We remain optimistic about our current portfolio and about the general attractiveness of the convertible securities market. Given the highly uncertain investing environment, demand for convertibles remains strong. Larry Keele, Portfolio Manager Oaktree Capital Management, LLC June 12, 2002 -------------------------------------------------------------------------------- PORTFOLIO CHANGES SIX MONTHS ENDED MAY 31, 2002 COMMENTS -------------------------------------------------------------------------------- NEW HOLDINGS Pride International Statistically attractive convertible with (2.50% convertible improving company fundamentals. note due 3/1/2007) -------------------------------------------------------------------------------- Royal Caribbean Cruises Extremely cheap convertible with short- (0% convertible note dated put (May 2004) and low conversion due 5/18/2021) premium. Company fundamentals improving, with well-booked summer travel season. -------------------------------------------------------------------------------- Charming Shoppes Newly issued convertible with excellent (4.75% convertible note call protection. Strong management team due 6/1/2012) with margin expansion potential for recently acquired Lane Bryant stores. -------------------------------------------------------------------------------- Duane Reade Five-year noncallable security with short- (2.148% convertible dated puts offers great imbalance of upside note due 4/16/2022) potential to downside risk. ================================================================================ ELIMINATED Brocade Communications Sold due to high conversion premium. (2.0% convertible note due 1/1/2007) -------------------------------------------------------------------------------- LSI Logic Stock declined, leading to very high (4.0% convertible note conversion premium. due 11/1/2006) -------------------------------------------------------------------------------- Newell Currently callable security trading with (5.25% preferred) above-average conversion premium. Took profits on appreciated holding. -------------------------------------------------------------------------------- Mirant Sold due to developing a conversion (6.25% preferred) on premium above our threshold for a convertible preferred security. -------------------------------------------------------------------------------- SEE PAGE 12 FOR A COMPLETE LISTING OF THE FUND'S HOLDINGS. 7 Fund Profile As of May 31, 2002 for Convertible Securities Fund This Profile provides a snapshot of the fund's characteristics, compared where appropriate to an unmanaged broad market index. Key terms are defined on pages 9-10. ----------------------------------------- FINANCIAL ATTRIBUTES Number of Securities 73 Yield 3.9% Conversion Premium 29.5% Average Weighted Maturity 4.8 years Average Coupon 4.4% Average Quality BB Average Duration 3.1 years Foreign Holdings 3.9% Turnover Rate 136%* Expense Ratio 0.92%* Cash Investments 8.4% ----------------------------------------- ----------------------------------------- DISTRIBUTION BY CREDIT QUALITY (% OF BONDS) Aaa/AAA 1.7% Aa/AA 0.0 A/A 7.3 Baa/BBB 17.8 Ba/BB 21.1 B/B 25.1 Below B/B 4.8 Not Rated 22.2 ----------------------------------------- Total 100.0% ----------------------------------------- ----------------------------------------- TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) General Motors Corp. 3.8% (automobiles) Service Corp. International 3.5 (diversified services) Washington Mutual Capital Trust I 2.8 (banking) Union Pacific Capital Trust 2.8 (railroad) EchoStar Communications Corp. 2.7 (telecommunications) Universal Health Services, Inc. 2.7 (health products and services) ICN Pharmaceuticals, Inc. 2.3 (pharmaceuticals) Titan Capital Trust 2.3 (telecommunications) General Semiconductor Corp. 2.2 (electronics) Ford Motor Co. Capital Trust II 2.2 (automobiles) ----------------------------------------- Top Ten 27.3% ----------------------------------------- ----------------------------------------- VOLATILITY MEASURES WILSHIRE FUND 5000 ----------------------------------------- R-Squared 0.67 1.00 Beta 0.80 1.00 ----------------------------------------- ----------------------------------------- Distribution by Maturity (% of bonds) Under 1 Year 0.0% 1-5 Years 57.7 5-10 Years 40.5 10-20 Years 1.8 20-30 Years 0.0 Over 30 Years 0.0 ----------------------------------------- Total 100.0% ----------------------------------------- [COMPUTER] Visit our website www.vanguard.com for regularly updated fund information. *Annualized. 8 ----------------------------------------- SECTOR DIVERSIFICATION (% OF PORTFOLIO) Auto & Transportation 16.9% Consumer Discretionary 20.3 Consumer Staples 2.9 Financial Services 12.0 Health Care 14.4 Integrated Oils 0.0 Other Energy 4.1 Materials & Processing 0.0 Producer Durables 8.7 Technology 17.6 Utilities 3.1 ----------------------------------------- Glossary of Investment Terms AVERAGE COUPON. The average interest rate paid on the securities held by a fund. It is expressed as a percentage of face value. -------------------------------------------------------------------------------- AVERAGE DURATION. An estimate of how much a fund's share price will fluctuate in response to a change in interest rates. To see how the price could shift, multiply the fund's duration by the change in rates. If interest rates rise by one percentage point, the share price of a fund with an average duration of five years would decline by about 5%. If rates decrease by a percentage point, the fund's share price would rise by 5%. -------------------------------------------------------------------------------- AVERAGE QUALITY. An indicator of credit risk, this figure is the average of the ratings assigned to a fund's holdings by credit-rating agencies. The agencies make their judgment after appraising an issuer's ability to meet its obligations. Quality is graded on a scale, with Aaa or AAA indicating the most creditworthy bond issuers. -------------------------------------------------------------------------------- AVERAGE WEIGHTED MATURITY. The average length of time until securities held by a fund reach maturity (or are called) and are repaid. In general, the longer the average weighted maturity, the more a fund's share price will fluctuate in response to changes in market interest rates. -------------------------------------------------------------------------------- BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the overall market (or appropriate market index). The market (or index) is assigned a beta of 1.00, so a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the overall market rose or fell by 10%. -------------------------------------------------------------------------------- CASH INVESTMENTS. The percentage of a fund's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. -------------------------------------------------------------------------------- CONVERSION PREMIUM. The average percentage by which the weighted average market price of the convertible securities held by a fund exceeds the weighted average market price of their underlying common stocks. For example, if a stock is trading at $25 per share and a bond convertible into the stock is trading at a price equivalent to $30 per share of stock, the conversion premium is 20% ($54$25 5 20%). -------------------------------------------------------------------------------- 9 Glossary of Investment Terms (continued) EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. FOREIGN HOLDINGS. The percentage of a fund's net assets represented by securities of companies based outside the United States. R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the overall market (or its benchmark index). If a fund's total returns were precisely synchronized with the overall market's return, its R-squared would be 1.00. If the fund's returns bore no relationship to the market's returns, its R-squared would be 0. TURNOVER RATE. An indication of the fund's trading activity. Funds with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). YIELD. A snapshot of a fund's income from interest and dividends. The yield, expressed as a percentage of the fund's net asset value, is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. 10 Performance Summary As of May 31, 2002 for Convertible Securities Fund All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the fund. Note, too, that both share price and return can fluctuate widely. An investor's shares, when redeemed, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the redemption of fund shares. -------------------------------------------------------------------------------- FISCAL-YEAR TOTAL RETURNS (%) NOVEMBER 30, 1991-MAY 31, 2002 Fiscal Year Convertible CS First Boston Securities Convertibles Index 1992 26 21.7 1993 13.9 19.2 1994 -4.4 -3.9 1995 17.1 24 1996 14.9 15.3 1997 14.8 15.4 1998 -2.2 1.4 1999 24.8 30.6 2000 5.3 1.5 2001 4 -3.6 2002* -4.4 -1.6 *Six months ended May 31, 2002. Note: See Financial Highlights table on page 17 for dividend and capital gains information. -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED MARCH 31, 2002 This table presents average annual total returns through the latest calendar quarter--rather than through the end of the fiscal period. Securities and Exchange Commission rules require that we provide this information. TEN YEARS ONE FIVE ------------------------------- INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL -------------------------------------------------------------------------------- Convertible Securities Fund 6/17/1986 -1.15% 8.17% 4.74% 4.63% 9.37% -------------------------------------------------------------------------------- 11 FINANCIAL STATEMENTS MAY 31, 2002 (UNAUDITED) STATEMENT OF NET ASSETS This Statement provides a detailed list of the fund's holdings, including each security's market value on the last day of the reporting period. Securities are grouped and subtotaled by asset type (common stocks, bonds, etc.) and by industry sector. Other assets are added to, and liabilities are subtracted from, the value of Total Investments to calculate the fund's Net Assets. Finally, Net Assets are divided by the outstanding shares of the fund to arrive at its share price, or Net Asset Value (NAV) Per Share. At the end of the Statement of Net Assets, you will find a table displaying the composition of the fund's net assets. Because all income and any realized gains must be distributed to shareholders each year, the bulk of net assets consists of Paid-in Capital (money invested by shareholders). The amounts shown for Undistributed Net Investment Income and Accumulated Net Realized Gains usually approximate the sums the fund had available to distribute to shareholders as income dividends or capital gains as of the statement date, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. -------------------------------------------------------------------------------- FACE MARKET AMOUNT VALUE* CONVERTIBLE SECURITIES FUND (000) (000) -------------------------------------------------------------------------------- CONVERTIBLE BONDS (70.7%) -------------------------------------------------------------------------------- AUTO & Transportation (8.8%) Continental Airlines, Inc. 4.50%, 2/1/2007 $ 4,420 $ 3,934 General Motors Corp. 4.50%, 3/6/2032 405 11,164 Magna International Inc. 4.875%, 2/15/2005 6,585 6,141 United Parcel Service, Inc. 1.75%, 9/27/2007 4,550 4,618 ------ 25,857 ------ CONSUMER DISCRETIONARY (18.6%) Avon Products, Inc. 0.00%, 7/12/2020 12,095 6,471 Barnes & Noble, Inc. 5.25%, 3/15/2009 3,555 4,097 Charming Shoppes, Inc. (1) 4.75%, 6/1/2012 3,330 3,505 EchoStar Communications Corp. (1) 5.75%, 5/15/2008 3,250 2,892 5.75%, 5/15/2008 5,610 4,993 IKON Office Solutions, Inc. (1) 5.00%, 5/1/2007 1,940 1,811 The Interpublic Group of Cos., Inc. 1.80%, 9/16/2004 4,735 4,646 J.C. Penney & Co., Inc. (1) 5.00%, 10/15/2008 2,855 3,019 5.00%, 10/15/2008 1,860 1,967 Lamar Advertising Co. 5.25%, 9/15/2006 $ 1,000 $ 1,087 The Pep Boys (Manny, Moe & Jack) (1) 4.25%, 6/1/2007 685 679 Royal Caribbean Cruises Ltd. 0.00%, 5/18/2021 11,348 4,922 Service Corp. International 6.75%, 6/22/2008 11,470 10,280 Waste Connections, Inc. (1) 5.50%, 4/15/2006 3,255 3,747 5.50%, 4/15/2006 245 282 ------- 54,398 ------- CONSUMER STAPLES (2.6%) Duane Reade Inc. (1) 2.148%, 4/16/2022 8,450 5,133 Performance Food Group Co. 5.50%, 10/16/2008 1,915 2,506 ------ 7,639 ------ FINANCIAL SERVICES (3.5%) Bisys Group, Inc. 4.00%, 3/15/2006 1,855 2,242 National Data Corp. 5.00%, 11/1/2003 3,645 3,768 Ohio Casualty Corp. (3) 5.00%, 3/19/2022 1,820 2,095 Travelers Property Casualty Corp. 4.50%, 4/15/2032 82 2,010 ------ 10,115 ------ 12 -------------------------------------------------------------------------------- FACE MARKET AMOUNT VALUE* (000) (000) -------------------------------------------------------------------------------- HEALTH CARE (13.2%) -------------------------------------------------------------------------------- Cephalon, Inc. 5.25%, 5/1/2006 $ 5,125 $ 5,022 Community Health Systems, Inc. 4.25%, 10/15/2008 2,670 2,957 ICN Pharmaceuticals, Inc. (1) 6.50%, 7/15/2008 6,540 6,867 Lifepoint Hospitals, Inc. (1) 4.50%, 6/1/2009 2,290 2,419 Province Healthcare Co. (1) 4.25%, 10/10/2008 1,650 1,865 (1) 4.50%, 11/20/2005 1,415 1,615 4.50%, 11/20/2005 1,765 2,014 Sunrise Assisted Living, Inc. (1) 5.25%, 2/1/2009 1,740 1,777 Total Renal Care Holdings 5.625%, 7/15/2006 5,180 5,342 7.00%, 5/15/2009 1,000 965 Universal Health Services, Inc. (1) 0.426%, 6/23/2020 10,885 6,694 0.426%, 6/23/2020 1,895 1,165 ------- 38,702 ------- OTHER ENERGY (2.6%) Devon Energy Corp. 4.95%, 8/15/2008 3,580 3,517 Pride International, Inc. (1) 2.50%, 3/1/2007 3,140 4,102 ------ 7,619 ------ PRODUCER DURABLES (6.4%) Briggs & Stratton Corp. (1) 5.00%, 5/15/2006 1,705 1,799 5.00%, 5/15/2006 1,850 1,952 Kulicke & Soffa Industries, Inc. 4.75%, 12/15/2006 4,580 4,105 (1) 5.25%, 8/15/2006 150 152 5.25%, 8/15/2006 2,115 2,139 L-3 Communications Holdings, Inc. (1) 5.25%, 6/1/2009 1,575 2,628 Photronics, Inc. (1) 4.75%, 12/15/2006 1,945 1,862 Veeco Instruments, Inc. (1) 4.125%, 12/21/2008 4,100 4,131 ------- 18,768 ------- TECHNOLOGY (13.9%) Acxiom Corp. (1) 3.75%, 2/15/2009 3,695 4,406 Adaptec, Inc. (1) 3.00%, 3/5/2007 4,905 5,371 Anixter International, Inc. 0.00%, 6/28/2020 16,025 4,647 Documentum, Inc. (1) 4.50%, 4/1/2007 1,175 909 Edo Corp. (1) 5.25%, 4/15/2007 $ 2,520 $ 2,936 Fairchild Semiconductor Corp. (1) 5.00%, 11/1/2008 3,845 4,369 General Semiconductor Corp. 5.75%, 12/15/2006 6,065 6,520 HNC Software, Inc. (1) 5.25%, 9/1/2008 2,950 2,943 International Rectifier Corp. 4.25%, 7/15/2007 4,230 4,040 Mentor Graphics Corp. (1) 6.875%, 6/15/2007 485 509 Semtech Corp. 4.50%, 2/1/2007 3,795 3,857 ------ 40,507 ------ UTILITIES (1.1%) Mediacom Communications Corp. 5.25%, 7/1/2006 3,695 3,219 -------------------------------------------------------------------------------- TOTAL CONVERTIBLE BONDS (Cost $200,761) 206,824 -------------------------------------------------------------------------------- Shares -------------------------------------------------------------------------------- CONVERTIBLE PREFERRED STOCKS (20.9%) -------------------------------------------------------------------------------- AUTO & Transportation (6.7%) Continental Airlines Financial Trust 6.00% Cvt. Pfd. 59,700 1,552 Ford Motor Co. Capital Trust II 6.50% Cvt. Pfd. 107,300 6,508 Tower Automotive Capital Trust 6.75% Cvt. Pfd. 93,100 3,247 Union Pacific Capital Trust 6.25% Cvt. Pfd. 161,900 8,156 ------ 19,463 ------ FINANCIAL SERVICES (7.5%) * Commerce Capital Trust II (1) 5.95% Cvt. Pfd. 90,700 5,000 Reinsurance Group of America, Inc. 5.75% Cvt. Pfd. 100,000 4,900 United Rentals Trust I 6.50% Cvt. Pfd. 99,700 3,888 Washington Mutual Capital Trust I (1) 5.375% Cvt. Pfd. 148,300 7,990 5.375% Cvt. Pfd. 5,300 286 ------ 22,064 ------ OTHER ENERGY (1.1%) Newfield Financial Trust I 6.50% Cvt. Pfd. 61,900 3,346 13 -------------------------------------------------------------------------------- FACE MARKET AMOUNT VALUE* CONVERTIBLE SECURITIES FUND (000) (000) -------------------------------------------------------------------------------- PRODUCER DURABLES (1.6%) Northrop Grumman Corp. 7.00% Cvt. Pfd. 33,100 $ 4,610 TECHNOLOGY (2.3%) Titan Capital Trust (1) 5.75% Cvt. Pfd. 121,800 4,765 5.75% Cvt. Pfd. 47,300 1,851 ------ 6,616 ------ UTILITIES (1.7%) Dominion Resources, Inc. 9.50% Cvt. Pfd. 82,400 4,997 -------------------------------------------------------------------------------- TOTAL CONVERTIBLE PREFERRED STOCKS (Cost $58,668) 61,096 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- FACE AMOUNT (000) -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (8.6%) -------------------------------------------------------------------------------- REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 1.83%, 6/3/2002 $19,949 19,949 1.83%, 6/3/2002--Note F 5,183 5,183 -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (Cost $25,132) 25,132 -------------------------------------------------------------------------------- TOTAL INVESTMENTS (100.2%) (Cost $284,561) 293,052 -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-0.2%) -------------------------------------------------------------------------------- Other Assets--Note C 7,058 Liabilities--Note F (7,613) ------ (555) ------ -------------------------------------------------------------------------------- NET ASSETS (100%) -------------------------------------------------------------------------------- Applicable to 25,813,433 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $292,497 ================================================================================ NET ASSET VALUE PER SHARE $11.33 ================================================================================ *See Note A in Notes to Financial Statements. *Non-income-producing security. New issue that has not paid a dividend as of May 31, 2002. (1)Security exempt from registration under Rule 144A of the Securities Act of 1933. These securities may be sold in transactions exempt from registration, normally to qualified institutional buyers. At May 31, 2002, the aggregate value of these securities was $97,990,000, representing 33.5% of net assets. -------------------------------------------------------------------------------- AMOUNT PER (000) SHARE -------------------------------------------------------------------------------- AT MAY 31, 2002, NET ASSETS CONSISTED OF: -------------------------------------------------------------------------------- Paid-in Capital $343,115 $13.29 Undistributed Net Investment Income--Note D 2,143 .08 Accumulated Net Realized Losses--Note D (61,252) (2.37) Unrealized Appreciation--Note E 8,491 .33 -------------------------------------------------------------------------------- NET ASSETS $292,497 $11.33 ================================================================================ 14 STATEMENT OF OPERATIONS This Statement shows the types of income earned by the fund during the reporting period, and details the operating expenses charged to the fund. These expenses directly reduce the amount of investment income available to pay to shareholders as income dividends. This Statement also shows any Net Gain (Loss) realized on the sale of investments, and the increase or decrease in the Unrealized Appreciation (Depreciation) of investments during the period. -------------------------------------------------------------------------------- CONVERTIBLE SECURITIES FUND SIX MONTHS ENDED MAY 31, 2002 (000) -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends $ 1,821 Interest 5,726 Security Lending 41 -------------------------------------------------------------------------------- Total Income 7,588 -------------------------------------------------------------------------------- EXPENSES Investment Advisory Fees--Note B Basic Fee 595 Performance Adjustment 286 The Vanguard Group--Note C Management and Administrative 416 Marketing and Distribution 25 Custodian Fees 12 Auditing Fees 6 Shareholders' Reports 12 -------------------------------------------------------------------------------- Total Expenses 1,352 -------------------------------------------------------------------------------- NET INVESTMENT INCOME 6,236 -------------------------------------------------------------------------------- REALIZED NET GAIN (LOSS) ON INVESTMENT SECURITIES SOLD (15,575) -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES(4,415) -------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $(13,754) ================================================================================ 15 STATEMENT OF CHANGES IN NET ASSETS This Statement shows how the fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the amount shareholders invested in the fund, either by purchasing shares or by reinvesting distributions, as well as the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed are shown at the end of the Statement. -------------------------------------------------------------------------------- Convertible Securities Fund --------------------------------- Six Months Year Ended Ended May 31, 2002 Nov. 30, 2001 (000) (000) -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 6,236 $ 13,550 Realized Net Gain (Loss) (15,575) (45,463) Change in Unrealized Appreciation (Depreciation) (4,415) 43,437 -------------------------------------------------------------------------------- Net Increase (Decrease) in Net Assets Resulting from Operations (13,754) 11,524 -------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income (6,553) (13,913) Realized Capital Gain* -- (12,982) -------------------------------------------------------------------------------- Total Distributions (6,553) (26,895) -------------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS1 Issued 48,910 69,354 Issued in Lieu of Cash Distributions 5,679 23,996 Redeemed (41,970) (101,252) -------------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions 12,619 (7,902) -------------------------------------------------------------------------------- Total Increase (Decrease) (7,688) (23,273) -------------------------------------------------------------------------------- NET ASSETS Beginning of Period 300,185 323,458 -------------------------------------------------------------------------------- End of Period $292,497 $300,185 ================================================================================ 1Shares Issued (Redeemed) Issued 4,207 5,508 Issued in Lieu of Cash Distributions 482 1,959 Redeemed (3,633) (8,221) -------------------------------------------------------------------------------- Net Increase (Decrease) in Shares Outstanding 1,056 (754) ================================================================================ *Includes fiscal 2001 short-term gain distributions totaling $8,146,000. Short-term gain distributions are treated as ordinary income dividends for tax purposes. 16 FINANCIAL HIGHLIGHTS This table summarizes the fund's investment results and distributions to shareholders on a per-share basis. It also presents the Total Return and shows net investment income and expenses as percentages of average net assets. These data will help you assess: the variability of the fund's net income and total returns from year to year; the relative contributions of net income and capital gains to the fund's total return; how much it costs to operate the fund; and the extent to which the fund tends to distribute capital gains. The table also shows the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of 100% means that the average security is held in the fund for one year.
CONVERTIBLE SECURITIES FUND ------------------------------------------------------------------------------------------------------------------- YEAR ENDED NOVEMBER 30, FOR A SHARE OUTSTANDING SIX MONTHS ENDED -------------------------------------------- THROUGHOUT EACH PERIOD MAY 31, 2002 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $12.12 $12.68 $13.18 $11.10 $13.01 $13.07 ------------------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .25 .53 .56 .52 .52 .53 Net Realized and Unrealized Gain (Loss) on Investments (.78) (.04) .19 2.13 (.77) 1.17 ------------------------------------------------------------------------------------------------------------------- Total from Investment Operations (.53) .49 .75 2.65 (.25) 1.70 ------------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.26) (.54) (.55) (.57) (.54) (.47) Distributions from Realized Capital Gains -- (.51) (.70) -- (1.12) (1.29) ------------------------------------------------------------------------------------------------------------------- Total Distributions (.26) (1.05) (1.25) (.57) (1.66) (1.76) ------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $11.33 $12.12 $12.68 $13.18 $11.10 $13.01 =================================================================================================================== TOTAL RETURN -4.44% 3.98% 5.27% 24.85% -2.16% 14.81% =================================================================================================================== RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $292 $300 $323 $180 $172 $189 Ratio of Total Expenses to Average Net Assets 0.92%* 0.71% 0.56% 0.55% 0.73% 0.67% Ratio of Net Investment Income to Average Net Assets 4.22%* 4.21% 4.19% 4.30% 4.36% 4.29% Portfolio Turnover Rate 136%* 156% 182% 162% 186% 182% =================================================================================================================== *Annualized.
NOTES TO FINANCIAL STATEMENTS Vanguard Convertible Securities Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. The fund consistently follows such policies in preparing its financial statements. 1. SECURITY VALUATION: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. Bonds are valued using the latest bid prices or using valuations based on a matrix system (which considers such factors as security prices, yields, maturities, and ratings), both as furnished by independent pricing services. Temporary cash investments are valued at cost, which approximates market value. Securities for which market quotations are not readily available are valued by methods deemed by the board of trustees to represent fair value. 2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Accordingly, no provision for federal income taxes is required in the financial statements. 3. REPURCHASE AGREEMENTS: The fund, along with other members of The Vanguard Group, transfers uninvested cash balances to a pooled cash account, which is invested in repurchase agreements secured by U.S. government securities. Securities pledged as collateral for repurchase agreements are held by a custodian bank until the agreements mature. Each agreement requires that the market value of the collateral be sufficient to cover payments of interest and principal; however, in the event of default or bankruptcy by the other party to the agreement, retention of the collateral may be subject to legal proceedings. 4. DISTRIBUTIONS: Distributions to shareholders are recorded on the ex-dividend date. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. 5. OTHER: Dividend income is recorded on the ex-dividend date. Security transactions are accounted for on the date the securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. Premiums and discounts on debt securities purchased are amortized and accreted, respectively, to interest income over the lives of the respective securities. B. Oaktree Capital Management, LLC, provides investment advisory services to the fund for a fee calculated at an annual percentage rate of average net assets. The basic fee is subject to quarterly adjustments based on performance for the preceding three years relative to the Credit Suisse First Boston Convertible Securities Index. For the six months ended May 31, 2002, the advisory fee represented an effective annual basic rate of 0.40% of the fund's average net assets before an increase of $286,000 (0.19%) based on performance. C. The Vanguard Group furnishes at cost corporate management, administrative, marketing, and distribution services. The costs of such services are allocated to the fund under methods approved by the board of trustees. The fund has committed to provide up to 0.40% of its net assets in capital contributions to Vanguard. At May 31, 2002, the fund had contributed capital of $54,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 0.05% of Vanguard's capitalization. The fund's trustees and officers are also directors and officers of Vanguard. 18 D. During the six months ended May 31, 2002, the fund purchased $199,699,000 of investment securities and sold $186,047,000 of investment securities, other than temporary cash investments. At November 30, 2001, the fund had available a capital loss carryforward of $45,572,000 to offset future net capital gains through November 30, 2009. Certain of the fund's convertible preferred stock investments are treated as debt securities for tax purposes. During the six months ended May 31, 2002, the fund realized gains of $114,000 from the sale of these securities, which are included in distributable net investment income for tax purposes; accordingly, such gains have been reclassified from accumulated net realized gains to undistributed net investment income. E. At May 31, 2002, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $8,491,000, consisting of unrealized gains of $14,877,000 on securities that had risen in value since their purchase and $6,386,000 in unrealized losses on securities that had fallen in value since their purchase. F. The market value of securities on loan to broker/dealers at May 31, 2002, was $5,062,000, for which the fund held cash collateral of $5,183,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. 19 ADVANTAGES OF VANGUARD.COM(TM) [COMPUTER] Why wait for the mail? You can get fund reports like this one sooner--and reduce the amount of mail you receive from us. Simply choose to view your fund reports online. Consider the benefits of using Vanguard.com. On our website, you can: * Choose to stop receiving fund reports and prospectuses via U.S. mail, and view them online instead. * Request a courtesy e-mail to notify you when a new fund report or prospectus is available. When you receive fund reports and prospectuses online, you lower Vanguard's printing and postage costs--and that helps to reduce the expense ratios of your funds. You will continue to receive confirmations of purchases, redemptions, and other account activity by mail. HOW TO NOTIFY US ABOUT YOUR MAILING PREFERENCES You can easily tell us to stop mailing your fund reports and prospectuses. Just log on to Vanguard.com (or follow the easy steps to register for secure, online access to your accounts) and update your Web Profile. Registered users can also view their account values; download records of recent transactions; research and track the performance of individual securities and funds; buy, exchange, and sell fund shares; and much more. If you invest directly with us, you can also elect to receive all of your account statements online or to have us mail out only your year-end statements, which detail every transaction you make during the year. However, if you invest with us through an employer-sponsored retirement plan or a financial intermediary, some of these options may not be available to you. All Vanguard shareholders can choose to receive our electronic newsletters: Economic Week in Review, a recap of each week's key economic reports and market activity; and What's New at Vanguard, an update on Vanguard investments, services, and online resources, delivered every month and whenever there's breaking news. YOUR ONLINE INFORMATION IS SECURE Vanguard.com uses some of the most secure forms of online communication available, including data encryption and Secure Sockets Layer (SSL) protocol. These technologies provide a high level of security and privacy when you access your account information, initiate online transactions, or send us messages. 20 THE PEOPLE WHO GOVERN YOUR FUND The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are a part owner of the fund. Your fund trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides services to them on an at-cost basis. A majority of Vanguard's board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. Our independent board members bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the activities of the funds. Among board members' responsibilities are selecting investment advisers for the funds; monitoring fund operations, performance, and costs; reviewing contracts; nominating and selecting new trustees/directors; and electing Vanguard officers. ================================================================================ TRUSTEES (Year Elected ) JOHN J. BRENNAN (1987) Chairman of the Board, Chief Executive Officer, and Director/Trustee of The Vanguard Group, Inc., and of each of the investment companies served by The Vanguard Group. CHARLES D. ELLIS (2001) The Partners of '63 (pro bono ventures in education); Senior Adviser 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 (2001) Chairman and Chief Executive Officer of Rohm and Haas Co. (chemicals); Director of Technitrol, Inc. (electronic components), and Agere Systems (communications components); Board Member of the American Chemistry Council; and Trustee of Drexel University. JOANN HEFFERNAN HEISEN (1998)Vice President, Chief Information Officer, and Member of the Executive Committee of Johnson & Johnson (pharmaceuticals/consumer products); Director of the Medical Center at Princeton and Women's Research and Education Institute. BURTON G. MALKIEL (1977) Chemical Bank Chairman's Professor of Economics, Princeton University; Director of Vanguard Investment Series plc (Irish investment fund), Vanguard Group (Ireland) Limited (Irish investment management firm), Prudential Insurance Co. of America, BKF Capital (investment management firm), The Jeffrey Co. (holding company), and NeuVis, Inc. (software company). ALFRED M. RANKIN, JR. (1993) Chairman, President, Chief Executive Officer, and Director of NACCO Industries, Inc. (forklift trucks/housewares/lignite); Director of Goodrich Corporation (industrial products/aircraft systems and services). J. LAWRENCE WILSON (1985) Retired Chairman and Chief Executive Officer of Rohm and Haas Co. (chemicals); Director of Cummins Inc. (diesel engines), The Mead Corp. (paper products), and AmerisourceBergen Corp. (pharmaceutical distribution); Trustee of Vanderbilt University. -------------------------------------------------------------------------------- EXECUTIVE OFFICERS R. GREGORY BARTON Secretary; Managing Director and General Counsel of The Vanguard Group, Inc.; Secretary of The Vanguard Group and of each of the investment companies served by The Vanguard Group. THOMAS J. HIGGINS Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies served by The Vanguard Group. More information about the trustees is in the Statement of Additional Information, available from The Vanguard Group. VANGUARD SENIOR MANAGEMENT TEAM Mortimer J. Buckley, Information Technology. F. William McNabb, III, Institutional Investor Group. James H. Gately, Direct Investor Services. Michael S. Miller, Planning and Development. Kathleen C. Gubanich, Human Resources. Ralph K. Packard, Finance. Ian A. MacKinnon, Fixed Income Group. George U. Sauter, Quantitative Equity Group. -------------------------------------------------------------------------------- John C. Bogle, Founder; Chairman and Chief Executive Officer, 1974-;1996. [LOGO] The Vanguard Group Post Office Box 2600 Valley Forge, PA 19482-2600 Vanguard, The Vanguard Group, Vanguard.com, Admiral, Explorer, and the ship logo are trademarks of The Vanguard Group, Inc. S&P MIDCAP 400 is a trademark of The McGraw-Hill Companies, Inc. All other marks are the property of their respective owners. All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. ABOUT OUR COVER Our cover photographs were taken by Michael Kahn in September 2000 aboard HMS Rose in New York's Long Island Sound. Mr. Kahn is a renowned photographer--and accomplished sailor--whose work often focuses on seascapes and nautical images. The photographs are copyrighted by Mr. Kahn. FOR MORE INFORMATION This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. To receive a free copy of the prospectus or the Statement of Additional Information, or to request additional information about the fund or other Vanguard funds, please contact us at one of the adjacent telephone numbers or by e-mail through Vanguard.com(TM). Prospectuses may also be viewed online. WORLD WIDE WEB www.vanguard.com FUND INFORMATION 1-800-662-7447 DIRECT INVESTOR ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 TEXT TELEPHONE 1-800-952-3335 (C)2002 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. Q822 072002