N-CSRS 1 malvernfunds_final.htm malvernfunds_final.htm - Generated by SEC Publisher for SEC Filing

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT OF

REGISTERED MANAGEMENT INVESTMENT COMPANIES

Investment Company Act file number: 811-05628

Name of Registrant: Vanguard Malvern Funds
Address of Registrant: P.O. Box 2600
  Valley Forge, PA 19482

 

Name and address of agent for service: Heidi Stam, Esquire
  P.O. Box 876
  Valley Forge, PA 19482

 

Registrant’s telephone number, including area code: (610) 669-1000

Date of fiscal year end: September 30

Date of reporting period: October 1, 2015 – March 31, 2016

Item 1: Reports to Shareholders



Semiannual Report | March 31, 2016

Vanguard U.S. Value Fund


 

Vanguard’s Principles for Investing Success

We want to give you the best chance of investment success. These principles, grounded in Vanguard’s research and experience, can put you on the right path.

Goals. Create clear, appropriate investment goals.

Balance. Develop a suitable asset allocation using broadly diversified funds. Cost. Minimize cost.

Discipline. Maintain perspective and long-term discipline.

A single theme unites these principles: Focus on the things you can control.

We believe there is no wiser course for any investor.

Contents  
Your Fund’s Total Returns. 1
Chairman’s Letter. 2
Advisor’s Report. 8
Fund Profile. 10
Performance Summary. 11
Financial Statements. 12
About Your Fund’s Expenses. 24
Trustees Approve Advisory Arrangement. 26
Glossary. 27

 

Please note: The opinions expressed in this report are just that—informed opinions. They should not be considered promises or advice. Also, please keep in mind that the information and opinions cover the period through the date on the front of this report. Of course, the risks of investing in your fund are spelled out in the prospectus.

See the Glossary for definitions of investment terms used in this report.

About the cover: Pictured is a sailing block on the Brilliant, a 1932 schooner docked in Mystic, Connecticut. A type of pulley, the sailing block helps coordinate the setting of the sails. At Vanguard, the intricate coordination of technology and people allows us to help millions of clients around the world reach their financial goals.


 

Your Fund’s Total Returns

 
Six Months Ended March 31, 2016  
  Total
  Returns
Vanguard U.S. Value Fund 4.78%
Russell 3000 Value Index 7.15
Multi-Cap Value Funds Average 5.18
Multi-Cap Value Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company.  

 

 
Your Fund’s Performance at a Glance        
September 30, 2015, Through March 31, 2016        
      Distributions Per Share
  Starting Ending Income Capital
  Share Price Share Price Dividends Gains
Vanguard U.S. Value Fund $16.48 $16.27 $0.358 $0.653

 


 


Chairman’s Letter

Dear Shareholder,

Despite a bout of volatility, U.S. stocks produced solid gains for the six months ended March 31, 2016. Stocks of larger-capitalization companies generally outpaced those of smaller firms, while growth stocks finished slightly ahead of their value counterparts.

Against this investment backdrop, Vanguard U.S. Value Fund, which focuses on mid- and large-cap value stocks, returned 4.78%. The result trailed the 7.15% return of its benchmark index, the Russell 3000 Value Index Fund, as well the 5.18% average return of its peers.

Eight of the fund’s ten industry sectors posted positive results, with stocks of utilities, industrials, and information technology companies adding most to returns. Financials, one of the market’s weakest performers for the period, weighed heavily on performance. The fund’s holdings in most sectors failed to keep pace with those represented in the index, leading to its relative underperformance.

Stocks charted an uneven course en route to a favorable outcome
The broad U.S. stock market returned about 7% over the six months. The period began and ended strongly, with fluctuations in the middle as China’s economic slowdown and falling oil and commodity prices worried investors.

2


 

Stocks rallied in March as investors again seemed encouraged by news about monetary policy. The Federal Reserve indicated, after a mid-March meeting, that it would raise interest rates fewer times in 2016 than previously anticipated. And central bankers in Europe and Asia kept up stimulus measures to combat weak growth and low inflation.

International stocks returned about 3% for the period after surging more than 8% in March. Stocks from emerging markets and from developed markets of the Pacific region outperformed European stocks, which were nearly flat.

Bonds produced gains following a subpar start
After posting weak results for the first three months of the period, bonds managed solid gains in the final three. The broad U.S. taxable bond market returned 2.44% for the fiscal half year.

With stocks volatile and the Fed proceeding cautiously with rate hikes, bonds proved attractive. The yield of the 10-year U.S. Treasury note closed at 1.77% at the end of March, down from 2.05% six months earlier. (Bond prices and yields move in opposite directions.)

 
Market Barometer      
 
      Total Returns
    Periods Ended March 31, 2016
  Six One Five Years
  Months Year (Annualized)
Stocks      
Russell 1000 Index (Large-caps) 7.75% 0.50% 11.35%
Russell 2000 Index (Small-caps) 2.02 -9.76 7.20
Russell 3000 Index (Broad U.S. market) 7.30 -0.34 11.01
FTSE All-World ex US Index (International) 3.09 -8.53 0.70
 
Bonds      
Barclays U.S. Aggregate Bond Index (Broad taxable market) 2.44% 1.96% 3.78%
Barclays Municipal Bond Index (Broad tax-exempt market) 3.20 3.98 5.59
Citigroup Three-Month U.S. Treasury Bill Index 0.06 0.08 0.04
 
CPI      
Consumer Price Index 0.08% 0.85% 1.28%

 

3


 

Returns for money market funds and savings accounts remained limited by the Fed’s target rate of 0.25%–0.5%—still low despite rising a quarter percentage point in December.

International bond markets (as measured by the Barclays Global Aggregate Index ex USD) returned 6.90%. International bonds got a boost as foreign currencies strengthened against the dollar, a turn-about from the trend of recent years. Even without this currency benefit, however, international bond returns were solidly positive.

The fund delivered solid gains despite trailing its benchmark
Vanguard U.S. Value Fund focuses primarily on stocks of large and midsize companies that, in the opinion of its advisor, Vanguard Quantitative Equity Group, offer a good balance between reasonable valuations and attractive growth prospects relative to their peers. The advisor uses a quantitatively driven investment approach, employing a proprietary computer model to evaluate thousands of companies. The goal is to identify stocks that are selling below their true worth. The fund is well diversified, investing in more than 200 stocks across all market sectors.

 
Expense Ratios    
Your Fund Compared With Its Peer Group    
    Peer Group
  Fund Average
U.S. Value Fund 0.26% 1.15%
The fund expense ratio shown is from the prospectus dated January 27, 2016, and represents estimated costs for the current fiscal year. For the six months ended March 31, 2016, the fund’s annualized expense ratio was 0.23%. The peer-group expense ratio is derived from data provided by Lipper, a Thomson Reuters Company, and captures information through year-end 2015.
 
Peer group: Multi-Cap Value Funds.    

 

4


 

As I mentioned, your fund trailed its benchmark for the most recent six-month period. The fund’s underperformance can be attributed to disappointing results in several sectors.

While the fund notched gains in industrials, information technology, energy, consumer staples, and health care, its holdings in these sectors failed to keep pace with those of the benchmark. The fund’s consumer

 
Vanguard’s growth translates into lower costs for you
 
Research indicates that lower-cost investments have tended to outperform higher-cost ones.
So it’s little wonder that funds with lower expense ratios—including those at Vanguard—have
dominated the industry’s cash inflows in recent years.
 
Vanguard has long been a low-cost leader, with expenses well below those of many other
investment management companies. That cost difference remains a powerful advantage for
Vanguard clients. Why? Because a lower expense ratio allows a fund to pass along a greater
share of its returns to its investors.
 
What’s more, as you can see in the chart below, we’ve been able to lower our costs continually
as our assets under management have grown. Our steady growth has not been an explicit
business objective. Rather, we focus on putting our clients’ interests first at all times, and
giving them the best chance for investment success. But economies of scale—the cost
efficiencies that come with our growth—have allowed us to keep lowering our fund costs,
even as we invest in our people and technology.
 
The benefit of economies of scale

5


 

discretionary stocks lost ground, but the benchmark’s holdings in the sector added to returns. Both the fund and its index posted negative results in financials, although the sector held up better in the benchmark.

Telecommunication services was a bright spot for the fund, as its holdings in the sector produced modestly higher returns than those in the benchmark. The fund also had a stronger showing in the utilities sector, which contributed solidly to performance in both the fund and the index.

For more about the advisor’s strategy and the fund’s positioning during the six months, see the Advisor’s Report that follows this letter.

Consider rebalancing to manage your risk
Let’s say you’ve taken the time to carefully create an appropriate asset allocation for your investment portfolio. Your efforts have produced a diversified mix of stock, bond, and money market funds tailored to your goals, time horizon, and risk tolerance.

But what should you do when your portfolio drifts from its original asset allocation as the financial markets rise or fall? Consider rebalancing to bring it back to the proper mix.

Just one year of outsized returns can throw your allocation out of whack. Take 2013 as an example. That year, the broad stock market (as measured by the Russell 3000 Index) returned 33.55% and the broad taxable bond market (as measured by the Barclays U.S. Aggregate Bond Index) returned –2.02%. A hypothetical portfolio that tracked the broad domestic market indexes and started the year with 60% stocks and 40% bonds would have ended with a more aggressive mix of 67% stocks and 33% bonds.

Rebalancing to bring your portfolio back to its original targets would require you to shift assets away from areas that have been performing well toward those that have been falling behind. That isn’t easy or intuitive. Rebalancing is a way to minimize risk rather than maximize returns and to stick with your investment plan through different types of markets. (You can read more about our approach in Best Practices for Portfolio Rebalancing at vanguard.com/research.)

It’s not necessary to check your portfolio every day or every month, much less rebalance it that frequently. It may be more appropriate to monitor it annually or semiannually and rebalance when your allocation swings 5 percentage points or more from its target.

6


 

It’s important, of course, to be aware of the tax implications. You’ll want to consult with your tax advisor, but generally speaking, it may be a good idea to make any asset changes within a tax-advantaged retirement account or to direct new cash flows into the underweighted asset class.

However you go about it, keeping your asset allocation from drifting too far off target can help you stay on track with the investment plan you’ve crafted to meet your financial goals.

As always, thank you for investing with Vanguard.

Sincerely,


F. William McNabb III
Chairman and Chief Executive Officer
April 12, 2016

7


 

Advisor’s Report

For the six months ended March 31, 2016, Vanguard U.S. Value Fund returned 4.78%, lagging the Russell 3000 Value Index by 2.37 percentage points. For the six months, the broad U.S. equity market was up 7.30%. Improvement was seen primarily in large- and mid-capitalization stocks, which returned 7.75%, outpacing the 2.02% return of small-cap stocks. Within the broad market, growth stocks slightly outperformed their value counterparts during this period, returning 7.45%.

Developed and international markets saw improvements compared with their losses in the prior year; emerging markets surpassed developed markets by 4.85 percentage points. Performance within the Russell 3000 Value benchmark was strong: All ten sectors generated positive returns. Results were best in telecommunication services, utilities, and materials companies, but only mildly positive in energy and financial firms.

The U.S. economy continued to grow in 2016, but at a slower pace. Fourth-quarter 2015 real GDP grew 1.4%, compared with 2.0% in the third quarter. The deceleration was attributed primarily to downturns in nonresidential fixed investment, exports, and state and local government spending. Corporate profits decreased 8.1% in the fourth quarter, the largest quarterly decline since the first quarter of 2011. However, the U.S. job market further improved. Total nonfarm payroll employment rose by 215,000 in March; the unemployment rate rose slightly to 5.0%. In the first quarter of 2016, oil prices declined significantly, but have since recovered after bottoming out in mid-February. This volatility spilled over into the global stock markets, which saw similar price action in the quarter.

The Federal Reserve raised interest rates in December after keeping rates near zero since 2008. Further gradual rate hikes are expected later this year, depending on global economic data. Although rates are rising in the United States, several of the world’s central banks, including the European Central Bank and the Bank of Japan, are experimenting with negative interest rates in an attempt to spur economic growth.

While it’s important to understand how overall portfolio performance is affected by these macroeconomic factors, we emphasize that our investment process focuses on specific stock fundamentals and portfolio characteristics. Our stock selection model evaluates the companies within our investment universe to identify those with attractive characteristics that we believe will outperform over the long run. To do this, we use a strict quantitative process that focuses on a combination of five key themes: high quality—healthy balance sheets and consistent cash flow generation; effective use of capital—sound investment policies that favor internal over external funding; consistent earnings growth—a demonstrated ability to increase earnings year after year; strong market sentiment—market confirmation of our view; and reasonable valuation—avoidance of overpriced stocks.

8


 

We evaluate the interaction of these themes on all the stocks in our universe each day, seeking to capitalize on investor biases across the market. Using the results of our model, we then construct our portfolio with the goal of maximizing expected return, while minimizing exposure to risks that our research indicates do not improve returns, such as industry selection and other risks relative to our benchmark.

For the six-month period, our valuation, management decisions, and quality models contributed to performance. Our sentiment model made a minor contribution to performance, and our growth model mildly detracted from performance.

Our stock selection results over the past six months were disappointing across sectors. We were able to produce positive results in only the three best-performing sectors in the benchmark: telecommunication services, utilities, and materials.

In telecommunication services, our most successful positions included Verizon (+27.5%), CenturyLink (+32.0%), and Cincinnati Bell (+24.0%). Performance within utilities was driven by UGI (+17.2%), WGL Holdings (+27.4%), and Exelon (+23.3%). Materials benefited from our positions in Avery Dennison (+28.9%) and Dow Chemical (+22.1%).

We were not able to match the outperformance across all sectors. The most disappointing results were in financials, information technology, and energy. In financials, Santander (–48.6%), Universal Insurance (–38.5%), and Heritage Insurance (–18.6%) did not perform as expected. Fitbit (–59.8%), EarthLink Holdings (–26.1%), and Jabil Circuit (–13.2%) similarly detracted from performance in information technology. In energy, Teekay Tankers (–45.2%), Alon USA Energy (–41.6%), and Marathon Petroleum (–18.5%) detracted from performance.

Portfolio Managers:

James P. Stetler, Principal

Anatoly Shtekhman, CFA

Binbin Guo, Principal, Head of Equity
Research and Portfolio Strategies

Vanguard Quantitative Equity Group

April 18, 2016

9


 

U.S. Value Fund

Fund Profile
As of March 31, 2016

 
Portfolio Characteristics    
    Russell DJ
    3000 U.S. Total
    Value Market
  Fund Index FA Index
Number of Stocks 262 2,009 3,900
Median Market Cap $25.1B $46.9B $52.5B
Price/Earnings Ratio 15.6x 19.7x 21.8x
Price/Book Ratio 1.7x 1.8x 2.7x
Return on Equity 12.8% 12.4% 17.5%
Earnings Growth      
Rate 6.0% 3.2% 8.0%
Dividend Yield 2.7% 2.6% 2.1%
Foreign Holdings 0.9% 0.0% 0.0%
Turnover Rate      
(Annualized) 63%
Ticker Symbol VUVLX
Expense Ratio1 0.26%
30-Day SEC Yield 2.39%
Short-Term Reserves 0.2%

 

 
Sector Diversification (% of equity exposure)
    Russell DJ
    3000 U.S. Total
    Value Market
  Fund Index FA Index
Consumer      
Discretionary 5.7% 5.7% 13.6%
Consumer Staples 7.0 7.1 9.2
Energy 11.9 12.0 6.1
Financials 29.4 29.4 17.4
Health Care 11.1 11.1 13.7
Industrials 10.6 10.5 10.7
Information      
Technology 11.6 11.5 20.1
Materials 2.9 2.9 3.2
Telecommunication      
Services 2.7 2.7 2.5
Utilities 7.1 7.1 3.5

 

  
Volatility Measures    
  Russell DJ
  3000 U.S. Total
  Value Market
  Index FA Index
R-Squared 0.98 0.95
Beta 0.97 0.95
These measures show the degree and timing of the fund’s fluctuations compared with the indexes over 36 months.

 

 
Ten Largest Holdings (% of total net assets)
Johnson & Johnson Pharmaceuticals 2.9%
Exxon Mobil Corp. Integrated Oil & Gas 2.8
General Electric Co. Industrial  
  Conglomerates 2.6
JPMorgan Chase & Co. Diversified Banks 2.5
Berkshire Hathaway Inc. Multi-Sector Holdings 2.3
Wells Fargo & Co. Diversified Banks 1.9
Bank of America Corp. Diversified Banks 1.7
Citigroup Inc. Diversified Banks 1.6
Procter & Gamble Co. Household Products 1.5
AT&T Inc. Integrated  
  Telecommunication  
  Services 1.3
Top Ten   21.1%
The holdings listed exclude any temporary cash investments and equity index products.

 

Investment Focus


1 The expense ratio shown is from the prospectus dated January 27, 2016, and represents estimated costs for the current fiscal year. For the six months ended March 31, 2016, the annualized expense ratio was 0.23%.

10


 

U.S. Value Fund

Performance Summary

All of the returns in this report represent past performance, which is not a guarantee of future results that may be achieved by the fund. (Current performance may be lower or higher than the performance data cited. For performance data current to the most recent month-end, visit our website at vanguard.com/performance.) Note, too, that both investment returns and principal value can fluctuate widely, so an investor’s shares, when sold, 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 sale of fund shares.

Fiscal-Year Total Returns (%): September 30, 2005, Through March 31, 2016


Average Annual Total Returns: Periods Ended March 31, 2016

  Inception One Five Ten
  Date Year Years Years
U.S. Value Fund 6/29/2000 -2.22% 11.30% 5.60%

 

See Financial Highlights for dividend and capital gains information.

11


 

U.S. Value Fund

Financial Statements (unaudited)

Statement of Net Assets
As of March 31, 2016

The fund reports a complete list of its holdings in regulatory filings four times in each fiscal year, at the quarter-ends. For the second and fourth fiscal quarters, the lists appear in the fund’s semiannual and annual reports to shareholders. For the first and third fiscal quarters, the fund files the lists with the Securities and Exchange Commission on Form N-Q. Shareholders can look up the fund’s Forms N-Q on the SEC’s website at sec.gov. Forms N-Q may also be reviewed and copied at the SEC’s Public Reference Room (see the back cover of this report for further information).

      Market
      Value
    Shares ($000)
Common Stocks (99.5%)1    
Consumer Discretionary (5.6%)    
  Target Corp. 154,741 12,732
  General Motors Co. 341,727 10,740
  Cooper Tire & Rubber Co. 179,200 6,634
  Whirlpool Corp. 29,566 5,332
  Darden Restaurants Inc. 64,566 4,281
  Best Buy Co. Inc. 96,281 3,123
* DISH Network Corp.    
  Class A 63,342 2,930
  Carnival Corp. 54,209 2,861
  PVH Corp. 27,090 2,683
* Isle of Capri Casinos Inc. 186,600 2,612
* DreamWorks Animation    
  SKG Inc. Class A 103,745 2,588
  News Corp. Class B 195,071 2,585
  Comcast Corp. Class A 40,874 2,497
  Gannett Co. Inc. 147,924 2,240
  DR Horton Inc. 49,578 1,499
* MSG Networks Inc. 63,800 1,103
  Brunswick Corp. 22,818 1,095
  Tupperware Brands Corp. 16,947 983
  Hasbro Inc. 11,320 907
  New York Times Co.    
  Class A 67,261 838
* Discovery Communications    
  Inc. Class A 29,217 836
* ZAGG Inc. 88,391 796
  Abercrombie & Fitch Co. 23,841 752
  American Eagle Outfitters    
  Inc. 43,237 721
  Ethan Allen Interiors Inc. 22,157 705
* Cooper-Standard Holding    
  Inc. 5,500 395
      74,468
Consumer Staples (7.0%)    
  Procter & Gamble Co. 248,419 20,447
  Wal-Mart Stores Inc. 210,757 14,435

 

      Market
      Value
    Shares ($000)
  Tyson Foods Inc. Class A 139,900 9,326
*,^ Herbalife Ltd. 118,614 7,302
  Bunge Ltd. 118,900 6,738
  Kroger Co. 150,200 5,745
  Dean Foods Co. 326,662 5,658
  Universal Corp. 68,500 3,891
  Ingles Markets Inc. Class A 80,900 3,034
  ConAgra Foods Inc. 64,793 2,891
  Clorox Co. 19,926 2,512
  Philip Morris International    
  Inc. 22,858 2,243
* Omega Protein Corp. 105,484 1,787
  Mondelez International Inc.    
  Class A 39,200 1,573
  Energizer Holdings Inc. 32,401 1,312
  Fresh Del Monte Produce    
  Inc. 24,084 1,013
* SUPERVALU Inc. 139,796 805
  Walgreens Boots Alliance    
  Inc. 9,400 792
  SpartanNash Co. 24,140 732
  Nu Skin Enterprises Inc.    
  Class A 17,806 681
      92,917
Energy (11.9%)    
  Exxon Mobil Corp. 437,809 36,596
  Chevron Corp. 157,433 15,019
  Phillips 66 142,700 12,356
  Valero Energy Corp. 167,500 10,743
  Marathon Petroleum Corp. 234,542 8,720
^ Nordic American Tankers    
  Ltd. 504,903 7,114
  Tesoro Corp. 81,285 6,991
  PBF Energy Inc. Class A 200,900 6,670
  Rowan Cos. plc Class A 405,968 6,536
  Noble Corp. plc 584,635 6,051
  Ensco plc Class A 413,162 4,285
^ Ship Finance International    
  Ltd. 305,388 4,242

 

12


 

U.S. Value Fund

      Market
      Value
    Shares ($000)
  Alon USA Energy Inc. 389,688 4,022
  Schlumberger Ltd. 49,546 3,654
  Teekay Tankers Ltd.    
  Class A 985,400 3,616
  Scorpio Tankers Inc. 596,140 3,476
  HollyFrontier Corp. 67,443 2,382
^ Frontline Ltd. 256,280 2,145
  DHT Holdings Inc. 326,923 1,883
  CVR Energy Inc. 71,263 1,860
*,^ Seadrill Ltd. 524,676 1,731
  Teekay Corp. 163,863 1,419
* Cameron International    
  Corp. 19,800 1,328
  Atwood Oceanics Inc. 139,536 1,280
  Spectra Energy Corp. 29,188 893
* Par Pacific Holdings Inc. 45,146 847
* FMC Technologies Inc. 24,931 682
  Oceaneering International    
  Inc. 20,292 675
* TETRA Technologies Inc. 101,055 642
      157,858
Financials (29.3%)    
  JPMorgan Chase & Co. 559,340 33,124
* Berkshire Hathaway Inc.    
  Class B 213,863 30,343
  Wells Fargo & Co. 518,330 25,066
  Bank of America Corp. 1,689,176 22,838
  Citigroup Inc. 518,493 21,647
  Capital One Financial Corp. 161,633 11,203
  Travelers Cos. Inc. 95,600 11,157
  Prudential Financial Inc. 150,528 10,871
  PNC Financial Services    
  Group Inc. 126,661 10,712
  Bank of New York Mellon    
  Corp. 274,966 10,127
  US Bancorp 236,497 9,599
  Discover Financial Services 178,239 9,076
  Hartford Financial Services    
  Group Inc. 183,949 8,476
  Everest Re Group Ltd. 40,700 8,035
  Assured Guaranty Ltd. 278,400 7,043
* Walker & Dunlop Inc. 279,951 6,794
  Hospitality Properties Trust 248,096 6,589
* MGIC Investment Corp. 821,029 6,297
* Synchrony Financial 210,000 6,019
  Gaming and Leisure    
  Properties Inc. 181,402 5,609
  AmTrust Financial Services    
  Inc. 215,687 5,582
  Government Properties    
  Income Trust 310,015 5,534
  Ameriprise Financial Inc. 58,300 5,481
  Heritage Insurance    
  Holdings Inc. 330,455 5,277

 

      Market
      Value
    Shares ($000)
  Navient Corp. 414,312 4,959
  Digital Realty Trust Inc. 53,100 4,699
  Communications Sales    
  & Leasing Inc. 204,048 4,540
^ Universal Insurance    
  Holdings Inc. 243,380 4,332
  Mack-Cali Realty Corp. 179,709 4,223
  VEREIT Inc. 470,100 4,170
  Fifth Third Bancorp 239,185 3,992
* Santander Consumer USA    
  Holdings Inc. 378,000 3,965
  CBL & Associates    
  Properties Inc. 322,413 3,837
  GEO Group Inc. 109,131 3,784
  Apple Hospitality REIT Inc. 187,900 3,722
* INTL. FCStone Inc. 138,166 3,693
  DuPont Fabros Technology    
  Inc. 89,900 3,644
  CubeSmart 94,700 3,153
  Summit Hotel Properties    
  Inc. 261,900 3,135
  Weingarten Realty Investors 83,100 3,118
  SunTrust Banks Inc. 83,668 3,019
  AvalonBay Communities Inc. 14,431 2,745
  Unum Group 84,754 2,621
  Ryman Hospitality    
  Properties Inc. 50,100 2,579
  Kimco Realty Corp. 87,554 2,520
  Goldman Sachs Group Inc. 14,015 2,200
  UDR Inc. 50,115 1,931
  Maiden Holdings Ltd. 148,600 1,923
* Flagstar Bancorp Inc. 87,600 1,880
  HCI Group Inc. 55,600 1,851
  Nasdaq Inc. 27,634 1,834
  Lexington Realty Trust 208,917 1,797
  American International    
  Group Inc. 29,048 1,570
  Piedmont Office Realty    
  Trust Inc. Class A 74,400 1,511
  Xenia Hotels & Resorts Inc. 80,700 1,261
  EPR Properties 18,100 1,206
  United Fire Group Inc. 23,349 1,023
  Great Western Bancorp Inc. 36,669 1,000
* Ally Financial Inc. 49,622 929
  Corrections Corp. of    
  America 28,512 914
* E*TRADE Financial Corp. 36,653 898
  Regions Financial Corp. 109,003 856
  Care Capital Properties Inc. 30,917 830
  HCP Inc. 25,345 826
  Monmouth Real Estate    
  Investment Corp. 68,038 809
  Aflac Inc. 12,316 778
  Select Income REIT 31,234 720

 

13


 

U.S. Value Fund

      Market
      Value
    Shares ($000)
* KCG Holdings Inc. Class A 57,322 685
  NorthStar Realty Finance    
  Corp. 50,681 665
      388,846
Health Care (11.0%)    
  Johnson & Johnson 359,613 38,910
  Pfizer Inc. 542,363 16,076
  Merck & Co. Inc. 176,101 9,318
* HCA Holdings Inc. 118,508 9,250
  Anthem Inc. 64,500 8,965
* Express Scripts Holding Co. 102,009 7,007
  Aetna Inc. 60,088 6,751
  Medtronic plc 86,443 6,483
  Bristol-Myers Squibb Co. 101,300 6,471
* Quintiles Transnational    
  Holdings Inc. 95,469 6,215
  Eli Lilly & Co. 74,630 5,374
  UnitedHealth Group Inc. 29,139 3,756
* Amsurg Corp. 46,100 3,439
  Cardinal Health Inc. 36,929 3,026
  AbbVie Inc. 52,100 2,976
* Charles River Laboratories    
  International Inc. 29,700 2,255
  Amgen Inc. 14,500 2,174
* ICU Medical Inc. 15,144 1,577
* INC Research Holdings Inc.    
  Class A 33,600 1,385
* Amedisys Inc. 23,300 1,126
  Abbott Laboratories 26,307 1,100
* PharMerica Corp. 45,138 998
* Emergent BioSolutions Inc. 20,775 755
* Orthofix International NV 16,798 697
* Allergan plc 2,435 653
      146,737
Industrials (10.5%)    
  General Electric Co. 1,069,540 34,001
  Northrop Grumman Corp. 45,833 9,070
  General Dynamics Corp. 68,058 8,941
  Owens Corning 155,400 7,347
  Comfort Systems USA Inc. 228,080 7,246
  BWX Technologies Inc. 214,600 7,202
* JetBlue Airways Corp. 304,233 6,425
* Spirit AeroSystems    
  Holdings Inc. Class A 138,871 6,299
  PACCAR Inc. 108,846 5,953
  General Cable Corp. 483,950 5,909
  Global Brass & Copper    
  Holdings Inc. 206,225 5,145
* ACCO Brands Corp. 446,654 4,011
  GATX Corp. 73,102 3,472
  Alaska Air Group Inc. 38,816 3,184
  United Technologies Corp. 27,219 2,725
* Aegion Corp. Class A 126,100 2,659
  SkyWest Inc. 118,651 2,372

 

      Market
      Value
    Shares ($000)
  Briggs & Stratton Corp. 95,881 2,293
  Ennis Inc. 99,521 1,946
* Quanta Services Inc. 68,643 1,549
  Southwest Airlines Co. 32,699 1,465
  Cintas Corp. 16,307 1,464
  Pitney Bowes Inc. 64,401 1,387
* Virgin America Inc. 30,476 1,175
  Waste Management Inc. 18,284 1,079
  West Corp. 44,108 1,006
  American Railcar Industries    
  Inc. 22,998 937
* TriNet Group Inc. 64,182 921
* RPX Corp. 75,474 850
  Trinity Industries Inc. 41,233 755
  Tetra Tech Inc. 22,990 686
  National Presto Industries    
  Inc. 7,759 650
      140,124
Information Technology (11.5%)  
  Microsoft Corp. 303,300 16,751
  Intel Corp. 403,601 13,057
  Cisco Systems Inc. 379,527 10,805
* Tech Data Corp. 97,098 7,454
  CSRA Inc. 270,612 7,279
  Avnet Inc. 162,995 7,221
  SYNNEX Corp. 77,000 7,129
* NeoPhotonics Corp. 503,800 7,073
  Booz Allen Hamilton    
  Holding Corp. Class A 233,000 7,055
* Sykes Enterprises Inc. 209,808 6,332
  Jabil Circuit Inc. 322,200 6,209
  CDW Corp. 148,900 6,179
  Computer Sciences Corp. 174,534 6,002
* Cirrus Logic Inc. 145,500 5,298
* Advanced Micro Devices    
  Inc. 1,776,578 5,063
* Sigma Designs Inc. 732,800 4,983
  NVIDIA Corp. 118,034 4,206
  Leidos Holdings Inc. 78,902 3,970
* Aspen Technology Inc. 100,700 3,638
* CACI International Inc.    
  Class A 28,719 3,064
  EarthLink Holdings Corp. 494,300 2,803
* First Data Corp. Class A 169,669 2,196
* NETGEAR Inc. 48,100 1,942
* Sanmina Corp. 56,500 1,321
  QUALCOMM Inc. 25,300 1,294
* Extreme Networks Inc. 404,028 1,257
  Xerox Corp. 78,653 878
* NCR Corp. 28,096 841
  International Business    
  Machines Corp. 5,161 782
*,^ Fitbit Inc. Class A 50,165 760
      152,842

 

14


 

U.S. Value Fund

      Market
      Value
    Shares ($000)
Materials (2.9%)    
  Dow Chemical Co. 246,319 12,528
  Avery Dennison Corp. 103,111 7,435
  LyondellBasell Industries    
  NV Class A 68,700 5,879
  Cabot Corp. 71,108 3,437
  International Paper Co. 66,409 2,725
  Domtar Corp. 64,871 2,627
* Kraton Performance    
  Polymers Inc. 81,136 1,404
  Schnitzer Steel Industries    
  Inc. 67,400 1,243
  Bemis Co. Inc. 20,583 1,066
      38,344
Telecommunication Services (2.7%)  
  AT&T Inc. 457,814 17,933
  Verizon Communications    
  Inc. 166,199 8,988
  CenturyLink Inc. 192,999 6,168
* Cincinnati Bell Inc. 600,704 2,325
      35,414
Utilities (7.1%)    
  Exelon Corp. 318,630 11,426
  American Electric Power    
  Co. Inc. 164,500 10,923
  Public Service Enterprise    
  Group Inc. 218,669 10,308
  PPL Corp. 263,122 10,017
  FirstEnergy Corp. 251,733 9,055
  Entergy Corp. 105,424 8,358
  UGI Corp. 202,325 8,152
  WGL Holdings Inc. 104,743 7,580
  CMS Energy Corp. 116,905 4,961
  Edison International 52,900 3,803
  ONE Gas Inc. 42,369 2,589
  Ameren Corp. 30,352 1,520
  Ormat Technologies Inc. 25,877 1,067
  NextEra Energy Inc. 8,822 1,044
  SCANA Corp. 14,293 1,003
  Xcel Energy Inc. 21,829 913
  New Jersey Resources    
  Corp. 24,781 903
  Chesapeake Utilities Corp. 13,896 875
      94,497
Total Common Stocks    
(Cost $1,215,106)   1,322,047

 

      Market
      Value
    Shares ($000)
Temporary Cash Investments (1.6%)1  
Money Market Fund (1.5%)    
2,3 Vanguard Market Liquidity    
  Fund, 0.495% 20,094,855 20,095
 
    Face  
    Amount  
    ($000)  
U.S. Government and Agency Obligations (0.1%)
4,5 Federal Home Loan    
  Bank Discount Notes,    
  0.476%, 8/17/16 400 399
4,5 Federal Home Loan    
  Bank Discount Notes,    
  0.486%, 8/24/16 100 100
      499
Total Temporary Cash Investments  
(Cost $20,594)   20,594
Total Investments (101.1%)    
(Cost $1,235,700)   1,342,641
 
      Amount
      ($000)
Other Assets and Liabilities (-1.1%)  
Other Assets    
Investment in Vanguard   111
Receivables for Accrued Income 1,903
Receivables for Capital Shares Issued 1,361
Other Assets   4
Total Other Assets   3,379
Liabilities    
Payables for Investment Securities  
Purchased   (1,098)
Collateral for Securities on Loan (13,116)
Payables for Capital Shares Redeemed (1,897)
Payables to Vanguard   (1,510)
Other Liabilities   (16)
Total Liabilities   (17,637)
Net Assets (100%)    
Applicable to 81,645,454 outstanding  
$.001 par value shares of beneficial  
interest (unlimited authorization) 1,328,383
Net Asset Value Per Share   $16.27

 

15


 

U.S. Value Fund

At March 31, 2016, net assets consisted of:
  Amount
  ($000)
Paid-in Capital 1,211,811
Undistributed Net Investment Income 5,188
Accumulated Net Realized Gains 4,344
Unrealized Appreciation (Depreciation)  
Investment Securities 106,941
Futures Contracts 99
Net Assets 1,328,383

 

See Note A in Notes to Financial Statements.
* Non-income-producing security.
^ Includes partial security positions on loan to broker-dealers. The total value of securities on loan is $12,339,000.
1 The fund invests a portion of its cash reserves in equity markets through the use of index futures contracts. After giving effect to futures investments, the fund’s effective common stock and temporary cash investment positions represent 99.9% and 1.2%, respectively, of net assets.
2 Affiliated money market fund available only to Vanguard funds and certain trusts and accounts managed by Vanguard. Rate shown is the 7-day yield.
3 Includes $13,116,000 of collateral received for securities on loan.
4 The issuer operates under a congressional charter; its securities are generally neither guaranteed by the U.S. Treasury nor backed by the full faith and credit of the U.S. government.
5 Securities with a value of $399,000 have been segregated as initial margin for open futures contracts.
REIT—Real Estate Investment Trust.
See accompanying Notes, which are an integral part of the Financial Statements.
16


 

U.S. Value Fund

Statement of Operations

  Six Months Ended
  March 31, 2016
  ($000)
Investment Income  
Income  
Dividends 17,055
Interest1 13
Securities Lending 561
Total Income 17,629
Expenses  
The Vanguard Group—Note B  
Investment Advisory Services 330
Management and Administrative 1,034
Marketing and Distribution 102
Custodian Fees 9
Shareholders’ Reports 11
Total Expenses 1,486
Net Investment Income 16,143
Realized Net Gain (Loss)  
Investment Securities Sold 3,455
Futures Contracts 285
Realized Net Gain (Loss) 3,740
Change in Unrealized Appreciation (Depreciation)  
Investment Securities 39,228
Futures Contracts 210
Change in Unrealized Appreciation (Depreciation) 39,438
Net Increase (Decrease) in Net Assets Resulting from Operations 59,321
1 Interest income from an affiliated company of the fund was $12,000.  

 

See accompanying Notes, which are an integral part of the Financial Statements.

17


 

U.S. Value Fund

Statement of Changes in Net Assets

  Six Months Ended Year Ended
  March 31, September 30,
  2016 2015
  ($000) ($000)
Increase (Decrease) in Net Assets    
Operations    
Net Investment Income 16,143 25,998
Realized Net Gain (Loss) 3,740 63,327
Change in Unrealized Appreciation (Depreciation) 39,438 (107,756)
Net Increase (Decrease) in Net Assets Resulting from Operations 59,321 (18,431)
Distributions    
Net Investment Income (26,754) (19,263)
Realized Capital Gain (48,800)
Total Distributions (75,554) (19,263)
Capital Share Transactions    
Issued 194,882 436,088
Issued in Lieu of Cash Distributions 71,550 18,266
Redeemed (136,751) (318,266)
Net Increase (Decrease) from Capital Share Transactions 129,681 136,088
Total Increase (Decrease) 113,448 98,394
Net Assets    
Beginning of Period 1,214,935 1,116,541
End of Period1 1,328,383 1,214,935
1 Net Assets—End of Period includes undistributed (overdistributed) net investment income of $5,188,000 and $15,799,000.

 

See accompanying Notes, which are an integral part of the Financial Statements.

18


 

U.S. Value Fund

Financial Highlights

  Six Months          
  Ended          
For a Share Outstanding March 31,     Year Ended September 30,
Throughout Each Period 2016 2015 2014 2013 2012 2011
Net Asset Value, Beginning of Period $16.48 $16.95 $14.41 $11.89 $9.20 $9.28
Investment Operations            
Net Investment Income .208 .355 .299 .304 .2761 .207
Net Realized and Unrealized Gain (Loss)            
on Investments .593 (.543) 2.531 2.506 2.632 (.112)
Total from Investment Operations .801 (.188) 2.830 2.810 2.908 .095
Distributions            
Dividends from Net Investment Income (.358) (.282) (.290) (.290) (.218) (.175)
Distributions from Realized Capital Gains (.653)
Total Distributions (1.011) (.282) (.290) (.290) (.218) (.175)
Net Asset Value, End of Period $16.27 $16.48 $16.95 $14.41 $11.89 $9.20
 
Total Return 2 4.78% -1.18% 19.89% 24.16% 32.10% 0.89%
 
Ratios/Supplemental Data            
Net Assets, End of Period (Millions) $1,328 $1,215 $1,117 $829 $602 $454
Ratio of Total Expenses to            
Average Net Assets 0.23% 0.26% 0.29% 0.29% 0.29% 0.29%
Ratio of Net Investment Income to            
Average Net Assets 2.61% 2.10% 1.92% 2.26% 2.54% 1.95%
Portfolio Turnover Rate 63% 66% 57% 75% 69% 60%
The expense ratio, net income ratio, and turnover rate for the current period have been annualized.    
1 Calculated based on average shares outstanding.
2 Total returns do not include account service fees that may have applied in the periods shown. Fund prospectuses provide information about any applicable account service fees.

 

See accompanying Notes, which are an integral part of the Financial Statements.

19


 

U.S. Value Fund

Notes to Financial Statements

Vanguard U.S. Value 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. investment companies. The fund consistently follows such policies in preparing its financial statements.

1. Security Valuation: Securities are valued as of the close of trading on the New York Stock Exchange (generally 4 p.m., Eastern time) on the valuation date. Equity securities are valued at the latest quoted sales prices or official closing prices taken from the primary market in which each security trades; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Securities for which market quotations are not readily available, or whose values have been materially affected by events occurring before the fund’s pricing time but after the close of the securities’ primary markets, are valued by methods deemed by the board of trustees to represent fair value. Investments in Vanguard Market Liquidity Fund are valued at that fund’s net asset value. Temporary cash investments acquired over 60 days to maturity are valued using the latest bid prices or using valuations based on a matrix system (which considers such factors as security prices, yields, maturities, and ratings), both as furnished by independent pricing services. Other temporary cash investments are valued at amortized cost, which approximates market value.

2. Futures Contracts: The fund uses index futures contracts to a limited extent, with the objective of maintaining full exposure to the stock market while maintaining liquidity. The fund may purchase or sell futures contracts to achieve a desired level of investment, whether to accommodate portfolio turnover or cash flows from capital share transactions. The primary risks associated with the use of futures contracts are imperfect correlation between changes in market values of stocks held by the fund and the prices of futures contracts, and the possibility of an illiquid market. Counterparty risk involving futures is mitigated because a regulated clearinghouse is the counterparty instead of the clearing broker. To further mitigate counterparty risk, the fund trades futures contracts on an exchange, monitors the financial strength of its clearing brokers and clearinghouse, and has entered into clearing agreements with its clearing brokers. The clearinghouse imposes initial margin requirements to secure the fund’s performance and requires daily settlement of variation margin representing changes in the market value of each contract.

Futures contracts are valued at their quoted daily settlement prices. The aggregate settlement values of the contracts are not recorded in the Statement of Net Assets. Fluctuations in the value of the contracts are recorded in the Statement of Net Assets as an asset (liability) and in the Statement of Operations as unrealized appreciation (depreciation) until the contracts are closed, when they are recorded as realized futures gains (losses).

During the six months ended March 31, 2016, the fund’s average investments in long and short futures contracts represented less than 1% and 0% of net assets, respectively, based on the average of aggregate settlement values at each quarter-end during the period.

3. Federal Income Taxes: The fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Management has analyzed the fund’s tax positions taken for all open federal income tax years (September 30, 2012–2015), and for the period ended March 31, 2016, and has concluded that no provision for federal income tax is required in the fund’s financial statements.

4. Distributions: Distributions to shareholders are recorded on the ex-dividend date.

20


 

U.S. Value Fund

5. Securities Lending: To earn additional income, the fund lends its securities to qualified institutional borrowers. Security loans are subject to termination by the fund at any time, and are required to be secured at all times by collateral in an amount at least equal to the market value of securities loaned. Daily market fluctuations could cause the value of loaned securities to be more or less than the value of the collateral received. When this occurs, the collateral is adjusted and settled on the next business day. The fund further mitigates its counterparty risk by entering into securities lending transactions only with a diverse group of prequalified counterparties, monitoring their financial strength, and entering into master securities lending agreements with its counterparties. The master securities lending agreements provide that, in the event of a counterparty’s default (including bankruptcy), the fund may terminate any loans with that borrower, determine the net amount owed, and sell or retain the collateral up to the net amount owed to the fund; however, such actions may be subject to legal proceedings. While collateral mitigates counterparty risk, in the absence of a default the fund may experience delays and costs in recovering the securities loaned. The fund invests cash collateral received in Vanguard Market Liquidity Fund, and records a liability in the Statement of Net Assets for the return of the collateral, during the period the securities are on loan. Securities lending income represents fees charged to borrowers plus income earned on invested cash collateral, less expenses associated with the loan.

6. Credit Facility: The fund and certain other funds managed by The Vanguard Group (“Vanguard”) participate in a $3.1 billion committed credit facility provided by a syndicate of lenders pursuant to a credit agreement that may be renewed annually; each fund is individually liable for its borrowings, if any, under the credit facility. Borrowings may be utilized for temporary and emergency purposes, and are subject to the fund’s regulatory and contractual borrowing restrictions. The participating funds are charged administrative fees and an annual commitment fee of 0.10% of the undrawn amount of the facility; these fees are allocated to the funds based on a method approved by the fund’s board of trustees and included in Management and Administrative expenses on the fund’s Statement of Operations. Any borrowings under this facility bear interest at a rate based upon the higher of the one-month London Interbank Offered Rate, federal funds effective rate, or overnight bank funding rate plus an agreed-upon spread.

The fund had no borrowings outstanding at March 31, 2016, or at any time during the period then ended.

7. Other: Dividend income is recorded on the ex-dividend date. Interest income includes income distributions received from Vanguard Market Liquidity Fund and is accrued daily. Premiums and discounts on debt securities purchased are amortized and accreted, respectively, to interest income over the lives of the respective securities. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold.

B. In accordance with the terms of a Funds’ Service Agreement (the “FSA”) between Vanguard and the fund, Vanguard furnishes to the fund investment advisory, corporate management, administrative, marketing, and distribution services at Vanguard’s cost of operations (as defined by the FSA). These costs of operations are allocated to the fund based on methods and guidelines approved by the board of trustees. Vanguard does not require reimbursement in the current period for certain costs of operations (such as deferred compensation/benefits and risk/insurance costs); the fund’s liability for these costs of operations is included in Payables to Vanguard on the Statement of Net Assets.

21


 

U.S. Value Fund

Upon the request of Vanguard, the fund may invest up to 0.40% of its net assets as capital in Vanguard. At March 31, 2016, the fund had contributed to Vanguard capital in the amount of $111,000, representing 0.01% of the fund’s net assets and 0.04% of Vanguard’s capitalization. The fund’s trustees and officers are also directors and employees, respectively, of Vanguard.

C. Various inputs may be used to determine the value of the fund’s investments. These inputs are summarized in three broad levels for financial statement purposes. The inputs or methodologies used to value securities are not necessarily an indication of the risk associated with investing in those securities.

Level 1Quoted prices in active markets for identical securities.
Level 2Other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.).
Level 3Significant unobservable inputs (including the fund’s own assumptions used to determine the fair value of investments).

The following table summarizes the market value of the fund’s investments as of March 31, 2016, based on the inputs used to value them:

  Level 1 Level 2 Level 3
Investments ($000) ($000) ($000)
Common Stocks 1,322,047
Temporary Cash Investments 20,095 499
Futures Contracts—Assets1 3
Futures Contracts—Liabilities1 (16)
Total 1,342,129 499
1 Represents variation margin on the last day of the reporting period.      

 

D. At March 31, 2016, the aggregate settlement value of open futures contracts and the related unrealized appreciation (depreciation) were:

        ($000)
      Aggregate  
    Number of Settlement Unrealized
    Long (Short) Value Appreciation
Futures Contracts Expiration Contracts Long (Short) (Depreciation)
E-mini S&P 500 Index June 2016 52 5,334 99

 

Unrealized appreciation (depreciation) on open futures contracts is required to be treated as realized gain (loss) for tax purposes.

22


 

U.S. Value Fund

E. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. Differences may be permanent or temporary. Permanent differences are reclassified among capital accounts in the financial statements to reflect their tax character. Temporary differences arise when certain items of income, expense, gain, or loss are recognized in different periods for financial statement and tax purposes. These differences will reverse at some time in the future. Differences in classification may also result from the treatment of short-term gains as ordinary income for tax purposes. The fund’s tax-basis capital gains and losses are determined only at the end of each fiscal year.

At March 31, 2016, the cost of investment securities for tax purposes was $1,236,006,000. Net unrealized appreciation of investment securities for tax purposes was $106,635,000, consisting of unrealized gains of $169,631,000 on securities that had risen in value since their purchase and $62,996,000 in unrealized losses on securities that had fallen in value since their purchase.

F. During the six months ended March 31, 2016, the fund purchased $472,431,000 of investment securities and sold $400,213,000 of investment securities, other than temporary cash investments.

G. Capital shares issued and redeemed were:

  Six Months Ended Year Ended
  March 31, 2016 September 30, 2015
  Shares Shares
  (000) (000)
Issued 11,998 24,986
Issued in Lieu of Cash Distributions 4,339 1,064
Redeemed (8,408) (18,195)
Net Increase (Decrease) in Shares Outstanding 7,929 7,855

 

H. Management has determined that no material events or transactions occurred subsequent to March 31, 2016, that would require recognition or disclosure in these financial statements.

23


 

About Your Fund’s Expenses

As a shareholder of the fund, you incur ongoing costs, which include costs for portfolio management, administrative services, and shareholder reports (like this one), among others. Operating expenses, which are deducted from a fund’s gross income, directly reduce the investment return of the fund.

A fund’s expenses are expressed as a percentage of its average net assets. This figure is known as the expense ratio. The following examples are intended to help you understand the ongoing costs (in dollars) of investing in your fund and to compare these costs with those of other mutual funds. The examples are based on an investment of $1,000 made at the beginning of the period shown and held for the entire period.

The accompanying table illustrates your fund’s costs in two ways:

Based on actual fund return. This section helps you to estimate the actual expenses that you paid over the period. The ”Ending Account Value“ shown is derived from the fund‘s actual return, and the third column shows the dollar amount that would have been paid by an investor who started with $1,000 in the fund. You may use the information here, together with the amount you invested, to estimate the expenses that you paid over the period.

To do so, simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number given for your fund under the heading ”Expenses Paid During Period.“

Based on hypothetical 5% yearly return. This section is intended to help you compare your fund‘s costs with those of other mutual funds. It assumes that the fund had a yearly return of 5% before expenses, but that the expense ratio is unchanged. In this case—because the return used is not the fund’s actual return—the results do not apply to your investment. The example is useful in making comparisons because the Securities and Exchange Commission requires all mutual funds to calculate expenses based on a 5% return. You can assess your fund’s costs by comparing this hypothetical example with the hypothetical examples that appear in shareholder reports of other funds.

Note that the expenses shown in the table are meant to highlight and help you compare ongoing costs only and do not reflect transaction costs incurred by the fund for buying and selling securities. Further, the expenses do not include any purchase, redemption, or account service fees described in the fund prospectus. If such fees were applied to your account, your costs would be higher. Your fund does not carry a “sales load.”

The calculations assume no shares were bought or sold during the period. Your actual costs may have been higher or lower, depending on the amount of your investment and the timing of any purchases or redemptions.

You can find more information about the fund’s expenses, including annual expense ratios, in the Financial Statements section of this report. For additional information on operating expenses and other shareholder costs, please refer to your fund’s current prospectus.

24


 

 
Six Months Ended March 31, 2016      
 
  Beginning Ending Expenses
  Account Value Account Value Paid During
U.S. Value Fund 9/30/2015 3/31/2016 Period
Based on Actual Fund Return $1,000.00 $1,047.79 $1.18
Based on Hypothetical 5% Yearly Return 1,000.00 1,023.85 1.16
The calculations are based on expenses incurred in the most recent six-month period. The fund’s annualized six-month expense ratio for that period is 0.23%. The dollar amounts shown as “Expenses Paid” are equal to the annualized expense ratio multiplied by the average account value over the period, multiplied by the number of days in the most recent six-month period, then divided by the number of days in the most recent 12-month period (183/366).

 

25


 

Trustees Approve Advisory Arrangement

The board of trustees of Vanguard U.S. Value Fund has renewed the fund’s investment advisory arrangement with The Vanguard Group, Inc. (Vanguard), through its Quantitative Equity Group. The board determined that continuing the fund’s internalized management structure was in the best interests of the fund and its shareholders.

The board based its decision upon an evaluation of the advisor’s investment staff, portfolio management process, and performance. The trustees considered the factors discussed below, among others. However, no single factor determined whether the board approved the arrangement. Rather, it was the totality of the circumstances that drove the board’s decision.

Nature, extent, and quality of services
The board reviewed the quality of the fund’s investment management services since Vanguard began managing the fund in 2008, and took into account the organizational depth and stability of the advisor. The board considered that Vanguard has been managing investments for more than three decades. The Quantitative Equity Group adheres to a sound, disciplined investment management process; the team has considerable experience, stability, and depth.

The board concluded that Vanguard’s experience, stability, depth, and performance, among other factors, warranted continuation of the advisory arrangement.

Investment performance
The board considered the performance of the fund, including any periods of outperformance or underperformance relative to a benchmark index and peer group. The board concluded that the performance was such that the advisory arrangement should continue. Information about the fund’s most recent performance can be found in the Performance Summary section of this report.

Cost
The board concluded that the fund’s expense ratio was well below the average expense ratio charged by funds in its peer group and that the fund’s advisory fee rate was also well below its peer-group average. Information about the fund’s expenses appears in the About Your Fund’s Expenses section of this report as well as in the Financial Statements section.

The board does not conduct a profitability analysis of Vanguard because of Vanguard’s unique “at-cost” structure. Unlike most other mutual fund management companies, Vanguard is owned by the funds it oversees, and produces “profits” only in the form of reduced expenses for fund shareholders.

The benefit of economies of scale
The board also concluded that the fund’s at-cost arrangement with Vanguard ensures that the fund will realize economies of scale as it grows, with the cost to shareholders declining as fund assets increase.

The board will consider whether to renew the advisory arrangement again after a one-year period.

26


 

Glossary

30-Day SEC Yield. A fund’s 30-day SEC yield is derived using a formula specified by the U.S. Securities and Exchange Commission. Under the formula, data related to the fund’s security holdings in the previous 30 days are used to calculate the fund’s hypothetical net income for that period, which is then annualized and divided by the fund’s estimated average net assets over the calculation period. For the purposes of this calculation, a security’s income is based on its current market yield to maturity (for bonds), its actual income (for asset-backed securities), or its projected dividend yield (for stocks). Because the SEC yield represents hypothetical annualized income, it will differ—at times significantly—from the fund’s actual experience. As a result, the fund’s income distributions may be higher or lower than implied by the SEC yield.

Beta. A measure of the magnitude of a fund’s past share-price fluctuations in relation to the ups and downs of a given market index. The index is assigned a beta of 1.00. Compared with a given index, a fund with a beta of 1.20 typically would have seen its share price rise or fall by 12% when the index rose or fell by 10%. For this report, beta is based on returns over the past 36 months for both the fund and the index. Note that a fund’s beta should be reviewed in conjunction with its R-squared (see definition). The lower the R-squared, the less correlation there is between the fund and the index, and the less reliable beta is as an indicator of volatility.

Dividend Yield. Dividend income earned by stocks, expressed as a percentage of the aggregate market value (or of net asset value, for a fund). The yield is determined by dividing the amount of the annual dividends by the aggregate value (or net asset value) at the end of the period. For a fund, the dividend yield is based solely on stock holdings and does not include any income produced by other investments.

Earnings Growth Rate. The average annual rate of growth in earnings over the past five years for the stocks now in a fund.

Equity Exposure. A measure that reflects a fund’s investments in stocks and stock futures. Any holdings in short-term reserves are excluded.

Expense Ratio. A fund’s total annual operating expenses expressed as a percentage of the fund’s average net assets. The expense ratio includes management and administrative expenses, but does not include the transaction costs of buying and selling portfolio securities.

Foreign Holdings. The percentage of a fund represented by securities or depositary receipts of companies based outside the United States.

Inception Date. The date on which the assets of a fund (or one of its share classes) are first invested in accordance with the fund’s investment objective. For funds with a subscription period, the inception date is the day after that period ends. Investment performance is measured from the inception date.

Median Market Cap. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund’s stocks, weighted by the proportion of the fund’s assets invested in each stock. Stocks representing half of the fund’s assets have market capitalizations above the median, and the rest are below it.

Price/Book Ratio. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds.

27


 

Price/Earnings Ratio. The ratio of a stock’s current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company’s future growth.

R-Squared. A measure of how much of a fund’s past returns can be explained by the returns from the market in general, as measured by a given index. If a fund’s total returns were precisely synchronized with an index’s returns, its R-squared would be 1.00. If the fund’s returns bore no relationship to the index’s returns, its R-squared would be 0. For this report, R-squared is based on returns over the past 36 months for both the fund and the index.

Return on Equity. The annual average rate of return generated by a company during the past five years for each dollar of shareholder’s equity (net income divided by shareholder’s equity). For a fund, the weighted average return on equity for the companies whose stocks it holds.

Short-Term Reserves. The percentage of a fund invested in highly liquid, short-term securities that can be readily converted to cash.

Turnover Rate. An indication of the fund’s trading activity. Funds with high turnover rates incur higher transaction costs and may be more likely to distribute capital gains (which may be taxable to investors). The turnover rate excludes in-kind transactions, which have minimal impact on costs.

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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’s 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. The independent board members have distinguished backgrounds in business, academia, and public service. Each of the trustees and executive officers oversees 198 Vanguard funds.

The following table provides information for each trustee and executive officer of the fund. More information about the trustees is in the Statement of Additional Information, which can be obtained, without charge, by contacting Vanguard at 800-662-7447, or online at vanguard.com.

InterestedTrustee1 Rajiv L. Gupta
Born 1945. Trustee Since December 2001.2 Principal
F. William McNabb III Occupation(s) During the Past Five Years and Other
Born 1957. Trustee Since July 2009. Chairman of Experience: Chairman and Chief Executive Officer
the Board. Principal Occupation(s) During the Past (retired 2009) and President (2006–2008) of
Five Years and Other Experience: Chairman of the Rohm and Haas Co. (chemicals); Director of Tyco
Board of The Vanguard Group, Inc., and of each of International PLC (diversified manufacturing and
the investment companies served by The Vanguard services), HP Inc. (printer and personal computer
Group, since January 2010; Director of The Vanguard manufacturing), and Delphi Automotive PLC
Group since 2008; Chief Executive Officer and (automotive components); Senior Advisor at
President of The Vanguard Group, and of each of New Mountain Capital.
the investment companies served by The Vanguard
Group, since 2008; Director of Vanguard Marketing Amy Gutmann
Corporation; Managing Director of The Vanguard Born 1949. Trustee Since June 2006. Principal
Group (1995–2008). Occupation(s) During the Past Five Years and
Other Experience: President of the University of
IndependentTrustees Pennsylvania; Christopher H. Browne Distinguished
Professor of Political Science, School of Arts and
Emerson U. Fullwood Sciences, and Professor of Communication, Annenberg
Born 1948. Trustee Since January 2008. Principal School for Communication, with secondary faculty
Occupation(s) During the Past Five Years and Other appointments in the Department of Philosophy, School
Experience: Executive Chief Staff and Marketing of Arts and Sciences, and at the Graduate School of
Officer for North America and Corporate Vice President Education, University of Pennsylvania; Trustee of the
(retired 2008) of Xerox Corporation (document manage- National Constitution Center; Chair of the Presidential
ment products and services); Executive in Residence Commission for the Study of Bioethical Issues.
and 2009–2010 Distinguished Minett Professor at
the Rochester Institute of Technology; Lead Director JoAnn Heffernan Heisen
of SPX FLOW, Inc. (multi-industry manufacturing); Born 1950. Trustee Since July 1998. Principal
Director of the United Way of Rochester, the University Occupation(s) During the Past Five Years and
of Rochester Medical Center, Monroe Community Other Experience: Corporate Vice President and
College Foundation, North Carolina A&T University, Chief Global Diversity Officer (retired 2008) and
and Roberts Wesleyan College. Member of the Executive Committee (1997–2008)
of Johnson & Johnson (pharmaceuticals/medical
devices/consumer products); Director of Skytop
Lodge Corporation (hotels) and the Robert Wood
Johnson Foundation; Member of the Advisory
Board of the Institute for Women’s Leadership
at Rutgers University.

 


 

 
F. Joseph Loughrey Executive Officers
Born 1949. Trustee Since October 2009. Principal
Occupation(s) During the Past Five Years and Other Glenn Booraem
Experience: President and Chief Operating Officer Born 1967. Treasurer Since May 2015. Principal
(retired 2009) of Cummins Inc. (industrial machinery); Occupation(s) During the Past Five Years and
Chairman of the Board of Hillenbrand, Inc. (specialized Other Experience: Principal of The Vanguard Group,
consumer services), and of Oxfam America; Director Inc.; Treasurer of each of the investment companies
of SKF AB (industrial machinery), Hyster-Yale Materials served by The Vanguard Group; Controller of each of
Handling, Inc. (forklift trucks), the Lumina Foundation the investment companies served by The Vanguard
for Education, and the V Foundation for Cancer Group (2010–2015); Assistant Controller of each of
Research; Member of the Advisory Council for the the investment companies served by The Vanguard
College of Arts and Letters and of the Advisory Board Group (2001–2010).
to the Kellogg Institute for International Studies, both
at the University of Notre Dame. Thomas J. Higgins
Born 1957. Chief Financial Officer Since September
Mark Loughridge 2008. Principal Occupation(s) During the Past Five
Born 1953. Trustee Since March 2012. Principal Years and Other Experience: Principal of The Vanguard
Occupation(s) During the Past Five Years and Other Group, Inc.; Chief Financial Officer of each of the
Experience: Senior Vice President and Chief Financial investment companies served by The Vanguard Group;
Officer (retired 2013) at IBM (information technology Treasurer of each of the investment companies served
services); Fiduciary Member of IBM’s Retirement Plan by The Vanguard Group (1998–2008).
Committee (2004–2013); Director of the Dow Chemical
Company; Member of the Council on Chicago Booth. Peter Mahoney
Born 1974. Controller Since May 2015. Principal
Scott C. Malpass Occupation(s) During the Past Five Years and
Born 1962. Trustee Since March 2012. Principal Other Experience: Head of Global Fund Accounting
Occupation(s) During the Past Five Years and Other at The Vanguard Group, Inc.; Controller of each of the
Experience: Chief Investment Officer and Vice investment companies served by The Vanguard Group;
President at the University of Notre Dame; Assistant Head of International Fund Services at The Vanguard
Professor of Finance at the Mendoza College of Group (2008–2014).
Business at Notre Dame; Member of the Notre Dame
403(b) Investment Committee, the Board of Advisors Heidi Stam
for Spruceview Capital Partners, and the Investment Born 1956. Secretary Since July 2005. Principal
Advisory Committee of Major League Baseball; Board Occupation(s) During the Past Five Years and Other
Member of TIFF Advisory Services, Inc., and Catholic Experience: Managing Director of The Vanguard
Investment Services, Inc. (investment advisors). Group, Inc.; General Counsel of The Vanguard Group;
Secretary of The Vanguard Group and of each of the
André F. Perold investment companies served by The Vanguard Group;
Born 1952. Trustee Since December 2004. Principal Director and Senior Vice President of Vanguard
Occupation(s) During the Past Five Years and Other Marketing Corporation.
Experience: George Gund Professor of Finance and
Banking, Emeritus at the Harvard Business School Vanguard Senior ManagementTeam
(retired 2011); Chief Investment Officer and Managing Mortimer J. Buckley James M. Norris
Partner of HighVista Strategies LLC (private investment Kathleen C. Gubanich Thomas M. Rampulla
firm); Director of Rand Merchant Bank; Overseer of Martha G. King Glenn W. Reed
the Museum of Fine Arts Boston. John T. Marcante Karin A. Risi
Chris D. McIsaac
Peter F. Volanakis
Born 1955. Trustee Since July 2009. Principal Chairman Emeritus and Senior Advisor
Occupation(s) During the Past Five Years and Other
Experience: President and Chief Operating Officer John J. Brennan
(retired 2010) of Corning Incorporated (communications Chairman, 1996–2009
equipment); Trustee of Colby-Sawyer College and Chief Executive Officer and President, 1996–2008
Chairman of its Finance and Enrollment Committee;
Member of the Advisory Board of the Norris Cotton Founder
Cancer Center.
John C. Bogle
Chairman and Chief Executive Officer, 1974–1996

 

1 Mr. McNabb is considered an “interested person,” as defined in the Investment Company Act of 1940, because he is an officer of the
Vanguard funds.
2 December 2002 for Vanguard Equity Income Fund, the Vanguard Municipal Bond Funds, and the Vanguard State Tax-Exempt Funds.


 

 

    P.O. Box 2600
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Connect with Vanguard® > vanguard.com  
 
 
 
Fund Information > 800-662-7447   CFA® is a registered trademark owned by CFA Institute.
Direct Investor Account Services > 800-662-2739  
Institutional Investor Services > 800-523-1036  
Text Telephone for People    
Who Are Deaf or Hard of Hearing> 800-749-7273  
 
This material may be used in conjunction  
with the offering of shares of any Vanguard  
fund only if preceded or accompanied by  
the fund’s current prospectus.  
 
All comparative mutual fund data are from Lipper, a  
Thomson Reuters Company, or Morningstar, Inc., unless  
otherwise noted.    
 
You can obtain a free copy of Vanguard’s proxy voting  
guidelines by visiting vanguard.com/proxyreporting or by  
calling Vanguard at 800-662-2739. The guidelines are  
also available from the SEC’s website, sec.gov. In  
addition, you may obtain a free report on how your fund  
voted the proxies for securities it owned during the 12  
months ended June 30. To get the report, visit either  
vanguard.com/proxyreporting or sec.gov.  
 
You can review and copy information about your fund at  
the SEC’s Public Reference Room in Washington, D.C. To  
find out more about this public service, call the SEC at  
202-551-8090. Information about your fund is also  
available on the SEC’s website, and you can receive  
copies of this information, for a fee, by sending a  
request in either of two ways: via email addressed to  
publicinfo@sec.gov or via regular mail addressed to the  
Public Reference Section, Securities and Exchange  
Commission, Washington, DC 20549-1520.  
 
    © 2016 The Vanguard Group, Inc.
    All rights reserved.
    Vanguard Marketing Corporation, Distributor.
 
    Q1242 052016

 



Semiannual Report | March 31, 2016

Vanguard Capital Value Fund


 

Vanguard’s Principles for Investing Success

We want to give you the best chance of investment success. These principles, grounded in Vanguard’s research and experience, can put you on the right path.

Goals. Create clear, appropriate investment goals.

Balance. Develop a suitable asset allocation using broadly diversified funds. Cost. Minimize cost.

Discipline. Maintain perspective and long-term discipline.

A single theme unites these principles: Focus on the things you can control.

We believe there is no wiser course for any investor.

Contents  
Your Fund’s Total Returns. 1
Chairman’s Letter. 2
Advisor’s Report. 7
Fund Profile. 12
Performance Summary. 13
Financial Statements. 14
About Your Fund’s Expenses. 26
Trustees Approve Advisory Arrangement. 28
Glossary. 29

 

Please note: The opinions expressed in this report are just that—informed opinions. They should not be considered promises or advice. Also, please keep in mind that the information and opinions cover the period through the date on the front of this report. Of course, the risks of investing in your fund are spelled out in the prospectus.
See the Glossary for definitions of investment terms used in this report.
About the cover: Pictured is a sailing block on the Brilliant, a 1932 schooner docked in Mystic, Connecticut. A type of pulley, the sailing block helps coordinate the setting of the sails. At Vanguard, the intricate coordination of technology and people allows us to help millions of clients around the world reach their financial goals.


 

Your Fund’s Total Returns

 
Six Months Ended March 31, 2016  
  Total
  Returns
Vanguard Capital Value Fund 1.19%
Russell 3000 Value Index 7.15
Multi-Cap Value Funds Average 5.18
Multi-Cap Value Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company.  

 

 
Your Fund’s Performance at a Glance        
September 30, 2015, Through March 31, 2016        
      Distributions Per Share
  Starting Ending Income Capital
  Share Price Share Price Dividends Gains
Vanguard Capital Value Fund $11.45 $10.45 $0.144 $1.046

 

1


 

 

 

 

Chairman’s Letter

Dear Shareholder,

Vanguard Capital Value Fund returned 1.19% for the six months ended March 31, 2016. It trailed its benchmark index, the average return of its peers, and the broad U.S. stock market, all of which returned 5% or more.

Larger-capitalization firms easily outperformed smaller-company stocks. At the same time, value stocks, typically viewed as potentially underpriced, slightly trailed their growth counterparts, which are expected to generate faster earnings growth. Value stocks across the capitalization spectrum are the focus of the fund’s advisor, Wellington Management Company.

Stocks charted an uneven course en route to a solid outcome
The broad U.S. stock market returned about 7% over the six months. The period began and ended strongly, with fluctuations in the middle as China’s economic slowdown and falling oil and commodity prices worried investors.

Stocks rallied in March as investors again seemed encouraged by news about monetary policy. The Federal Reserve indicated, after a mid-March meeting, that it would raise interest rates fewer times in 2016 than previously anticipated. And central bankers in Europe and Asia kept up stimulus measures to combat weak growth and low inflation.

2


 

International stocks returned about 3% for the period after surging more than 8% in March. Stocks from emerging markets and from developed markets of the Pacific region outperformed European stocks, which were nearly flat.

Bonds produced gains following a subpar start
After posting weak results for the first three months of the period, bonds managed solid gains in the final three. The broad U.S. taxable bond market returned 2.44% for the fiscal half year.

With stocks volatile and the Fed proceeding cautiously with rate hikes, bonds proved attractive. The yield of the 10-year U.S. Treasury note closed at 1.77% at the end of March, down from 2.05% six months earlier. (Bond prices and yields move in opposite directions.)

Returns for money market funds and savings accounts remained limited by the Fed’s target rate of 0.25%–0.5%—still low despite rising a quarter percentage point in December.

International bond markets (as measured by the Barclays Global Aggregate Index ex USD) returned 6.90%. International bonds got a boost as foreign currencies strengthened against the dollar, a turn-about from the trend of recent years. Even without this currency benefit, however, international bond returns were solidly positive.

 
Market Barometer      
 
      Total Returns
    Periods Ended March 31, 2016
  Six One Five Years
  Months Year (Annualized)
Stocks      
Russell 1000 Index (Large-caps) 7.75% 0.50% 11.35%
Russell 2000 Index (Small-caps) 2.02 -9.76 7.20
Russell 3000 Index (Broad U.S. market) 7.30 -0.34 11.01
FTSE All-World ex US Index (International) 3.09 -8.53 0.70
 
Bonds      
Barclays U.S. Aggregate Bond Index (Broad taxable market) 2.44% 1.96% 3.78%
Barclays Municipal Bond Index (Broad tax-exempt market) 3.20 3.98 5.59
Citigroup Three-Month U.S. Treasury Bill Index 0.06 0.08 0.04
 
CPI      
Consumer Price Index 0.08% 0.85% 1.28%

 

3


 

The fund underperformed in eight of ten industry sectors
Capital Value’s two portfolio managers at Wellington Management independently manage separate portions of the fund’s assets. They employ a relatively aggressive approach in selecting companies of all sizes that they believe are misunderstood or underappreciated by the market.

Unlike the case with stock funds that invest in one market segment, the Capital Value Fund’s flexibility to invest in various segments can lead to higher portfolio turnover and wider performance swings. This strategy led to underperformance for the six months.

In seven of the ten industry sectors, the managers’ selections underperformed their counterparts in the fund’s benchmark, the Russell 3000 Value Index. Health care proved the most significant detractor, as the volatile biotechnology subsector was a sore point. While the index’s biotech listings returned about 2%, the fund’s biotech portfolio returned –25%.

Information technology was also a hindrance, with the fund’s IT holdings returning about –3% compared with nearly 13% for the index. And although the benchmark’s energy stocks (+4%) rebounded a bit as oil prices began to stabilize, the fund’s energy portfolio (–6%) was hurt by losses among oil and gas exploration firms.

 
Expense Ratios    
Your Fund Compared With Its Peer Group    
    Peer Group
  Fund Average
Capital Value Fund 0.50% 1.15%
The fund expense ratio shown is from the prospectus dated January 27, 2016, and represents estimated costs for the current fiscal year. For the six months ended March 31, 2016, the fund’s annualized expense ratio was 0.23%. This decrease from the estimated expense ratio reflects a performance-based investment advisory fee adjustment. When the performance adjustment is positive, the fund’s expenses increase; when it is negative, expenses decrease. The peer-group expense ratio is derived from data provided by Lipper, a Thomson Reuters Company, and captures information through year-end 2015.
 
Peer group: Multi-Cap Value Funds.    

 

4


 

The fund’s financial stocks, its largest sector, also declined, returning about –6%, even as financials in the index ended the period about where they started. Consumer finance and insurance holdings were the fund’s biggest relative detractors in the sector.

Materials and consumer discretionary were notable bright spots. The managers’ holdings in materials returned about 23% as their paper and forest product selections were standouts. Consumer discretionary stocks—particularly hotels and casinos—were also strong performers.

 
Vanguard’s growth translates into lower costs for you
 
Research indicates that lower-cost investments have tended to outperform higher-cost ones.
So it’s little wonder that funds with lower expense ratios—including those at Vanguard—have
dominated the industry’s cash inflows in recent years.
 
Vanguard has long been a low-cost leader, with expenses well below those of many other
investment management companies. That cost difference remains a powerful advantage for
Vanguard clients. Why? Because a lower expense ratio allows a fund to pass along a greater
share of its returns to its investors.
 
What’s more, as you can see in the chart below, we’ve been able to lower our costs continually
as our assets under management have grown. Our steady growth has not been an explicit
business objective. Rather, we focus on putting our clients’ interests first at all times, and
giving them the best chance for investment success. But economies of scale—the cost
efficiencies that come with our growth—have allowed us to keep lowering our fund costs,
even as we invest in our people and technology.
 
The benefit of economies of scale

5


 

The Advisor’s Report that follows this letter provides more details about the managers’ oversight of the fund during the six months.

Consider rebalancing to manage your risk
After you’ve created an investment portfolio—with a diversified mix of stock, bond, and money market funds tailored to your goals, time horizon, and risk tolerance—what’s next?

As stocks and bonds rise or fall over time, and your portfolio drifts from its original asset allocation, consider rebalancing back to your targets.

Just one year of outsized returns can throw your allocation out of whack. For example, take a year like 2013, when the broad stock market returned nearly 34% and the broad taxable bond market declined. A hypothetical simple portfolio that began the year with 60% stocks and 40% bonds would have ended with a more aggressive mix of 67% stocks and 33% bonds.

Rebalancing means shifting dollars from assets that have performed well toward those that have fallen behind. That isn’t easy or intuitive, but it helps to manage risk because, over time, riskier assets tend to grow faster. (You can read more about our approach in Best Practices for Portfolio Rebalancing, at vanguard.com/research.)

You might consider, for example, monitoring your portfolio annually or semiannually and rebalancing when your allocations shift about 5 percentage points from their target. And be aware of the tax implications of selling.

Keeping your asset allocation from drifting too far off target can help you stay on track with the investment plan you’ve crafted to meet your financial goals.

As always, thank you for investing with Vanguard.

Sincerely,


F. William McNabb III
Chairman and Chief Executive Officer
April 12, 2016

6


 

Advisor’s Report

For the six months ended March 31, 2016, the Capital Value Fund returned 1.19%, reflecting the combined results of two managers at your fund’s investment advisor, Wellington Management Company llp. The use of two managers who independently oversee separate portions of the portfolio provides exposure to distinct yet complementary investment approaches, enhancing the diversification of your fund. It is not uncommon for different managers to have different views about individual securities or the broader investment environment.

The managers have prepared a discussion of the investment environment that existed during the half year and of how their portfolio positioning reflects this assessment. These comments were prepared on April 18, 2016.

Portfolio Manager:

Peter I. Higgins, CFA
Senior Managing Director

Our investment approach is to identify stocks that possess considerable upside potential because of compelling valuation characteristics along with catalysts that we believe could unlock that potential within 12 to 18 months. We often employ a contrarian approach that seeks to exploit inefficiencies in the market. We attempt to anticipate changes, both positive and negative, that could affect our investment thesis. We believe that in the short term, markets can be quite irrational, and so our trading activity tries to capture some of these anomalies. We do not try to mimic any index; instead, our goal is to substantially outperform the market in the intermediate to longer term.

Our holdings in the information technology sector weighed on relative results. Selection was also weak in financials and health care. Cobalt International Energy (energy), Portola Pharmaceuticals (health care), and SunEdison (information technology) were our largest relative detractors.

Shares of Cobalt, an oil exploration and production company with an oil portfolio in North America and West Africa, fell amid general weakness in oil prices. We continue to hold the stock because we believe that Cobalt may have a world-class inventory of prospective discoveries. Shares of Portola—a biopharmaceutical company focused on therapeutics for thrombosis, hematological disorders, and inflammation—fell after it released mixed results from a trial of a key drug, betrixaban. We believe that the stock is oversold and undervalued based on Portola’s lead asset, andexanet alfa, which has a significant market opportunity with potential value greater than Portola’s current market capitalization.

Investor skepticism about SunEdison, a U.S.-based solar-installation firm, has focused on the company’s long-term ability to grow its business at its targeted aggressive rate. Unrest in capital markets also weighed on its stock price and hindered SunEdison’s ability to continue financing its operations by accessing the markets. We sold the holding to pursue

7


 

opportunities with more attractive risk/ reward profiles as we became more concerned about the company’s ability to execute on its business plan.

Selection in materials, on the other hand, helped offset negative results. Our underweight exposure to financials was also beneficial. Top individual contributors to performance for the six months included Norbord (materials) and XPO Logistics (industrials).

The stock of Norbord, an international forest products company headquartered in Toronto, Ontario, rose after it reported better-than-expected quarterly results.

We believe that Norbord is well-positioned to benefit from improving demand trends for oriented strand board in North America and Europe over the medium to long term, driven by strengthening housing markets. Shares of XPO Logistics, a U.S.-based provider of supply-chain logistics, rose after its fourth-quarter results beat consensus expectations and it issued favorable guidance. We believe that XPO is transitioning from an acquisition story to an integration story with a focus on organic growth, cash flow, and pay-down of debt. We remain positive on XPO over the long term, as it has repeatedly exceeded most of its previous goals.

As always, our sector positioning remains a product of our bottom-up stock-selection process. During the half year, our exposure to health care and financials increased, though financials remains one of our most underweighted sectors. In health care, we established a new position in Merck and added to our position in Allergan; both are U.S.-based pharmaceutical companies. In financials, we added a holding in Bank of America, a U.S.-based multinational banking and financial services corporation.

Our exposure to energy and information technology, on the other hand, declined. In energy, we trimmed our holdings in Pioneer Natural Resources, a petroleum, natural gas, and natural gas liquids exploration and production company. In IT, we eliminated our position in semiconductor manufacturer Micron Technology.

We consider our portfolio well-positioned for an uncertain economic environment, and we continue to believe that the United States will remain the preferred market for investment globally. Five changes have improved the near-term outlook for U.S. equities: increased stimulus in China, a rebound in oil prices, more accommodative central banks, a weaker U.S. dollar, and easier U.S. financial conditions.

In early 2016, stocks moved in virtual lockstep with the price of oil as fears of a recession weighed on investors’ minds. But in the second half of the first quarter, stocks surged as solid economic data, a stabilization in oil prices, and accommodative commentary from the Federal Reserve helped calm the market’s jitters. We believe that the Fed’s recent dovish tone signals that it will limit the number of interest rate hikes this year, and that the Fed will continue to proceed cautiously in adjusting policy, which should help U.S. equities.

8


 

Although we cannot predict market outcomes, we continue to identify companies with compelling valuations, the potential for improvement in sentiment, and identifiable catalysts.

Portfolio Manager:

David W. Palmer, CFA
Senior Managing Director

Our portion of the fund focuses on stocks that trade at a discounted multiple to the broad market, based on either current earnings or those we expect within a reasonable time frame. Our approach searches for companies with pronounced negative sentiment, controversy, or perceived event risk that, through our fundamental research and analysis, we find to be temporary or overstated. Because individual holdings can be out of phase with the market for extended periods, we seek to build a portfolio of stocks with unique drivers, diversified across capitalization sizes and industries.

It was encouraging to see equity markets post a gain for the six months, though the path was not a straight line. What started as a rally into the end of calendar year 2015, with hopes for a reacceleration of earnings prospects in 2016, soured somewhat in January as companies forecast muted growth and investors worried about destabilization in China’s economy.

By the end of March, however, markets looked favorably on the Federal Reserve’s revised outlook for fewer interest rate hikes this year, and most subsegments of the market moved higher, with the key exception of rate-sensitive financials.

Given the relatively cautious tone of many corporate management teams in providing guidance for the year ahead, it’s not surprising that investors bid up the prices of less economically sensitive stocks. Telecommunication services and utilities were the best-performing sectors in the Russell 3000 Value Index for the six months, with consumer staples also outperforming the benchmark. Financials were the worst performer in the index, and the energy, consumer discretionary, and health care sectors also lagged the broad market. Our contrarian value approach led us to research and evaluate many of these areas in the face of investor uncertainty, and we added new health care and energy investments at what we felt were highly attractive valuations.

Among the holdings that contributed to six-month performance were metals distributor Reliance Steel & Aluminum, casino-gambling operator Las Vegas Sands, and integrated utility Exelon. Reliance adjusted quickly to a difficult demand environment by downsizing its energy division, improving its inventory management, and investing for growth in automotive and aerospace, all while its rivals were reeling from sharper downturns in their businesses. Reliance also used its impressive cash generation to repurchase stock and make several targeted acquisitions, increasing its earning power.

9


 

Las Vegas Sands benefited from improved market sentiment toward casino stocks in Macau, as industry profits appeared to find a floor after a protracted decline. The company also demonstrated prudent expense control and continued to bump up its dividend. Exelon removed an area of uncertainty by reaching an agreement with regulators to complete its long-delayed acquisition of Maryland-regulated electric utility Pepco. It also articulated a credible plan for raising the dividend modestly over the next three years.

Stock selection was beneficial in materials and consumer discretionary, although we faced challenges in a few areas, notably technology, energy, and financials. In energy, cash flows for natural gas producer Southwestern Energy were much lower than expected because of the extremely mild U.S. heating season; the December-through-February period was the warmest ever measured by the National Oceanic and Atmospheric Administration for the contiguous 48 states. Southwestern has greatly reduced its capital budget until futures prices merit a resumption of drilling.

Among the portfolio’s biggest detractors was Western Digital, which makes data-storage media. The U.S. Treasury said it would investigate the company’s plan to sell a 15% stake to a Chinese state-owned entity for the attractive price of $3.8 billion; after that, the sale was canceled, complicating Western Digital’s plans for financing its takeover of flash-memory producer SanDisk. Although the deal’s terms without the Chinese investment are less attractive, we believe that the current stock price meaningfully discounts the prospects of the combined company.

Retirement-services provider Principal Financial underperformed amid stock market volatility, falling long-term interest rates, and concerns about new retirement-industry regulations from the U.S. Department of Labor. Our research suggests that Principal has been executing relatively well in a competitive industry, and the government regulations proposed in early April appear largely benign to Principal’s business.

Southwestern, Western Digital, and Principal Financial all remained in our portfolio at the end of the period.

Our team is always on the lookout for good companies with attractive assets that have sold off at notable discounts to their underlying value because of perceived near-term difficulties. There has been no shortage of these situations in recent months, and we have acquired a range of new holdings that we believe offer intriguing risk/reward prospects and a diverse set of future performance drivers.

In health care, we initiated positions in several companies, including drug distributor McKesson, generics manufacturer Teva Pharmaceutical, and testing device and consumables maker Cepheid, among others. In particular, McKesson is a strong franchise whose shares have significantly underperformed after it reduced earnings guidance because of contract losses

10


 

related to customer consolidation and pressure on generic drug pricing. Although the company is in the penalty box with investors, we consider the stock’s discount to the market multiple highly attractive.

In energy, we added positions in producers Anadarko Petroleum, Cabot Oil & Gas, and Energen amid sharp selloffs for each. In technology, we bought a stake in semiconductor capital equipment maker Lam Research, whose acquisition of rival KLA-Tencor we expect will result in significant synergy savings and cash-generation potential.

Through these additions, we strive to invest in assets that we believe should deliver superior returns over time to Capital Value shareholders, with an appropriate eye toward managing the risk and diversification of the portfolio. We appreciate your trust and confidence in our efforts.

11


 

Capital Value Fund

Fund Profile
As of March 31, 2016

 
Portfolio Characteristics    
    Russell DJ
    3000 U.S. Total
    Value Market
  Fund Index FA Index
Number of Stocks 151 2,009 3,900
Median Market Cap $12.7B $46.9B $52.5B
Price/Earnings Ratio 32.0x 19.7x 21.8x
Price/Book Ratio 1.8x 1.8x 2.7x
Return on Equity 10.6% 12.4% 17.5%
Earnings Growth      
Rate 6.6% 3.2% 8.0%
Dividend Yield 1.6% 2.6% 2.1%
Foreign Holdings 9.2% 0.0% 0.0%
Turnover Rate      
(Annualized) 124%
Ticker Symbol VCVLX
Expense Ratio1 0.50%
30-Day SEC Yield 1.32%
Short-Term Reserves 0.1%

 

 
Sector Diversification (% of equity exposure)
    Russell DJ
    3000 U.S. Total
    Value Market
  Fund Index FA Index
Consumer      
Discretionary 9.7% 5.7% 13.6%
Consumer Staples 1.2 7.1 9.2
Energy 10.7 12.0 6.1
Financials 22.0 29.4 17.4
Health Care 19.6 11.1 13.7
Industrials 8.0 10.5 10.7
Information      
Technology 18.0 11.5 20.1
Materials 5.5 2.9 3.2
Other 0.8 0.0 0.0
Telecommunication      
Services 1.0 2.7 2.5
Utilities 3.5 7.1 3.5

 

 
Volatility Measures    
  Russell DJ
  3000 U.S. Total
  Value Market
  Index FA Index
R-Squared 0.83 0.83
Beta 1.30 1.29
These measures show the degree and timing of the fund’s
fluctuations compared with the indexes over 36 months.

 

 
Ten Largest Holdings (% of total net assets)
Merck & Co. Inc. Pharmaceuticals 3.1%
TherapeuticsMD Inc. Pharmaceuticals 2.6
MetLife Inc. Life & Health  
  Insurance 2.3
Citigroup Inc. Diversified Banks 2.1
Pioneer Natural Oil & Gas Exploration  
Resources Co. & Production 2.0
Allergan plc Pharmaceuticals 2.0
Alphabet Inc. Internet Software &  
  Services 1.9
Cisco Systems Inc. Communications  
  Equipment 1.8
Mylan NV Pharmaceuticals 1.6
Reliance Steel &    
Aluminum Co. Steel 1.6
Top Ten   21.0%
The holdings listed exclude any temporary cash investments and equity index products.

 

Investment Focus


1 The expense ratio shown is from the prospectus dated January 27, 2016, and represents estimated costs for the current fiscal year. For the six months ended March 31, 2016, the annualized expense ratio was 0.23%.

12


 

Capital Value Fund

Performance Summary

All of the returns in this report represent past performance, which is not a guarantee of future results that may be achieved by the fund. (Current performance may be lower or higher than the performance data cited. For performance data current to the most recent month-end, visit our website at vanguard.com/performance.) Note, too, that both investment returns and principal value can fluctuate widely, so an investor’s shares, when sold, 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 sale of fund shares.

Fiscal-Year Total Returns (%): September 30, 2005, Through March 31, 2016


 
Average Annual Total Returns: Periods Ended March 31, 2016      
 
  Inception One Five Ten
  Date Year Years Years
Capital Value Fund 12/17/2001 -17.59% 4.79% 4.77%

 

See Financial Highlights for dividend and capital gains information.

13


 

Capital Value Fund

Financial Statements (unaudited)

Statement of Net Assets
As of March 31, 2016

The fund reports a complete list of its holdings in regulatory filings four times in each fiscal year, at the quarter-ends. For the second and fourth fiscal quarters, the lists appear in the fund’s semiannual and annual reports to shareholders. For the first and third fiscal quarters, the fund files the lists with the Securities and Exchange Commission on Form N-Q. Shareholders can look up the fund’s Forms N-Q on the SEC’s website at sec.gov. Forms N-Q may also be reviewed and copied at the SEC’s Public Reference Room (see the back cover of this report for further information).

      Market
      Value
    Shares ($000)
Common Stocks (99.2%)    
Consumer Discretionary (9.7%)  
* Amazon.com Inc. 23,907 14,192
  Las Vegas Sands Corp. 264,353 13,662
  Expedia Inc. 63,235 6,818
  Ralph Lauren Corp.    
  Class A 61,900 5,958
* TripAdvisor Inc. 75,197 5,001
  Signet Jewelers Ltd. 36,528 4,530
* LifeLock Inc. 360,281 4,349
* Restoration Hardware    
  Holdings Inc. 103,455 4,335
  Sky plc 271,461 3,989
* Kate Spade & Co. 149,760 3,822
* Norwegian Cruise Line    
  Holdings Ltd. 66,500 3,677
  Sands China Ltd. 894,000 3,650
  Aramark 104,275 3,454
* Global Brands Group    
  Holding Ltd. 26,480,000 3,208
* DISH Network Corp.    
  Class A 58,960 2,727
  Melco Crown    
  Entertainment Ltd. ADR 148,300 2,448
  Fiat Chrysler    
  Automobiles NV 266,328 2,149
  Newell Rubbermaid Inc. 41,540 1,840
  Advance Auto Parts Inc. 10,955 1,756
  DSW Inc. Class A 23,014 636
  Quebecor Inc. Class B 14,000 368
      92,569
Consumer Staples (1.2%)    
  British American    
  Tobacco plc 139,468 8,156
^ Coty Inc. Class A 129,700 3,609
      11,765
Energy (10.7%)    
  Pioneer Natural    
  Resources Co. 135,335 19,047
  Halliburton Co. 254,474 9,090

 

      Market
      Value
    Shares ($000)
  Anadarko Petroleum Corp. 164,600 7,665
  Cabot Oil & Gas Corp. 330,557 7,507
* Cobalt International    
  Energy Inc. 2,474,898 7,350
  Canadian Natural    
  Resources Ltd. 258,896 6,990
  Golar LNG Ltd. 372,283 6,690
* Diamondback Energy Inc. 72,637 5,606
  Marathon Oil Corp. 479,753 5,344
  Helmerich & Payne Inc. 81,133 4,764
  HollyFrontier Corp. 128,477 4,538
*,^ Southwestern Energy Co. 533,261 4,303
  QEP Resources Inc. 273,900 3,865
  Energen Corp. 71,400 2,613
* Karoon Gas    
  Australia Ltd. 2,129,581 2,042
  Suncor Energy Inc. 69,610 1,936
  National Oilwell Varco Inc. 55,223 1,717
*,^ Trican Well Service Ltd. 653,300 599
      101,666
Financials (21.9%)    
  MetLife Inc. 499,379 21,943
  Citigroup Inc. 472,309 19,719
  Bank of America Corp. 1,077,749 14,571
  Raymond James    
  Financial Inc. 282,526 13,451
  American International    
  Group Inc. 242,708 13,119
  PNC Financial Services    
  Group Inc. 152,279 12,878
  Principal Financial    
  Group Inc. 322,462 12,721
  American Tower    
  Corporation 121,367 12,424
  JPMorgan Chase & Co. 203,300 12,040
* Markit Ltd. 328,036 11,596
  Arthur J Gallagher & Co. 209,874 9,335
  M&T Bank Corp. 72,444 8,041
  Torchmark Corp. 125,872 6,817
  Host Hotels & Resorts Inc. 395,400 6,603
  Unum Group 203,632 6,296

 

14


 

Capital Value Fund

      Market
      Value
    Shares ($000)
  Columbia Property    
  Trust Inc. 275,339 6,055
  STORE Capital Corp. 173,100 4,480
* Santander Consumer    
  USA Holdings Inc. 414,744 4,351
* LendingClub Corp. 523,635 4,346
* OneMain Holdings Inc.    
  Class A 152,162 4,174
  Boston Properties Inc. 26,100 3,317
  AvalonBay    
  Communities Inc. 6,831 1,299
      209,576
Health Care (19.5%)    
  Merck & Co. Inc. 556,116 29,424
*,^ TherapeuticsMD Inc. 3,852,264 24,654
* Allergan plc 70,120 18,794
* Mylan NV 328,015 15,204
  Bristol-Myers Squibb Co. 166,034 10,606
* Portola    
  Pharmaceuticals Inc. 491,900 10,035
  Eisai Co. Ltd. 145,733 8,762
* Envision Healthcare    
  Holdings Inc. 388,567 7,927
* Alder    
  Biopharmaceuticals Inc. 285,080 6,982
  McKesson Corp. 36,200 5,692
  Teva Pharmaceutical    
  Industries Ltd. ADR 103,800 5,554
* DexCom Inc. 69,660 4,731
* Biogen Inc. 17,753 4,621
  Perrigo Co. plc 34,797 4,452
* TESARO Inc. 97,300 4,284
* Regeneron    
  Pharmaceuticals Inc. 10,545 3,801
* Vertex Pharmaceuticals Inc.  45,895 3,648
* Cepheid 103,300 3,446
* Endo International plc 104,205 2,933
* Incyte Corp. 37,410 2,711
* MEDNAX Inc. 39,400 2,546
* Senseonics Holdings Inc. 684,488 1,958
* Cerner Corp. 35,640 1,888
*,^ Novavax Inc. 346,800 1,789
      186,442
Industrials (8.0%)    
*,^ XPO Logistics Inc. 407,231 12,502
  Eaton Corp. plc 152,658 9,550
  CSX Corp. 301,925 7,775
* Genesee & Wyoming Inc.    
  Class A 117,137 7,344
  Macquarie Infrastructure    
  Corp. 76,289 5,145
  Sanwa Holdings Corp. 578,400 4,303
* Generac Holdings Inc. 113,445 4,225
* Clean Harbors Inc. 80,037 3,949
* WESCO International Inc. 64,872 3,546
^ Sulzer AG 34,963 3,467

 

      Market
      Value
    Shares ($000)
  Norfolk Southern Corp. 40,200 3,347
  United Parcel Service Inc.    
  Class B 29,600 3,122
* Avis Budget Group Inc. 109,400 2,993
* Builders FirstSource Inc. 208,656 2,352
* FTI Consulting Inc. 65,375 2,321
*,^ Scorpio Bulkers Inc. 114,939 377
      76,318
Information Technology (18.0%)  
  Cisco Systems Inc. 597,289 17,005
* Alphabet Inc. Class C 16,794 12,511
* Envestnet Inc. 355,005 9,656
*,^ Quotient Technology Inc. 901,964 9,561
*,^ SunPower Corp. Class A 426,811 9,535
* ServiceNow Inc. 141,915 8,682
  Sumco Corp. 1,353,270 8,497
* Synaptics Inc. 93,826 7,482
*,^ Zillow Group Inc. 306,074 7,263
  Skyworks Solutions Inc. 84,075 6,549
*,^ Mobileye NV 171,220 6,385
  Samsung Electronics    
  Co. Ltd. 5,278 6,057
* ARRIS International plc 261,145 5,985
* Alphabet Inc. Class A 7,828 5,972
*,^ Gogo Inc. 519,266 5,717
* Workday Inc. Class A 69,760 5,360
* Alliance Data Systems Corp. 23,645 5,202
* Qorvo Inc. 97,935 4,937
* Mellanox Technologies Ltd. 89,670 4,872
  Western Digital Corp. 96,900 4,578
* Alibaba Group Holding Ltd.    
  ADR 49,500 3,912
  Nintendo Co. Ltd. 25,845 3,674
  Lam Research Corp. 44,100 3,643
  Silicon Motion Technology    
  Corp. ADR 84,831 3,292
  Cypress Semiconductor    
  Corp. 274,293 2,375
* Blackhawk Network    
  Holdings Inc. 46,025 1,579
* SunEdison    
  Semiconductor Ltd. 216,773 1,405
* Verint Systems Inc. 10,500 350
      172,036
Materials (5.5%)    
  Reliance Steel    
  & Aluminum Co. 219,519 15,189
  Celanese Corp. Class A 108,444 7,103
  International Paper Co. 111,630 4,581
  Norbord Inc. 225,120 4,479
  Huntsman Corp. 326,100 4,337
* Louisiana-Pacific Corp. 236,206 4,044
  Cabot Corp. 75,896 3,668
  Bemis Co. Inc. 57,100 2,957
  Nucor Corp. 51,800 2,450
* Constellium NV Class A 313,909 1,629

 

15


 

Capital Value Fund

    Market
    Value
  Shares ($000)
Goldcorp Inc. 97,280 1,579
^ Methanex Corp. 26,942 865
    52,881
Other (0.2%)    
*,1 Allstar Co-Invest LLC    
Private Placement NA 1,450
 
Telecommunication Services (1.0%)  
Verizon    
Communications Inc. 120,315 6,506
* T-Mobile US Inc. 89,600 3,432
    9,938
Utilities (3.5%)    
PG&E Corp. 226,461 13,524
Exelon Corp. 308,757 11,072
OGE Energy Corp. 198,800 5,692
Pattern Energy Group Inc.    
Class A 146,342 2,791
    33,079
Total Common Stocks    
(Cost $973,603)   947,720
Preferred Stocks (0.6%)    
*,2 Lithium Technologies    
Inc. Pfd. (Cost $5,828) 1,195,700 5,895
Temporary Cash Investments (3.8%)  
Money Market Fund (3.7%)    
3,4 Vanguard Market    
Liquidity Fund,    
0.495% 35,241,000 35,241
 
  Face  
  Amount  
  ($000)  
Repurchase Agreement (0.1%)  
RBS Securities, Inc.    
0.290%, 4/1/16 (Dated    
3/31/16, Repurchase Value  
$1,200,000, collateralized  
by U.S. Treasury Note/Bond  
1.375%, 9/30/20, with a    
value of $1,228,000) 1,200 1,200
Total Temporary Cash Investments  
(Cost $36,441)   36,441
Total Investments (103.6%)    
(Cost $1,015,872)   990,056

 

 
  Amount
  ($000)
Other Assets and Liabilities (-3.6%)  
Other Assets  
Investment in Vanguard 80
Receivables for Investment Securities Sold 16,746
Receivables for Accrued Income 1,727
Receivables for Capital Shares Issued 180
Other Assets 233
Total Other Assets 18,966
Liabilities  
Payables for Investment Securities  
Purchased (14,774)
Collateral for Securities on Loan (35,241)
Payables to Investment Advisor (28)
Payables for Capital Shares Redeemed (1,139)
Payables to Vanguard (2,310)
Other Liabilities (37)
Total Liabilities (53,529)
Net Assets (100%)  
Applicable to 91,404,422 outstanding  
$.001 par value shares of beneficial  
interest (unlimited authorization) 955,493
Net Asset Value Per Share $10.45

 

16


 

Capital Value Fund

 
At March 31, 2016, net assets consisted of:
  Amount
  ($000)
Paid-in Capital 1,128,240
Undistributed Net Investment Income 1,250
Accumulated Net Realized Losses (148,132)
Unrealized Appreciation (Depreciation)  
Investment Securities (25,816)
Forward Currency Contracts (37)
Foreign Currencies (12)
Net Assets 955,493

 

See Note A in Notes to Financial Statements.
* Non-income-producing security.
^ Includes partial security positions on loan to broker-dealers. The total value of securities on loan is $33,505,000.
1 Restricted security represents 0.2% of net assets. Shares not applicable for this private placement.
2 Restricted security represents 0.6% of net assets.
3 Affiliated money market fund available only to Vanguard funds and certain trusts and accounts managed by Vanguard. Rate shown is the 7-day yield.
4 Includes $35,241,000 of collateral received for securities on loan.
ADR—American Depositary Receipt.
See accompanying Notes, which are an integral part of the Financial Statements.

17


 

Capital Value Fund

Statement of Operations

  Six Months Ended
  March 31, 2016
  ($000)
Investment Income  
Income  
Dividends1 7,710
Interest 2
Securities Lending 835
Total Income 8,547
Expenses  
Investment Advisory Fees—Note B  
Basic Fee 1,136
Performance Adjustment (982)
The Vanguard Group—Note C  
Management and Administrative 850
Marketing and Distribution 132
Custodian Fees 46
Shareholders’ Reports 9
Trustees’ Fees and Expenses 1
Total Expenses 1,192
Expenses Paid Indirectly (11)
Net Expenses 1,181
Net Investment Income 7,366
Realized Net Gain (Loss)  
Investment Securities Sold (146,704)
Foreign Currencies and Forward Currency Contracts 667
Realized Net Gain (Loss) (146,037)
Change in Unrealized Appreciation (Depreciation)  
Investment Securities 152,773
Foreign Currencies and Forward Currency Contracts (226)
Change in Unrealized Appreciation (Depreciation) 152,547
Net Increase (Decrease) in Net Assets Resulting from Operations 13,876
1 Dividends are net of foreign withholding taxes of $88,000.  

 

See accompanying Notes, which are an integral part of the Financial Statements.

18


 

Capital Value Fund

Statement of Changes in Net Assets

  Six Months Ended Year Ended
  March 31, September 30,
  2016 2015
  ($000) ($000)
Increase (Decrease) in Net Assets    
Operations    
Net Investment Income 7,366 13,256
Realized Net Gain (Loss) (146,037) 130,824
Change in Unrealized Appreciation (Depreciation) 152,547 (352,612)
Net Increase (Decrease) in Net Assets Resulting from Operations 13,876 (208,532)
Distributions    
Net Investment Income (12,846) (18,062)
Realized Capital Gain1 (93,310) (154,201)
Total Distributions (106,156) (172,263)
Capital Share Transactions    
Issued 63,342 216,336
Issued in Lieu of Cash Distributions 99,619 162,455
Redeemed (173,738) (723,255)
Net Increase (Decrease) from Capital Share Transactions (10,777) (344,464)
Total Increase (Decrease) (103,057) (725,259)
Net Assets    
Beginning of Period 1,058,550 1,783,809
End of Period2 955,493 1,058,550
1 Includes fiscal 2016 and 2015 short-term gain distributions totaling $27,386,000 and $99,085,000, respectively. Short-term gain distributions are treated as ordinary income dividends for tax purposes.
2 Net Assets—End of Period includes undistributed (overdistributed) net investment income of $1,250,000 and $6,757,000.

 

See accompanying Notes, which are an integral part of the Financial Statements.

19


 

Capital Value Fund

Financial Highlights

  Six Months          
  Ended          
For a Share Outstanding March 31,     Year Ended September 30,
Throughout Each Period 2016 2015 2014 2013 2012 2011
Net Asset Value,            
Beginning of Period $11.45 $15.32 $14.57 $10.58 $8.59 $9.62
Investment Operations            
Net Investment Income . 085 .1291 .1782 .138 .155 .109
Net Realized and Unrealized Gain (Loss)            
on Investments .105 (2.330) 2.055 4.051 2.075 (1.054)
Total from Investment Operations .190 (2.201) 2.233 4.189 2.230 (.945)
Distributions            
Dividends from Net Investment Income (.144) (.175) (.111) (.199) (.100) (. 085)
Distributions from Realized Capital Gains (1.046) (1.494) (1.372) (.140)
Total Distributions (1.190) (1.669) (1.483) (.199) (.240) (.085)
Net Asset Value, End of Period $10.45 $11.45 $15.32 $14.57 $10.58 $8.59
 
Total Return3 1.19% -15.67% 16.50% 40.21% 26.50% -10.00%
 
Ratios/Supplemental Data            
Net Assets, End of Period (Millions) $955 $1,059 $1,784 $1,249 $659 $613
Ratio of Total Expenses to            
Average Net Assets4 0.23% 0.50% 0.47% 0.41% 0.47% 0.58%
Ratio of Net Investment Income to            
Average Net Assets 1.51% 0.93% 1.19%2 1.03% 1.42% 0.87%
Portfolio Turnover Rate 124% 90% 90% 132% 123% 149%
The expense ratio, net income ratio, and turnover rate for the current period have been annualized.    
1 Calculated based on average shares outstanding.
2 Net investment income per share and the ratio of net investment income to average net assets include $.018 and 0.12%, respectively, resulting from income received from Vodafone Group plc in the form of cash and shares in Verizon Communications Inc. in February 2014.
3 Total returns do not include account service fees that may have applied in the periods shown. Fund prospectuses provide information about any applicable account service fees.
4 Includes performance-based investment advisory fee increases (decreases) of (0.19%), 0.06%, 0.02%, (0.05%), 0.01% and 0.11%.

 

See accompanying Notes, which are an integral part of the Financial Statements.

20


 

Capital Value Fund

Notes to Financial Statements

Vanguard Capital Value 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. investment companies. The fund consistently follows such policies in preparing its financial statements.

1. Security Valuation: Securities are valued as of the close of trading on the New York Stock Exchange (generally 4 p.m., Eastern time) on the valuation date. Equity securities are valued at the latest quoted sales prices or official closing prices taken from the primary market in which each security trades; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Securities for which market quotations are not readily available, or whose values have been affected by events occurring before the fund’s pricing time but after the close of the securities’ primary markets, are valued at their fair values calculated according to procedures adopted by the board of trustees. These procedures include obtaining quotations from an independent pricing service, monitoring news to identify significant market- or security-specific events, and evaluating changes in the values of foreign market proxies (for example, ADRs, futures contracts, or exchange-traded funds), between the time the foreign markets close and the fund’s pricing time. When fair-value pricing is employed, the prices of securities used by a fund to calculate its net asset value may differ from quoted or published prices for the same securities. Investments in Vanguard Market Liquidity Fund are valued at that fund’s net asset value. Temporary cash investments acquired over 60 days to maturity are valued using the latest bid prices or using valuations based on a matrix system (which considers such factors as security prices, yields, maturities, and ratings), both as furnished by independent pricing services. Other temporary cash investments are valued at amortized cost, which approximates market value.

2. Foreign Currency: Securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars using exchange rates obtained from an independent third party as of the fund’s pricing time on the valuation date. Realized gains (losses) and unrealized appreciation (depreciation) on investment securities include the effects of changes in exchange rates since the securities were purchased, combined with the effects of changes in security prices. Fluctuations in the value of other assets and liabilities resulting from changes in exchange rates are recorded as unrealized foreign currency gains (losses) until the assets or liabilities are settled in cash, at which time they are recorded as realized foreign currency gains (losses).

3. Forward Currency Contracts: The fund enters into forward currency contracts to protect the value of securities and related receivables and payables against changes in future foreign exchange rates. The fund’s risks in using these contracts include movement in the values of the foreign currencies relative to the U.S. dollar and the ability of the counterparties to fulfill their obligations under the contracts. The fund mitigates its counterparty risk by entering into forward currency contracts only with a diverse group of prequalified counterparties, monitoring their financial strength, entering into master netting arrangements with its counterparties, and requiring its counterparties to transfer collateral as security for their performance. The master netting arrangements provide that, in the event of a counterparty’s default (including bankruptcy), the fund may terminate the forward currency contracts, determine the net amount owed by either party in accordance with its master netting arrangements, and sell or retain any collateral held up to the net amount owed to the fund under the master netting arrangements. The forward currency contracts contain provisions whereby a

21


 

Capital Value Fund

counterparty may terminate open contracts if the fund’s net assets decline below a certain level, triggering a payment by the fund if the fund is in a net liability position at the time of the termination. The payment amount would be reduced by any collateral the fund has pledged. Any assets pledged as collateral for open contracts are noted in the Statement of Net Assets. The value of collateral received or pledged is compared daily to the value of the forward currency contracts exposure with each counterparty, and any difference, if in excess of a specified minimum transfer amount, is adjusted and settled within two business days.

Forward currency contracts are valued at their quoted daily prices obtained from an independent third party, adjusted for currency risk based on the expiration date of each contract. The notional amounts of the contracts are not recorded in the Statement of Net Assets. Fluctuations in the value of the contracts are recorded in the Statement of Net Assets as an asset (liability) and in the Statement of Operations as unrealized appreciation (depreciation) until the contracts are closed, when they are recorded as realized forward currency contract gains (losses).

During the six months ended March 31, 2016, the fund’s average investment in forward currency contracts represented 1% of net assets, based on the average of notional amounts at each quarter-end during the period.

4. Repurchase Agreements: The fund enters into repurchase agreements with institutional counter-parties. Securities pledged as collateral to the fund under 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. The fund further mitigates its counterparty risk by entering into repurchase agreements only with a diverse group of prequalified counterparties, monitoring their financial strength, and entering into master repurchase agreements with its counterparties. The master repurchase agreements provide that, in the event of a counter-party’s default (including bankruptcy), the fund may terminate any repurchase agreements with that counterparty, determine the net amount owed, and sell or retain the collateral up to the net amount owed to the fund. Such action may be subject to legal proceedings, which may delay or limit the disposition of collateral.

5. Federal Income Taxes: The fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Management has analyzed the fund’s tax positions taken for all open federal income tax years (September 30, 2012–2015), and for the period ended March 31, 2016, and has concluded that no provision for federal income tax is required in the fund’s financial statements.

6. Distributions: Distributions to shareholders are recorded on the ex-dividend date.

7. Securities Lending: To earn additional income, the fund lends its securities to qualified institutional borrowers. Security loans are subject to termination by the fund at any time, and are required to be secured at all times by collateral in an amount at least equal to the market value of securities loaned. Daily market fluctuations could cause the value of loaned securities to be more or less than the value of the collateral received. When this occurs, the collateral is adjusted and settled on the next business day. The fund further mitigates its counterparty risk by entering into securities lending transactions only with a diverse group of prequalified counterparties, monitoring their financial strength, and entering into master securities lending agreements with its counterparties. The master securities lending agreements provide that, in the event of a counterparty’s default (including bankruptcy),

22


 

Capital Value Fund

the fund may terminate any loans with that borrower, determine the net amount owed, and sell or retain the collateral up to the net amount owed to the fund; however, such actions may be subject to legal proceedings. While collateral mitigates counterparty risk, in the absence of a default the fund may experience delays and costs in recovering the securities loaned. The fund invests cash collateral received in Vanguard Market Liquidity Fund, and records a liability in the Statement of Net Assets for the return of the collateral, during the period the securities are on loan. Securities lending income represents fees charged to borrowers plus income earned on invested cash collateral, less expenses associated with the loan.

8. Credit Facility: The fund and certain other funds managed by The Vanguard Group (“Vanguard”) participate in a $3.1 billion committed credit facility provided by a syndicate of lenders pursuant to a credit agreement that may be renewed annually; each fund is individually liable for its borrowings, if any, under the credit facility. Borrowings may be utilized for temporary and emergency purposes, and are subject to the fund’s regulatory and contractual borrowing restrictions. The participating funds are charged administrative fees and an annual commitment fee of 0.10% of the undrawn amount of the facility; these fees are allocated to the funds based on a method approved by the fund’s board of trustees and included in Management and Administrative expenses on the fund’s Statement of Operations. Any borrowings under this facility bear interest at a rate based upon the higher of the one-month London Interbank Offered Rate, federal funds effective rate, or overnight bank funding rate plus an agreed-upon spread.

The fund had no borrowings outstanding at March 31, 2016, or at any time during the period then ended.

9. Other: Dividend income is recorded on the ex-dividend date. Interest income is accrued daily. Premiums and discounts on debt securities purchased are amortized and accreted, respectively, to interest income over the lives of the respective securities. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold.

B. Wellington Management Company LLP provides investment advisory services to the fund for a fee calculated at an annual percentage rate of average net assets. The basic fee is subject to quarterly adjustments based on the fund’s performance relative to the Dow Jones U.S. Total Stock Market Float Adjusted Index for the preceding three years. For the six months ended March 31, 2016, the investment advisory fee represented an effective annual basic rate of 0.22% of the fund’s average net assets before a decrease of $982,000 (0.19%) based on performance.

C. In accordance with the terms of a Funds’ Service Agreement (the “FSA”) between Vanguard and the fund, Vanguard furnishes to the fund corporate management, administrative, marketing, and distribution services at Vanguard’s cost of operations (as defined by the FSA). These costs of operations are allocated to the fund based on methods and guidelines approved by the board of trustees. Vanguard does not require reimbursement in the current period for certain costs of operations (such as deferred compensation/benefits and risk/insurance costs); the fund’s liability for these costs of operations is included in Payables to Vanguard on the Statement of Net Assets.

Upon the request of Vanguard, the fund may invest up to 0.40% of its net assets as capital in Vanguard. At March 31, 2016, the fund had contributed to Vanguard capital in the amount of $80,000, representing 0.01% of the fund’s net assets and 0.03% of Vanguard’s capitalization. The fund’s trustees and officers are also directors and employees, respectively, of Vanguard.

23


 

Capital Value Fund

D. The fund has asked its investment advisor to direct certain security trades, subject to obtaining the best price and execution, to brokers who have agreed to rebate to the fund part of the commissions generated. Such rebates are used solely to reduce the fund’s management and administrative expenses. For the six months ended March 31, 2016, these arrangements reduced the fund’s expenses by $11,000 (an annual rate of 0.00% of average net assets).

E. Various inputs may be used to determine the value of the fund’s investments. These inputs are summarized in three broad levels for financial statement purposes. The inputs or methodologies used to value securities are not necessarily an indication of the risk associated with investing in those securities.

Level 1Quoted prices in active markets for identical securities.
Level 2Other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.).
Level 3Significant unobservable inputs (including the fund’s own assumptions used to determine the fair value of investments).

The following table summarizes the market value of the fund’s investments as of March 31, 2016, based on the inputs used to value them:

  Level 1 Level 2 Level 3
Investments ($000) ($000) ($000)
Common Stocks 888,316 57,954 1,450
Preferred Stocks 5,895
Temporary Cash Investments 35,241 1,200
Forward Currency Contracts—Liabilities (37)
Total 923,557 59,117 7,345

 

F. At March 31, 2016, the fund had open forward currency contracts to receive and deliver currencies as follows. Unrealized appreciation (depreciation) on open forward currency contracts is treated as realized gain (loss) for tax purposes.

            Unrealized
  Contract         Appreciation
   Settlement     Contract Amount (000)  (Depreciation)
Counterparty Date   Receive   Deliver ($000)
JPMorgan Chase Bank, N.A. 6/15/16 USD 3,927 GBP 2,759 (37)
GBP—British pound.            
USD—U.S. dollar.            

 

G. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. Differences may be permanent or temporary. Permanent differences are reclassified among capital accounts in the financial statements to reflect their tax character. Temporary differences arise when certain items of income, expense, gain, or loss are recognized in different periods for financial statement and tax purposes. These differences will reverse at some time in the future. Differences in classification may also result from the treatment of short-term gains as ordinary income for tax purposes. The fund’s tax-basis capital gains and losses are determined only at the end of each fiscal year.

24


 

Capital Value Fund

During the six months ended March 31, 2016, the fund realized net foreign currency losses of $27,000, which decreased distributable net income for tax purposes; accordingly, such losses have been reclassified from accumulated net realized losses to undistributed net investment income.

At March 31, 2016, the cost of investment securities for tax purposes was $1,015,872,000. Net unrealized depreciation of investment securities for tax purposes was $25,816,000, consisting of unrealized gains of $89,915,000 on securities that had risen in value since their purchase and $115,731,000 in unrealized losses on securities that had fallen in value since their purchase.

H. During the six months ended March 31, 2016, the fund purchased $631,392,000 of investment securities and sold $729,711,000 of investment securities, other than temporary cash investments.

I. Capital shares issued and redeemed were:

  Six Months Ended Year Ended
  March 31, 2016 September 30, 2015
  Shares Shares
  (000) (000)
Issued 5,695 15,385
Issued in Lieu of Cash Distributions 9,106 12,497
Redeemed (15,825) (51,913)
Net Increase (Decrease) in Shares Outstanding (1,024) (24,031)

 

J. Management has determined that no material events or transactions occurred subsequent to March 31, 2016, that would require recognition or disclosure in these financial statements.

25


 

About Your Fund’s Expenses

As a shareholder of the fund, you incur ongoing costs, which include costs for portfolio management, administrative services, and shareholder reports (like this one), among others. Operating expenses, which are deducted from a fund’s gross income, directly reduce the investment return of the fund.

A fund’s expenses are expressed as a percentage of its average net assets. This figure is known as the expense ratio. The following examples are intended to help you understand the ongoing costs (in dollars) of investing in your fund and to compare these costs with those of other mutual funds. The examples are based on an investment of $1,000 made at the beginning of the period shown and held for the entire period.

The accompanying table illustrates your fund’s costs in two ways:

Based on actual fund return. This section helps you to estimate the actual expenses that you paid over the period. The ”Ending Account Value“ shown is derived from the fund‘s actual return, and the third column shows the dollar amount that would have been paid by an investor who started with $1,000 in the fund. You may use the information here, together with the amount you invested, to estimate the expenses that you paid over the period.

To do so, simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number given for your fund under the heading ”Expenses Paid During Period.“

Based on hypothetical 5% yearly return. This section is intended to help you compare your fund‘s costs with those of other mutual funds. It assumes that the fund had a yearly return of 5% before expenses, but that the expense ratio is unchanged. In this case—because the return used is not the fund’s actual return—the results do not apply to your investment. The example is useful in making comparisons because the Securities and Exchange Commission requires all mutual funds to calculate expenses based on a 5% return. You can assess your fund’s costs by comparing this hypothetical example with the hypothetical examples that appear in shareholder reports of other funds.

Note that the expenses shown in the table are meant to highlight and help you compare ongoing costs only and do not reflect transaction costs incurred by the fund for buying and selling securities. Further, the expenses do not include any purchase, redemption, or account service fees described in the fund prospectus. If such fees were applied to your account, your costs would be higher. Your fund does not carry a “sales load.”

The calculations assume no shares were bought or sold during the period. Your actual costs may have been higher or lower, depending on the amount of your investment and the timing of any purchases or redemptions.

You can find more information about the fund’s expenses, including annual expense ratios, in the Financial Statements section of this report. For additional information on operating expenses and other shareholder costs, please refer to your fund’s current prospectus.

26


 

 
Six Months Ended March 31, 2016      
 
  Beginning Ending Expenses
  Account Value Account Value Paid During
Capital Value Fund 9/30/2015 3/31/2016 Period
Based on Actual Fund Return $1,000.00 $1,011.94 $1.16
Based on Hypothetical 5% Yearly Return 1,000.00 1,023.85 1.16
The calculations are based on expenses incurred in the most recent six-month period. The fund’s annualized six-month expense ratio for that period is 0.23%. The dollar amounts shown as “Expenses Paid” are equal to the annualized expense ratio multiplied by the average account value over the period, multiplied by the number of days in the most recent six-month period, then divided by the number of days in the most recent 12-month period (183/366).

 

27


 

Trustees Approve Advisory Arrangement

The board of trustees of Vanguard Capital Value Fund has renewed the fund’s investment advisory arrangement with Wellington Management Company LLP (Wellington Management). The board determined that renewing the fund’s advisory arrangement was in the best interests of the fund and its shareholders.

The board based its decision upon an evaluation of the advisor’s investment staff, portfolio management process, and performance. The trustees considered the factors discussed below, among others. However, no single factor determined whether the board approved the arrangement. Rather, it was the totality of the circumstances that drove the board’s decision.

Nature, extent, and quality of services
The board reviewed the quality of the fund’s investment management services over both the short and long term, and took into account the organizational depth and stability of the advisor. The board considered that Wellington Management, founded in 1928, is among the nation’s oldest and most respected institutional investment managers. The advisor seeks long-term capital appreciation in a relatively concentrated portfolio of undervalued stocks across the capitalization spectrum, employing an opportunistic and contrarian investment style. The two portfolio managers, who have slightly different approaches to value investing, are each generally responsible for managing approximately 50% of the overall fund. The portfolio managers also leverage their industry analysts to uncover investment opportunities. Wellington Management has advised the fund since the fund’s inception in 2001.

The board concluded that the advisor’s experience, stability, depth, and performance, among other factors, warranted continuation of the advisory arrangement.

Investment performance
The board considered the short- and long-term performance of the fund, including any periods of outperformance or underperformance relative to a benchmark index and peer group. The board concluded that the performance was such that the advisory arrangement should continue. Information about the fund’s most recent performance can be found in the Performance Summary section of this report.

Cost
The board concluded that the fund’s expense ratio was well below the average expense ratio charged by funds in its peer group and that the fund’s advisory fee rate was also well below its peer-group average. Information about the fund’s expenses appears in the About Your Fund’s Expenses section of this report as well as in the Financial Statements section, which also includes information about the fund’s advisory fee rate.

The board did not consider profitability of Wellington Management in determining whether to approve the advisory fee, because Wellington Management is independent of Vanguard and the advisory fee is the result of arm’s-length negotiations.

The benefit of economies of scale
The board concluded that the fund’s shareholders benefit from economies of scale because of the breakpoints in the fund’s advisory fee schedule. The breakpoints reduce the effective rate of the fee as the fund’s assets increase.

The board will consider whether to renew the advisory arrangement again after a one-year period.

28


 

Glossary

30-Day SEC Yield. A fund’s 30-day SEC yield is derived using a formula specified by the U.S. Securities and Exchange Commission. Under the formula, data related to the fund’s security holdings in the previous 30 days are used to calculate the fund’s hypothetical net income for that period, which is then annualized and divided by the fund’s estimated average net assets over the calculation period. For the purposes of this calculation, a security’s income is based on its current market yield to maturity (for bonds), its actual income (for asset-backed securities), or its projected dividend yield (for stocks). Because the SEC yield represents hypothetical annualized income, it will differ—at times significantly—from the fund’s actual experience. As a result, the fund’s income distributions may be higher or lower than implied by the SEC yield.

Beta. A measure of the magnitude of a fund’s past share-price fluctuations in relation to the ups and downs of a given market index. The index is assigned a beta of 1.00. Compared with a given index, a fund with a beta of 1.20 typically would have seen its share price rise or fall by 12% when the index rose or fell by 10%. For this report, beta is based on returns over the past 36 months for both the fund and the index. Note that a fund’s beta should be reviewed in conjunction with its R-squared (see definition). The lower the R-squared, the less correlation there is between the fund and the index, and the less reliable beta is as an indicator of volatility.

Dividend Yield. Dividend income earned by stocks, expressed as a percentage of the aggregate market value (or of net asset value, for a fund). The yield is determined by dividing the amount of the annual dividends by the aggregate value (or net asset value) at the end of the period. For a fund, the dividend yield is based solely on stock holdings and does not include any income produced by other investments.

Earnings Growth Rate. The average annual rate of growth in earnings over the past five years for the stocks now in a fund.

Equity Exposure. A measure that reflects a fund’s investments in stocks and stock futures. Any holdings in short-term reserves are excluded.

Expense Ratio. A fund’s total annual operating expenses expressed as a percentage of the fund’s average net assets. The expense ratio includes management and administrative expenses, but does not include the transaction costs of buying and selling portfolio securities.

Foreign Holdings. The percentage of a fund represented by securities or depositary receipts of companies based outside the United States.

Inception Date. The date on which the assets of a fund (or one of its share classes) are first invested in accordance with the fund’s investment objective. For funds with a subscription period, the inception date is the day after that period ends. Investment performance is measured from the inception date.

Median Market Cap. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund’s stocks, weighted by the proportion of the fund’s assets invested in each stock. Stocks representing half of the fund’s assets have market capitalizations above the median, and the rest are below it.

Price/Book Ratio. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds.

29


 

Price/Earnings Ratio. The ratio of a stock’s current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company’s future growth.

R-Squared. A measure of how much of a fund’s past returns can be explained by the returns from the market in general, as measured by a given index. If a fund’s total returns were precisely synchronized with an index’s returns, its R-squared would be 1.00. If the fund’s returns bore no relationship to the index’s returns, its R-squared would be 0. For this report, R-squared is based on returns over the past 36 months for both the fund and the index.

Return on Equity. The annual average rate of return generated by a company during the past five years for each dollar of shareholder’s equity (net income divided by shareholder’s equity). For a fund, the weighted average return on equity for the companies whose stocks it holds.

Short-Term Reserves. The percentage of a fund invested in highly liquid, short-term securities that can be readily converted to cash.

Turnover Rate. An indication of the fund’s trading activity. Funds with high turnover rates incur higher transaction costs and may be more likely to distribute capital gains (which may be taxable to investors). The turnover rate excludes in-kind transactions, which have minimal impact on costs.

30


 

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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’s 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. The independent board members have distinguished backgrounds in business, academia, and public service. Each of the trustees and executive officers oversees 198 Vanguard funds.

The following table provides information for each trustee and executive officer of the fund. More information about the trustees is in the Statement of Additional Information, which can be obtained, without charge, by contacting Vanguard at 800-662-7447, or online at vanguard.com.

 
InterestedTrustee1 Rajiv L. Gupta
Born 1945. Trustee Since December 2001.2 Principal
F. William McNabb III Occupation(s) During the Past Five Years and Other
Born 1957. Trustee Since July 2009. Chairman of Experience: Chairman and Chief Executive Officer
the Board. Principal Occupation(s) During the Past (retired 2009) and President (2006–2008) of
Five Years and Other Experience: Chairman of the Rohm and Haas Co. (chemicals); Director of Tyco
Board of The Vanguard Group, Inc., and of each of International PLC (diversified manufacturing and
the investment companies served by The Vanguard services), HP Inc. (printer and personal computer
Group, since January 2010; Director of The Vanguard manufacturing), and Delphi Automotive PLC
Group since 2008; Chief Executive Officer and (automotive components); Senior Advisor at
President of The Vanguard Group, and of each of New Mountain Capital.
the investment companies served by The Vanguard
Group, since 2008; Director of Vanguard Marketing Amy Gutmann
Corporation; Managing Director of The Vanguard Born 1949. Trustee Since June 2006. Principal
Group (1995–2008). Occupation(s) During the Past Five Years and
Other Experience: President of the University of
IndependentTrustees Pennsylvania; Christopher H. Browne Distinguished
Professor of Political Science, School of Arts and
Emerson U. Fullwood Sciences, and Professor of Communication, Annenberg
Born 1948. Trustee Since January 2008. Principal School for Communication, with secondary faculty
Occupation(s) During the Past Five Years and Other appointments in the Department of Philosophy, School
Experience: Executive Chief Staff and Marketing of Arts and Sciences, and at the Graduate School of
Officer for North America and Corporate Vice President Education, University of Pennsylvania; Trustee of the
(retired 2008) of Xerox Corporation (document manage- National Constitution Center; Chair of the Presidential
ment products and services); Executive in Residence Commission for the Study of Bioethical Issues.
and 2009–2010 Distinguished Minett Professor at
the Rochester Institute of Technology; Lead Director JoAnn Heffernan Heisen
of SPX FLOW, Inc. (multi-industry manufacturing); Born 1950. Trustee Since July 1998. Principal
Director of the United Way of Rochester, the University Occupation(s) During the Past Five Years and
of Rochester Medical Center, Monroe Community Other Experience: Corporate Vice President and
College Foundation, North Carolina A&T University, Chief Global Diversity Officer (retired 2008) and
and Roberts Wesleyan College. Member of the Executive Committee (1997–2008)
of Johnson & Johnson (pharmaceuticals/medical
devices/consumer products); Director of Skytop
Lodge Corporation (hotels) and the Robert Wood
Johnson Foundation; Member of the Advisory
Board of the Institute for Women’s Leadership
at Rutgers University.

 


 

 
F. Joseph Loughrey Executive Officers
Born 1949. Trustee Since October 2009. Principal
Occupation(s) During the Past Five Years and Other Glenn Booraem
Experience: President and Chief Operating Officer Born 1967. Treasurer Since May 2015. Principal
(retired 2009) of Cummins Inc. (industrial machinery); Occupation(s) During the Past Five Years and
Chairman of the Board of Hillenbrand, Inc. (specialized Other Experience: Principal of The Vanguard Group,
consumer services), and of Oxfam America; Director Inc.; Treasurer of each of the investment companies
of SKF AB (industrial machinery), Hyster-Yale Materials served by The Vanguard Group; Controller of each of
Handling, Inc. (forklift trucks), the Lumina Foundation the investment companies served by The Vanguard
for Education, and the V Foundation for Cancer Group (2010–2015); Assistant Controller of each of
Research; Member of the Advisory Council for the the investment companies served by The Vanguard
College of Arts and Letters and of the Advisory Board Group (2001–2010).
to the Kellogg Institute for International Studies, both
at the University of Notre Dame. Thomas J. Higgins
Born 1957. Chief Financial Officer Since September
Mark Loughridge 2008. Principal Occupation(s) During the Past Five
Born 1953. Trustee Since March 2012. Principal Years and Other Experience: Principal of The Vanguard
Occupation(s) During the Past Five Years and Other Group, Inc.; Chief Financial Officer of each of the
Experience: Senior Vice President and Chief Financial investment companies served by The Vanguard Group;
Officer (retired 2013) at IBM (information technology Treasurer of each of the investment companies served
services); Fiduciary Member of IBM’s Retirement Plan by The Vanguard Group (1998–2008).
Committee (2004–2013); Director of the Dow Chemical
Company; Member of the Council on Chicago Booth. Peter Mahoney
Born 1974. Controller Since May 2015. Principal
Scott C. Malpass Occupation(s) During the Past Five Years and
Born 1962. Trustee Since March 2012. Principal Other Experience: Head of Global Fund Accounting
Occupation(s) During the Past Five Years and Other at The Vanguard Group, Inc.; Controller of each of the
Experience: Chief Investment Officer and Vice investment companies served by The Vanguard Group;
President at the University of Notre Dame; Assistant Head of International Fund Services at The Vanguard
Professor of Finance at the Mendoza College of Group (2008–2014).
Business at Notre Dame; Member of the Notre Dame
403(b) Investment Committee, the Board of Advisors Heidi Stam
for Spruceview Capital Partners, and the Investment Born 1956. Secretary Since July 2005. Principal
Advisory Committee of Major League Baseball; Board Occupation(s) During the Past Five Years and Other
Member of TIFF Advisory Services, Inc., and Catholic Experience: Managing Director of The Vanguard
Investment Services, Inc. (investment advisors). Group, Inc.; General Counsel of The Vanguard Group;
Secretary of The Vanguard Group and of each of the
André F. Perold investment companies served by The Vanguard Group;
Born 1952. Trustee Since December 2004. Principal Director and Senior Vice President of Vanguard
Occupation(s) During the Past Five Years and Other Marketing Corporation.
Experience: George Gund Professor of Finance and
Banking, Emeritus at the Harvard Business School Vanguard Senior ManagementTeam
(retired 2011); Chief Investment Officer and Managing
Partner of HighVista Strategies LLC (private investment Mortimer J. Buckley James M. Norris
firm); Director of Rand Merchant Bank; Overseer of Kathleen C. Gubanich Thomas M. Rampulla
the Museum of Fine Arts Boston. Martha G. King Glenn W. Reed
John T. Marcante Karin A. Risi
Peter F. Volanakis Chris D. McIsaac
Born 1955. Trustee Since July 2009. Principal
Occupation(s) During the Past Five Years and Other Chairman Emeritus and Senior Advisor
Experience: President and Chief Operating Officer
(retired 2010) of Corning Incorporated (communications John J. Brennan
equipment); Trustee of Colby-Sawyer College and Chairman, 1996–2009
Chairman of its Finance and Enrollment Committee; Chief Executive Officer and President, 1996–2008
Member of the Advisory Board of the Norris Cotton
Cancer Center. Founder
 
John C. Bogle
Chairman and Chief Executive Officer, 1974–1996

 

1 Mr. McNabb is considered an “interested person,” as defined in the Investment Company Act of 1940, because he is an officer of the Vanguard funds.
2 December 2002 for Vanguard Equity Income Fund, the Vanguard Municipal Bond Funds, and the Vanguard State Tax-Exempt Funds.


 

 

    P.O. Box 2600
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Connect with Vanguard® > vanguard.com  
 
 
 
Fund Information > 800-662-7447   CFA® is a registered trademark owned by CFA Institute.
Direct Investor Account Services > 800-662-2739  
Institutional Investor Services > 800-523-1036  
Text Telephone for People    
Who Are Deaf or Hard of Hearing> 800-749-7273  
 
This material may be used in conjunction  
with the offering of shares of any Vanguard  
fund only if preceded or accompanied by  
the fund’s current prospectus.  
 
All comparative mutual fund data are from Lipper, a  
Thomson Reuters Company, or Morningstar, Inc., unless  
otherwise noted.    
 
You can obtain a free copy of Vanguard’s proxy voting  
guidelines by visiting vanguard.com/proxyreporting or by  
calling Vanguard at 800-662-2739. The guidelines are  
also available from the SEC’s website, sec.gov. In  
addition, you may obtain a free report on how your fund  
voted the proxies for securities it owned during the 12  
months ended June 30. To get the report, visit either  
vanguard.com/proxyreporting or sec.gov.  
 
You can review and copy information about your fund at  
the SEC’s Public Reference Room in Washington, D.C. To  
find out more about this public service, call the SEC at  
202-551-8090. Information about your fund is also  
available on the SEC’s website, and you can receive  
copies of this information, for a fee, by sending a  
request in either of two ways: via email addressed to  
publicinfo@sec.gov or via regular mail addressed to the  
Public Reference Section, Securities and Exchange  
Commission, Washington, DC 20549-1520.  
 
    © 2016 The Vanguard Group, Inc.
    All rights reserved.
    Vanguard Marketing Corporation, Distributor.
 
    Q3282 052016

 



Semiannual Report | March 31, 2016

Vanguard Short-Term Inflation-Protected
Securities Index Fund


 

Vanguard’s Principles for Investing Success

We want to give you the best chance of investment success. These principles, grounded in Vanguard’s research and experience, can put you on the right path.

Goals. Create clear, appropriate investment goals.

Balance. Develop a suitable asset allocation using broadly diversified funds. Cost. Minimize cost.

Discipline. Maintain perspective and long-term discipline.

A single theme unites these principles: Focus on the things you can control.

We believe there is no wiser course for any investor.

Contents  
Your Fund’s Total Returns. 1
Chairman’s Letter. 2
Fund Profile. 8
Performance Summary. 9
Financial Statements. 10
About Your Fund’s Expenses. 22
Trustees Approve Advisory Arrangement. 24
Glossary. 25

 

Please note: The opinions expressed in this report are just that—informed opinions. They should not be considered promises or advice. Also, please keep in mind that the information and opinions cover the period through the date on the front of this report. Of course, the risks of investing in your fund are spelled out in the prospectus.
See the Glossary for definitions of investment terms used in this report.
About the cover: Pictured is a sailing block on the Brilliant, a 1932 schooner docked in Mystic, Connecticut. A type of pulley, the sailing block helps coordinate the setting of the sails. At Vanguard, the intricate coordination of technology and people allows us to help millions of clients around the world reach their financial goals.


 

Your Fund’s Total Returns

 
Six Months Ended March 31, 2016        
  30-Day SEC Income Capital Total
  Yield Returns Returns Returns
Vanguard Short-Term Inflation-Protected Securities Index Fund        
Investor Shares -0.65% -0.19% 1.59% 1.40%
ETF Shares -0.55      
Market Price       1.48
Net Asset Value       1.43
Admiral™ Shares -0.55 -0.13 1.53 1.40
Institutional Shares -0.52 -0.13 1.53 1.40
Barclays U.S. Treasury Inflation-Protected Securities (TIPS) 0–5        
Year Index       1.46
Inflation-Protected Bond Funds Average       2.89

 

Inflation-Protected Bond Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company.

Admiral Shares carry lower expenses and are available to investors who meet certain account-balance requirements. Institutional Shares are available to certain institutional investors who meet specific administrative, service, and account-size criteria. The Vanguard ETF® Shares shown are traded on the Nasdaq exchange and are available only through brokers. The table provides ETF returns based on both the Nasdaq market price and the net asset value for a share. U.S. Pat. Nos. 6,879,964; 7,337,138; 7,720,749; 7,925,573; 8,090,646; and 8,417,623.

For the ETF Shares, the market price is determined by the midpoint of the bid-offer spread as of the closing time of the New York Stock Exchange (generally 4 p.m., Eastern time). The net asset value is also determined as of the NYSE closing time. For more information about how the ETF Shares' market prices have compared with their net asset value, visit vanguard.com, select your ETF, and then select the Price and Performance tab. The ETF premium/discount analysis there shows the percentages of days on which the ETF Shares' market price was above or below the NAV.

  
Your Fund’s Performance at a Glance        
September 30, 2015, Through March 31, 2016        
      Distributions Per Share
  Starting Ending Income Capital
  Share Price Share Price Dividends Gains
Vanguard Short-Term Inflation-Protected Securities        
Index Fund        
Investor Shares $24.23 $24.57 $0.000 $0.000
ETF Shares 48.36 49.05 0.000 0.000
Admiral Shares 24.27 24.61 0.000 0.000
Institutional Shares 24.28 24.62 0.000 0.000

 

1


 

 

Chairman’s Letter

Dear Shareholder,

Vanguard Short-Term Inflation-Protected Securities Index Fund returned 1.40% for Investor, Admiral, and Institutional Shares for the six months ended March 31, 2016. Returns were similar (+1.43%) for ETF Shares, based on net asset value.

The fund’s benchmark index returned 1.46%. As an index fund, the fund seeks to track its benchmark as closely as possible, after allowing for expenses. An index, of course, has no operating costs to detract from its returns.

Bonds produced gains following a subpar start
After posting weak results for the first three months of the period, bonds managed solid gains. The broad U.S. taxable bond market returned 2.44% for the fiscal half year.

With stocks volatile and the Fed proceeding cautiously with rate hikes, bonds proved attractive. The yield of the 10-year U.S. Treasury note closed at 1.77% at the end of March, down from 2.05% six months earlier. (Bond prices and yields move in opposite directions.)

Returns for money market funds and savings accounts remained limited by the Fed’s target rate of 0.25%–0.5%—still low despite rising a quarter of a percentage point in December.

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International bond markets (as measured by the Barclays Global Aggregate Index ex USD) returned 6.90%. International bonds got a boost as foreign currencies strengthened against the dollar, a turnabout from the trend of recent years. Even without this currency benefit, however, international bond returns were solidly positive.

Stocks charted an uneven course en route to a solid outcome
The broad U.S. stock market returned about 7% over the six months. The period began and ended strongly, with fluctuations in the middle as China’s economic slowdown and falling oil and commodity prices worried investors.

Stocks rallied in March as investors again seemed encouraged by news about monetary policy. The Federal Reserve indicated, after a mid-March meeting, that it would raise interest rates fewer times in 2016 than previously anticipated. And central bankers in Europe and Asia kept up stimulus measures to combat weak growth and low inflation.

International stocks returned about 3% for the period after surging more than 8% in March. Stocks from emerging markets and from developed markets of the Pacific region outperformed European stocks, which were nearly flat.

 
Market Barometer      
      Total Returns
           Periods Ended March 31, 2016
  Six One Five Years
  Months Year (Annualized)
Bonds      
Barclays U.S. Aggregate Bond Index (Broad taxable      
market) 2.44% 1.96% 3.78%
Barclays Municipal Bond Index (Broad tax-exempt market) 3.20 3.98 5.59
Citigroup Three-Month U.S. Treasury Bill Index 0.06 0.08 0.04
 
Stocks      
Russell 1000 Index (Large-caps) 7.75% 0.50% 11.35%
Russell 2000 Index (Small-caps) 2.02 -9.76 7.20
Russell 3000 Index (Broad U.S. market) 7.30 -0.34 11.01
FTSE All-World ex US Index (International) 3.09 -8.53 0.70
 
CPI      
Consumer Price Index 0.08% 0.85% 1.28%

 

3


Trends in the TIPS market caused fund yields to decline As you can see on page 1, the returns of the Short-Term Inflation-Protected Securities Index Fund consisted of negative income and positive capital (price) returns. Negative income is recorded when the values of some of the fund’s securities are adjusted downward because of low inflation. These reductions were greater than the income received from the fund’s portfolio of securities. But higher capital returns generated net positive total returns.

During the first few months of the period, yields of both TIPS and nominal Treasuries rose as markets expected the Fed to raise interest rates throughout 2016. But in January, falling commodity prices,China’s deceleration, and signals about a global slowdown prompted fears that disinflationary forces were still prevalent.

As a result, bond yields sank as their prices rose, and yields from short-term TIPS reentered negative territory. As has occurred often in recent years, investors were again willing to pay above face value for short-term TIPS, with the expectation that a future increase in inflation will trigger inflation adjustments that will, in turn, generate positive returns.

Speaking of inflation, the Consumer Price Index (CPI), which is the yardstick used to calculate how the principal values of TIPS are periodically adjusted for inflation, has remained tame. The actual measure used

 
Expense Ratios          
Your Fund Compared With Its Peer Group          
 
  Investor ETF Admiral Institutional Peer Group
  Shares Shares Shares Shares Average
Short-Term Inflation-Protected Securities          
Index Fund 0.17% 0.08% 0.08% 0.05% 0.75%
The fund expense ratios shown are from the prospectus dated January 27, 2016, and represent estimated costs for the current fiscal year. For the six months ended March 31, 2016, the fund’s annualized expense ratios were 0.15% for Investor Shares, 0.07% for ETF Shares, 0.07% for Admiral Shares, and 0.05% for Institutional Shares. The peer-group expense ratio is derived from data provided by Lipper, a Thomson Reuters Company, and captures information through year-end 2015.
 
Peer group: Inflation-Protected Bond Funds.          

 

4


 

by the Treasury is the monthly CPI change unadjusted for seasonal variations. This measure started at 0% and ended at 0.4% during the period. The 12-month unadjusted CPI started at 0.2% and finished at 0.9%.

Based on bond market activity, inflation over the next five years was expected to be 1.36% as of March 31. This is derived from the difference between the yields of TIPS and nominal Treasury securities.

Low TIPS yields again prevented the fund from making distributions The ultra-low interest rate environment that has prevented the fund from making any distributions since December 2014 caused the fund to skip quarterly distributions in December and March. The fund is conservative in making distributions to minimize the risk of overdistributing income by the end of a calendar year, a potential recordkeeping headache for shareholders. This risk is greatest during periods of deflation, low or slowing inflation, and low or negative yields, conditions that have characterized the TIPS market in recent years.

As the fund’s total income through the rest of calendar 2016 is calculated, distributions will resume should sufficient income be available.

Consider rebalancing to manage your risk
Let’s say you’ve taken the time to carefully create an appropriate asset allocation for your investment portfolio. Your efforts

 
Yields of U.S. Treasury Securities    
As of March 31, 2016    
  Inflation-Protected  
  Securities Nominal
Maturity (Real Yields) Securities
2 years -0.70% 0.72%
3 years -0.49 0.85
5 years -0.15 1.21
10 years 0.32 1.77
30 years 1.00 2.61
Source: Vanguard.    

 

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have produced a diversified mix of stock, bond, and money market funds tailored to your goals, time horizon, and risk tolerance

But what should you do when your portfolio drifts from its original asset allocation as the financial markets rise or fall? Consider rebalancing to bring it back to the proper mix.

Just one year of outsized returns can throw your allocation out of whack. Take 2013 as an example. That year, the broad stock market (as measured by the Russell 3000 Index) returned 33.55% and the broad taxable bond market (as measured by the Barclays U.S. Aggregate Bond Index) returned –2.02%. A hypothetical portfolio that tracked the broad domestic

Vanguard’s growth translates into lower costs for you
 
Research indicates that lower-cost investments have tended to outperform higher-cost ones.
So it’s little wonder that funds with lower expense ratios—including those at Vanguard—have
dominated the industry’s cash inflows in recent years.
 
Vanguard has long been a low-cost leader, with expenses well below those of many other
investment management companies. That cost difference remains a powerful advantage for
Vanguard clients. Why? Because a lower expense ratio allows a fund to pass along a greater
share of its returns to its investors.
 
What’s more, as you can see in the chart below, we’ve been able to lower our costs continually
as our assets under management have grown. Our steady growth has not been an explicit
business objective. Rather, we focus on putting our clients’ interests first at all times, and
giving them the best chance for investment success. But economies of scale—the cost
efficiencies that come with our growth—have allowed us to keep lowering our fund costs,
even as we invest in our people and technology.
 
The benefit of economies of scale

6


market indexes and started the year with 60% stocks and 40% bonds would have ended with a more aggressive mix of 67% stocks and 33% bonds.

Rebalancing to bring your portfolio back to its original targets would require you to shift assets away from areas that have been performing well toward those that have been falling behind. That isn’t easy or intuitive. It’s a way to minimize risk rather than maximize returns and to stick with your investment plan through different types of markets. (You can read more about our approach in Best Practices for Portfolio Rebalancing at vanguard.com/research.)

It’s not necessary to check your portfolio every day or every month, much less rebalance it that frequently. It may be more appropriate to monitor it annually or semiannually and rebalance when your allocation swings 5 percentage points or more from its target.

It’s important, of course, to be aware of the tax implications. You’ll want to consult with your tax advisor, but generally speaking, it may be a good idea to make any asset changes within a tax-advantaged retirement account or to direct new cash flows into the underweighted asset class.

However you go about it, keeping your asset allocation from drifting too far off target can help you stay on track with the investment plan you’ve crafted to meet your financial goals.

As always, thank you for investing with Vanguard.

Sincerely,


F. William McNabb III
Chairman and Chief Executive Officer
April 19, 2016


 

Short-Term Inflation-Protected Securities Index Fund

Fund Profile
As of March 31, 2016

 
Share-Class Characteristics        
  Investor   Admiral Institutional
  Shares ETF Shares Shares Shares
Ticker Symbol VTIPX VTIP VTAPX VTSPX
Expense Ratio1 0.17% 0.08% 0.08% 0.05%
30-Day SEC Yield2 -0.65% -0.55% -0.55% -0.52%

 

 
Financial Attributes      
 
    Barclays Barclays
    TIPS Aggregate
    0-5 Year Bond
  Fund Index Index
Number of Bonds 16 15 9,703
Yield to Maturity      
(before expenses) 1.0% 0.7% 2.2%
Average Coupon 0.8% 0.8% 3.2%
Average Duration 2.5 years 2.5 years 5.5 years
Average Effective      
Maturity 2.5 years 2.5 years 7.7 years
Short-Term Reserves 0.1%

 

  
Sector Diversification (% of portfolio)  
Treasury/Agency 100.0%
The agency and mortgage-backed securities sectors may include issues from government-sponsored enterprises; such issues are generally not backed by the full faith and credit of the U.S. government.

 

 
Volatility Measures    
  Barclays Barclays
  TIPS Aggregate
  0-5 Year Bond
  Index Index
R-Squared 0.99 0.38
Beta 1.00 0.38
These measures show the degree and timing of the fund’s fluctuations compared with the indexes over 36 months.

 

 
Distribution by Credit Quality (% of portfolio)
 
U.S. Government 100.0%
Credit-quality ratings are obtained from Barclays and are from Moody's, Fitch, and S&P. When ratings from all three agencies are used, the median rating is shown. When ratings from two of the agencies are used, the lower rating for each issue is shown. "Not Rated" is used to classify securities for which a rating is not available. For more information about these ratings, see the Glossary entry for Credit Quality.

 

 
Distribution by Effective Maturity  
(% of portfolio)  
Under 1 Year 17.4%
1 - 3 Years 35.8
3 - 5 Years 46.8

 

Investment Focus

 

 

 

 

1 The expense ratios shown are from the prospectus dated January 27, 2016, and represent estimated costs for the current fiscal year. For the six months ended March 31, 2016, the fund’s annualized expense ratios were 0.15% for Investor Shares, 0.07% for ETF Shares, 0.07% for Admiral Shares, and 0.05% for Institutional Shares.
2 Yields of inflation-protected securities tend to be lower than those of nominal bonds, because the former do not incorporate market expectations about inflation. The principal amounts—and thus the interest payments—of inflation-protected securities are adjusted over time to reflect inflation.
8


 

Short-Term Inflation-Protected Securities Index Fund

Performance Summary

All of the returns in this report represent past performance, which is not a guarantee of future results that may be achieved by the fund. (Current performance may be lower or higher than the performance data cited. For performance data current to the most recent month-end, visit our website at vanguard.com/performance.) Note, too, that both investment returns and principal value can fluctuate widely, so an investor’s shares, when sold, 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 sale of fund shares.

 
Fiscal-Year Total Returns (%): October 16, 2012, Through March 31, 2016  
        Barclays
        TIPS
        0-5 Year
      Investor Shares Index
Fiscal Year Income Returns Capital Returns Total Returns Total Returns
2013 0.09% -1.00% -0.91% -1.20%
2014 0.02 -0.04 -0.02 0.21
2015 0.70 -2.06 -1.36 -1.19
2016 -0.19 1.59 1.40 1.46
Note: For 2016, performance data reflect the six months ended March 31, 2016.    

 

 
Average Annual Total Returns: Periods Ended March 31, 2016      
 
          Since Inception
  Inception Date One Year Income Capital Total
Investor Shares 10/16/2012 1.24% 0.24% -0.50% -0.26%
ETF Shares 10/12/2012        
Market Price   1.38     -0.14
Net Asset Value   1.32     -0.18
Admiral Shares 10/16/2012 1.32 0.28 -0.45 -0.17
Institutional Shares 10/17/2012 1.36 0.29 -0.43 -0.14

 

See Financial Highlights for dividend and capital gains information.

9


 

Short-Term Inflation-Protected Securities Index Fund

Financial Statements (unaudited)

Statement of Net Assets
As of March 31, 2016

The fund reports a complete list of its holdings in regulatory filings four times in each fiscal year, at the quarter-ends. For the second and fourth fiscal quarters, the lists appear in the fund’s semiannual and annual reports to shareholders. For the first and third fiscal quarters, the fund files the lists with the Securities and Exchange Commission on Form N-Q. Shareholders can look up the fund’s Forms N-Q on the SEC’s website at sec.gov. Forms N-Q may also be reviewed and copied at the SEC’s Public Reference Room (see the back cover of this report for further information).

      Face Market
    Maturity Amount Value
  Coupon Date ($000) ($000)
U.S. Government and Agency Obligations (99.7%)        
U.S. Government Securities (99.7%)        
United States Treasury Inflation Indexed Bonds 0.125% 4/15/16 1,188,572 1,275,335
United States Treasury Inflation Indexed Bonds 2.500% 7/15/16 530,343 633,342
United States Treasury Inflation Indexed Bonds 2.375% 1/15/17 460,018 556,810
United States Treasury Inflation Indexed Bonds 0.125% 4/15/17 1,381,090 1,457,241
United States Treasury Inflation Indexed Bonds 2.625% 7/15/17 404,104 486,261
United States Treasury Inflation Indexed Bonds 1.625% 1/15/18 432,537 511,389
United States Treasury Inflation Indexed Bonds 0.125% 4/15/18 1,563,434 1,630,902
United States Treasury Inflation Indexed Bonds 1.375% 7/15/18 438,539 508,227
United States Treasury Inflation Indexed Bonds 2.125% 1/15/19 403,898 481,139
United States Treasury Inflation Indexed Bonds 0.125% 4/15/19 1,569,951 1,621,823
United States Treasury Inflation Indexed Bonds 1.875% 7/15/19 460,336 555,314
United States Treasury Inflation Indexed Bonds 1.375% 1/15/20 564,678 662,345
United States Treasury Inflation Indexed Bonds 0.125% 4/15/20 1,569,811 1,621,894
United States Treasury Inflation Indexed Bonds 1.250% 7/15/20 874,270 1,021,290
United States Treasury Inflation Indexed Bonds 1.125% 1/15/21 1,005,545 1,164,244
Total U. S. Government and Agency Obligations (Cost $14,041,717)     14,187,556
 
      Shares  
Temporary Cash Investment (0.1%)        
Money Market Fund (0.1%)        
1 Vanguard Market Liquidity Fund (Cost $9,317) 0.495%   9,317,238 9,317
Total Investments (99.8%) (Cost $14,051,034)       14,196,873

 

10


 

Short-Term Inflation-Protected Securities Index Fund

  Amount
  ($000)
Other Assets and Liabilities (0.2%)  
Other Assets  
Investment in VGI 1,217
Receivables for Accrued Income 26,913
Receivables for Capital Shares Issued 53,636
Total Other Assets 81,766
Liabilities  
Payables for Investment Securities Purchased (47,794)
Payables for Capital Shares Redeemed (1,799)
Payables to Vanguard (3,173)
Other Liabilities (2,567)
Total Liabilities (55,333)
Net Assets (100%) 14,223,306

 

 
At March 31, 2016, net assets consisted of:  
  Amount
  ($000)
Paid-in Capital 14,281,916
Overdistributed Net Investment Income (136,985)
Accumulated Net Realized Losses (67,464)
Unrealized Appreciation (Depreciation) 145,839
Net Assets 14,223,306
 
Investor Shares—Net Assets  
Applicable to 187,859,888 outstanding $.001 par value shares of  
beneficial interest (unlimited authorization) 4,614,832
Net Asset Value Per Share—Investor Shares $24.57
 
ETF Shares—Net Assets  
Applicable to 44,065,584 outstanding $.001 par value shares of  
beneficial interest (unlimited authorization) 2,161,228
Net Asset Value Per Share—ETF Shares $49.05
 
Admiral Shares—Net Assets  
Applicable to 114,812,752 outstanding $.001 par value shares of  
beneficial interest (unlimited authorization) 2,825,410
Net Asset Value Per Share—Admiral Shares $24.61
 
Institutional Shares—Net Assets  
Applicable to 187,709,305 outstanding $.001 par value shares of  
beneficial interest (unlimited authorization) 4,621,836
Net Asset Value Per Share—Institutional Shares $24.62

 

See Note A in Notes to Financial Statements.
1 Affiliated money market fund available only to Vanguard funds and certain trusts and accounts managed by Vanguard. Rate shown is the 7-day yield.
See accompanying Notes, which are an integral part of the Financial Statements.

11


 

Short-Term Inflation-Protected Securities Index Fund

Statement of Operations

  Six Months Ended
  March 31, 2016
  ($000)
Investment Income  
Income  
Interest Income (Loss)1 (120,709)
Total Income (Loss) (120,709)
Expenses  
The Vanguard Group—Note B  
Investment Advisory Services 188
Management and Administrative—Investor Shares 2,849
Management and Administrative—ETF Shares 597
Management and Administrative—Admiral Shares 707
Management and Administrative—Institutional Shares 876
Marketing and Distribution—Investor Shares 516
Marketing and Distribution—ETF Shares 78
Marketing and Distribution—Admiral Shares 144
Marketing and Distribution—Institutional Shares 58
Custodian Fees 38
Shareholders’ Reports—Investor Shares 31
Shareholders’ Reports—ETF Shares 29
Shareholders’ Reports—Admiral Shares 12
Shareholders’ Reports—Institutional Shares 1
Trustees’ Fees and Expenses 3
Total Expenses 6,127
Net Investment Income (Loss) (126,836)
Realized Net Gain (Loss)  
Investment Securities Sold (6,871)
Futures Contracts (1,704)
Realized Net Gain (Loss) (8,575)
Change in Unrealized Appreciation (Depreciation) of Investment Securities 330,229
Net Increase (Decrease) in Net Assets Resulting from Operations 194,818
1 Interest income from an affiliated company of the fund was $152,000.  

 

See accompanying Notes, which are an integral part of the Financial Statements.

12


 

Short-Term Inflation-Protected Securities Index Fund

Statement of Changes in Net Assets

  Six Months Ended Year Ended
  March 31, September 30,
  2016 2015
  ($000) ($000)
Increase (Decrease) in Net Assets    
Operations    
Net Investment Income (Loss) (126,836) (52,791)
Realized Net Gain (Loss) (8,575) (12,913)
Change in Unrealized Appreciation (Depreciation) 330,229 (73,400)
Net Increase (Decrease) in Net Assets Resulting from Operations 194,818 (139,104)
Distributions    
Net Investment Income    
Investor Shares (32,095)
ETF Shares (11,618)
Admiral Shares (12,111)
Institutional Shares (25,014)
Realized Capital Gain    
Investor Shares
ETF Shares
Admiral Shares
Institutional Shares
Total Distributions (80,838)
Capital Share Transactions    
Investor Shares 21,885 110,230
ETF Shares 292,729 532,047
Admiral Shares 660,677 640,240
Institutional Shares 720,077 1,193,894
Net Increase (Decrease) from Capital Share Transactions 1,695,368 2,476,411
Total Increase (Decrease) 1,890,186 2,256,469
Net Assets    
Beginning of Period 12,333,120 10,076,651
End of Period1 14,223,306 12,333,120
1 Net Assets—End of Period includes undistributed (overdistributed) net investment income of ($136,985,000) and ($11,083,000).

 

See accompanying Notes, which are an integral part of the Financial Statements.

13


 

Short-Term Inflation-Protected Securities Index Fund

Financial Highlights

 
Investor Shares        
  Six Months     Oct. 16,
  Ended Year Ended 20121 to
  March 31, September 30, Sept. 30,
For a Share Outstanding Throughout Each Period 2016 2015 2014 2013
Net Asset Value, Beginning of Period $24.23 $24.74 $24.75 $25.00
Investment Operations        
Net Investment Income (Loss) (.146) (.131) .183 . 015
Net Realized and Unrealized Gain (Loss) on Investments .486 (.206) (.189) (.241)
Total from Investment Operations .340 (.337) (.006) (.226)
Distributions        
Dividends from Net Investment Income (.173) (.004) (.024)
Distributions from Realized Capital Gains
Total Distributions (.173) (.004) (.024)
Net Asset Value, End of Period $24.57 $24.23 $24.74 $24.75
 
Total Return 2 1.40% -1.36% -0.02% -0.91%
 
Ratios/Supplemental Data        
Net Assets, End of Period (Millions) $4,615 $4,532 $4,517 $3,702
Ratio of Total Expenses to Average Net Assets 0.15% 0.17% 0.20% 0.20%3
Ratio of Net Investment Income (Loss) to Average Net Assets (1.96%) (0.53%) 0.88% 0.01%3
Portfolio Turnover Rate 4 23% 26% 18% 13%
The expense ratio, net income ratio, and turnover rate for the current period have been annualized.    
1 Inception.
2 Total returns do not include transaction or account service fees that may have applied in the periods shown. Fund prospectuses provide information about any applicable transaction and account service fees.
3 Annualized.
4 Excludes the value of portfolio securities received or delivered as a result of in-kind purchases or redemptions of the fund’s capital shares, including ETF Creation Units.

 

See accompanying Notes, which are an integral part of the Financial Statements.

14


 

Short-Term Inflation-Protected Securities Index Fund

Financial Highlights

 
ETF Shares        
  Six Months     Oct. 12,
  Ended Year Ended 20121 to
  March 31, September 30, Sept. 30,
For a Share Outstanding Throughout Each Period 2016 2015 2014 2013
Net Asset Value, Beginning of Period $48.36 $49.38 $49.36 $49.83
Investment Operations        
Net Investment Income (Loss) (. 269) (. 210) . 414 . 065
Net Realized and Unrealized Gain (Loss) on Investments .959 (.415) (.371) (.483)
Total from Investment Operations .690 (.625) .043 (.418)
Distributions        
Dividends from Net Investment Income (.395) (.023) (.052)
Distributions from Realized Capital Gains
Total Distributions (.395) (.023) (.052)
Net Asset Value, End of Period $49.05 $48.36 $49.38 $49.36
 
Total Return 1.43% -1.26% 0.09% -0.84%
 
Ratios/Supplemental Data        
Net Assets, End of Period (Millions) $2,161 $1,838 $1,336 $967
Ratio of Total Expenses to Average Net Assets 0.07% 0.08% 0.10% 0.10%2
Ratio of Net Investment Income (Loss) to Average Net Assets (1.88%) (0.44%) 0.98% 0.11%2
Portfolio Turnover Rate 3 23% 26% 18% 13%
The expense ratio, net income ratio, and turnover rate for the current period have been annualized.    
1 Inception.
2 Annualized.
3 Excludes the value of portfolio securities received or delivered as a result of in-kind purchases or redemptions of the fund’s capital shares, including ETF Creation Units.

 

See accompanying Notes, which are an integral part of the Financial Statements.

15


 

Short-Term Inflation-Protected Securities Index Fund

Financial Highlights

  
 Admiral Shares        
  Six Months     Oct. 16,
  Ended Year Ended 20121 to
  March 31, September 30, Sept. 30,
For a Share Outstanding Throughout Each Period 2016 2015 2014 2013
Net Asset Value, Beginning of Period $24.27 $24.77 $24.77 $25.00
Investment Operations        
Net Investment Income (Loss) (.134) (.105) . 209 . 025
Net Realized and Unrealized Gain (Loss) on Investments .474 (.197) (.195) (.229)
Total from Investment Operations .340 (.302) .014 (.204)
Distributions        
Dividends from Net Investment Income (.198) (.014) (.026)
Distributions from Realized Capital Gains
Total Distributions (.198) (.014) (.026)
Net Asset Value, End of Period $24.61 $24.27 $24.77 $24.77
 
Total Return 2 1.40% -1.22% 0.06% -0.82%
 
Ratios/Supplemental Data        
Net Assets, End of Period (Millions) $2,825 $2,126 $1,518 $776
Ratio of Total Expenses to Average Net Assets 0.07% 0.08% 0.10% 0.10%3
Ratio of Net Investment Income (Loss) to Average Net Assets (1.88%) (0.44%) 0.98% 0.11%3
Portfolio Turnover Rate 4 23% 26% 18% 13%
The expense ratio, net income ratio, and turnover rate for the current period have been annualized.    
1 Inception.
2 Total returns do not include transaction or account service fees that may have applied in the periods shown. Fund prospectuses provide information about any applicable transaction and account service fees.
3 Annualized.
4 Excludes the value of portfolio securities received or delivered as a result of in-kind purchases or redemptions of the fund’s capital shares, including ETF Creation Units.

 

See accompanying Notes, which are an integral part of the Financial Statements.

16


 

Short-Term Inflation-Protected Securities Index Fund

Financial Highlights

 
Institutional Shares        
  Six Months     Oct. 17,
  Ended Year Ended 20121 to
  March 31, September 30, Sept. 30,
For a Share Outstanding Throughout Each Period 2016 2015 2014 2013
Net Asset Value, Beginning of Period $24.28 $24.78 $24.77 $24.99
Investment Operations        
Net Investment Income (Loss) (.133) (. 099) . 215 . 026
Net Realized and Unrealized Gain (Loss) on Investments .473 (.196) (.189) (.220)
Total from Investment Operations .340 (.295) .026 (.194)
Distributions        
Dividends from Net Investment Income (.205) (.016) (.026)
Distributions from Realized Capital Gains
Total Distributions (.205) (.016) (.026)
Net Asset Value, End of Period $24.62 $24.28 $24.78 $24.77
 
Total Return 2 1.40% -1.19% 0.11% -0.78%
 
Ratios/Supplemental Data        
Net Assets, End of Period (Millions) $4,622 $3,837 $2,706 $1,262
Ratio of Total Expenses to Average Net Assets 0.05% 0.05% 0.07% 0.07%3
Ratio of Net Investment Income (Loss) to Average Net Assets (1.86%) (0.41%) 1.01% 0.14%3
Portfolio Turnover Rate 4 23% 26% 18% 13%
The expense ratio, net income ratio, and turnover rate for the current period have been annualized.    
1 Inception.
2 Total returns do not include transaction fees that may have applied in the periods shown. Fund prospectuses provide information about any applicable transaction fees.
3 Annualized.
4 Excludes the value of portfolio securities received or delivered as a result of in-kind purchases or redemptions of the fund’s capital shares, including ETF Creation Units.

 

See accompanying Notes, which are an integral part of the Financial Statements.

17


 

Short-Term Inflation-Protected Securities Index Fund

Notes to Financial Statements

Vanguard Short-Term Inflation-Protected Securities Index Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund offers four classes of shares: Investor Shares, ETF Shares, Admiral Shares, and Institutional Shares. Investor Shares are available to any investor who meets the fund’s minimum purchase requirements. ETF Shares are listed for trading on Nasdaq; they can be purchased and sold through a broker. Admiral Shares and Institutional Shares are designed for investors who meet certain administrative, service, and account-size criteria.

A. The following significant accounting policies conform to generally accepted accounting principles for U.S. investment companies. The fund consistently follows such policies in preparing its financial statements.

1. Security Valuation: Securities are valued as of the close of trading on the New York Stock Exchange (generally 4 p.m., Eastern time) on the valuation date. Bonds, and temporary cash investments acquired over 60 days to maturity, are valued using the latest bid prices or using valuations based on a matrix system (which considers such factors as security prices, yields, maturities, and ratings), both as furnished by independent pricing services. Investments in Vanguard Market Liquidity Fund are valued at that fund’s net asset value. Other temporary cash investments are valued at amortized cost, which approximates market value. Securities for which market quotations are not readily available, or whose values have been affected by events occurring before the fund’s pricing time but after the close of the securities’ primary markets, are valued by methods deemed by the board of trustees to represent fair value.

2. Futures Contracts: The fund uses futures contracts to invest in fixed income asset classes with greater efficiency and lower cost than is possible through direct investment, to add value when these instruments are attractively priced, or to adjust sensitivity to changes in interest rates. The primary risks associated with the use of futures contracts are imperfect correlation between changes in market values of bonds held by the fund and the prices of futures contracts, and the possibility of an illiquid market. Counterparty risk involving futures is mitigated because a regulated clearinghouse is the counterparty instead of the clearing broker. To further mitigate counterparty risk, the fund trades futures contracts on an exchange, monitors the financial strength of its clearing brokers and clearing-house, and has entered into clearing agreements with its clearing brokers. The clearinghouse imposes initial margin requirements to secure the fund’s performance and requires daily settlement of variation margin representing changes in the market value of each contract.

Futures contracts are valued at their quoted daily settlement prices. The aggregate settlement values of the contracts are not recorded in the Statement of Net Assets. Fluctuations in the value of the contracts are recorded in the Statement of Net Assets as an asset (liability) and in the Statement of Operations as unrealized appreciation (depreciation) until the contracts are closed, when they are recorded as realized futures gains (losses).

During the six months ended March 31, 2016, the fund’s average investments in long and short futures contracts each represented 0% of net assets, based on the average of aggregate settlement values at each quarter-end during the period. The fund had no open futures contracts at March 31, 2016.

3. Federal Income Taxes: The fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Management has analyzed the fund’s tax positions taken for all open federal income tax years (September 30, 2013–2015), and for the period ended March 31, 2016, and has concluded that no provision for federal income tax is required in the fund’s financial statements.

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Short-Term Inflation-Protected Securities Index Fund

4. Distributions: Distributions to shareholders are recorded on the ex-dividend date.

5. Credit Facility: The fund and certain other funds managed by The Vanguard Group (“Vanguard”) participate in a $3.1 billion committed credit facility provided by a syndicate of lenders pursuant to a credit agreement that may be renewed annually; each fund is individually liable for its borrowings, if any, under the credit facility. Borrowings may be utilized for temporary and emergency purposes, and are subject to the fund’s regulatory and contractual borrowing restrictions. The participating funds are charged administrative fees and an annual commitment fee of 0.10% of the undrawn amount of the facility; these fees are allocated to the funds based on a method approved by the fund’s board of trustees and included in Management and Administrative expenses on the fund’s Statement of Operations. Any borrowings under this facility bear interest at a rate based upon the higher of the one-month London Interbank Offered Rate, federal funds effective rate, or overnight bank funding rate plus an agreed-upon spread.

The fund had no borrowings outstanding at March 31, 2016, or at any time during the period then ended.

6. Other: Interest income includes income distributions received from Vanguard Market Liquidity Fund and is accrued daily. Premiums and discounts on debt securities purchased are amortized and accreted, respectively, to interest income over the lives of the respective securities. Inflation adjustments to the face amount of inflation-indexed securities are included in interest income. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold.

Each class of shares has equal rights as to assets and earnings, except that each class separately bears certain class-specific expenses related to maintenance of shareholder accounts (included in Management and Administrative expenses) and shareholder reporting. Marketing and distribution expenses are allocated to each class of shares based on a method approved by the board of trustees. Income, other non-class-specific expenses, and gains and losses on investments are allocated to each class of shares based on its relative net assets.

B. In accordance with the terms of a Funds’ Service Agreement (the “FSA”) between Vanguard and the fund, Vanguard furnishes to the fund investment advisory, corporate management, administrative, marketing, and distribution services at Vanguard’s cost of operations (as defined by the FSA). These costs of operations are allocated to the fund based on methods and guidelines approved by the board of trustees. Vanguard does not require reimbursement in the current period for certain costs of operations (such as deferred compensation/benefits and risk/insurance costs); the fund’s liability for these costs of operations is included in Payables to Vanguard on the Statement of Net Assets.

Upon the request of Vanguard, the fund may invest up to 0.40% of its net assets as capital in Vanguard. At March 31, 2016, the fund had contributed to Vanguard capital in the amount of $1,217,000, representing 0.01% of the fund’s net assets and 0.49% of Vanguard’s capitalization. The fund’s trustees and officers are also directors and employees, respectively, of Vanguard.

C. Various inputs may be used to determine the value of the fund’s investments. These inputs are summarized in three broad levels for financial statement purposes. The inputs or methodologies used to value securities are not necessarily an indication of the risk associated with investing in those securities.

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Short-Term Inflation-Protected Securities Index Fund

Level 1Quoted prices in active markets for identical securities.
Level 2Other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.).
Level 3Significant unobservable inputs (including the fund’s own assumptions used to determine the fair value of investments).

The following table summarizes the market value of the fund’s investments as of March 31, 2016, based on the inputs used to value them:

  Level 1 Level 2 Level 3
Investments ($000) ($000) ($000)
U.S. Government and Agency Obligations 14,187,556
Temporary Cash Investments 9,317
Total 9,317 14,187,556

 

D. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. Differences may be permanent or temporary. Permanent differences are reclassified among capital accounts in the financial statements to reflect their tax character. Temporary differences arise when certain items of income, expense, gain, or loss are recognized in different periods for financial statement and tax purposes. These differences will reverse at some time in the future. Differences in classification may also result from the treatment of short-term gains as ordinary income for tax purposes.

Certain of the fund’s U.S. Treasury inflation-indexed securities experienced deflation and amortization adjustments that reduced interest income and the cost of investments for financial statement purposes by an amount greater than the reduction of taxable income; the additional income reduction will be deferred for tax purposes until it is used to offset future inflation adjustments that increase taxable income. The difference becomes permanent if the securities are sold. During the six months ended March 31, 2016, the fund realized gains of $934,000 that were included in ordinary income for tax purposes as a result of deferred deflation and amortization adjustments; accordingly, such gains have been reclassified from accumulated net realized losses to overdistributed net investment income. Deferred inflation and amortization adjustments to securities held at March 31, 2016, totaling $69,341,000 are reflected as a reduction of the amount of tax-basis unrealized appreciation of investment securities.

During the six months ended March 31, 2016, the fund realized $11,799,000 of net capital gains resulting from in-kind redemptions—in which shareholders exchanged fund shares for securities held by the fund rather than for cash. Because such gains are not taxable to the fund, and are not distributed to shareholders, they have been reclassified from accumulated net realized losses to paid-in capital.

The fund’s tax-basis capital gains and losses are determined only at the end of each fiscal year. For tax purposes, at September 30, 2015, the fund had available capital losses totaling $45,559,000 that may be carried forward indefinitely to offset future capital gains. The fund will use these capital losses to offset net taxable capital gains, if any, realized during the year ending September 30, 2016; should the fund realize net capital losses for the year, the losses will be added to the loss carryforward balance above.

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Short-Term Inflation-Protected Securities Index Fund

At March 31, 2016, the cost of investment securities for tax purposes was $14,120,375,000. Net unrealized appreciation of investment securities for tax purposes was $76,498,000, consisting of unrealized gains of $78,222,000 on securities that had risen in value since their purchase and $1,724,000 in unrealized losses on securities that had fallen in value since their purchase.

E. During the six months ended March 31, 2016, the fund purchased $3,172,685,000 of investment securities and sold $1,612,997,000 of investment securities, other than temporary cash investments. Purchases and sales include $505,177,000 and $137,127,000, respectively, in connection with in-kind purchases and redemptions of the fund’s capital shares.

F. Capital share transactions for each class of shares were:

  Six Months Ended   Year Ended
  March 31, 2016 September 30, 2015
  Amount Shares Amount Shares
  ($000) (000) ($000) (000)
Investor Shares        
Issued 341,864 14,061 829,293 34,019
Issued in Lieu of Cash Distributions 31,998 1,322
Redeemed (319,979) (13,241) (751,061) (30,890)
Net Increase (Decrease)—Investor Shares 21,885 820 110,230 4,451
ETF Shares        
Issued 460,611 9,528 738,501 15,206
Issued in Lieu of Cash Distributions
Redeemed (167,882) (3,475) (206,454) (4,250)
Net Increase (Decrease)—ETF Shares 292,729 6,053 532,047 10,956
Admiral Shares        
Issued 967,779 39,869 1,106,772 45,451
Issued in Lieu of Cash Distributions 10,779 445
Redeemed (307,102) (12,663) (477,311) (19,565)
Net Increase (Decrease)—Admiral Shares 660,677 27,206 640,240 26,331
Institutional Shares        
Issued 1,245,108 51,327 1,866,248 76,449
Issued in Lieu of Cash Distributions 24,697 1,019
Redeemed (525,031) (21,655) (697,051) (28,609)
Net Increase (Decrease) —Institutional Shares 720,077 29,672 1,193,894 48,859

 

G. Management has determined that no material events or transactions occurred subsequent to March 31, 2016, that would require recognition or disclosure in these financial statements.

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About Your Fund’s Expenses

As a shareholder of the fund, you incur ongoing costs, which include costs for portfolio management, administrative services, and shareholder reports (like this one), among others. Operating expenses, which are deducted from a fund’s gross income, directly reduce the investment return of the fund.

A fund’s expenses are expressed as a percentage of its average net assets. This figure is known as the expense ratio. The following examples are intended to help you understand the ongoing costs (in dollars) of investing in your fund and to compare these costs with those of other mutual funds. The examples are based on an investment of $1,000 made at the beginning of the period shown and held for the entire period.

The accompanying table illustrates your fund’s costs in two ways:

Based on actual fund return. This section helps you to estimate the actual expenses that you paid over the period. The ”Ending Account Value“ shown is derived from the fund‘s actual return, and the third column shows the dollar amount that would have been paid by an investor who started with $1,000 in the fund. You may use the information here, together with the amount you invested, to estimate the expenses that you paid over the period.

To do so, simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number given for your fund under the heading ”Expenses Paid During Period.“

Based on hypothetical 5% yearly return. This section is intended to help you compare your fund‘s costs with those of other mutual funds. It assumes that the fund had a yearly return of 5% before expenses, but that the expense ratio is unchanged. In this case—because the return used is not the fund’s actual return—the results do not apply to your investment. The example is useful in making comparisons because the Securities and Exchange Commission requires all mutual funds to calculate expenses based on a 5% return. You can assess your fund’s costs by comparing this hypothetical example with the hypothetical examples that appear in shareholder reports of other funds.

Note that the expenses shown in the table are meant to highlight and help you compare ongoing costs only and do not reflect transaction costs incurred by the fund for buying and selling securities. Further, the expenses do not include any purchase, redemption, or account service fees described in the fund prospectus. If such fees were applied to your account, your costs would be higher. Your fund does not carry a “sales load.”

The calculations assume no shares were bought or sold during the period. Your actual costs may have been higher or lower, depending on the amount of your investment and the timing of any purchases or redemptions.

You can find more information about the fund’s expenses, including annual expense ratios, in the Financial Statements section of this report. For additional information on operating expenses and other shareholder costs, please refer to your fund’s current prospectus.

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Six Months Ended March 31, 2016      
  Beginning Ending Expenses
  Account Value Account Value Paid During
Short-Term Inflation-Protected Securities Index Fund 9/30/2015 3/31/2016 Period
Based on Actual Fund Return      
Investor Shares $1,000.00 $1,014.03 $0.76
ETF Shares 1,000.00 1,014.27 0.35
Admiral Shares 1,000.00 1,014.01 0.35
Institutional Shares 1,000.00 1,014.00 0.25
Based on Hypothetical 5% Yearly Return      
Investor Shares $1,000.00 $1,024.25 $0.76
ETF Shares 1,000.00 1,024.65 0.35
Admiral Shares 1,000.00 1,024.65 0.35
Institutional Shares 1,000.00 1,024.75 0.25

The calculations are based on expenses incurred in the most recent six-month period. The fund’s annualized six-month expense ratios for that period are 0.15% for Investor Shares, 0.07% for ETF Shares, 0.07% for Admiral Shares, and 0.05% for Institutional Shares. The dollar amounts shown as “Expenses Paid” are equal to the annualized expense ratio multiplied by the average account value over the period, multiplied by the number of days in the most recent six-month period, then divided by the number of days in the most recent 12-month period (183/366).

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Trustees Approve Advisory Arrangement

The board of trustees of Vanguard Short-Term Inflation-Protected Securities Index Fund has renewed the fund’s investment advisory arrangement with The Vanguard Group, Inc. (Vanguard)—through its Fixed Income Group. The board determined that continuing the fund’s internalized management structure was in the best interests of the fund and its shareholders.

The board based its decision upon an evaluation of the advisor’s investment staff, portfolio management process, and performance. The trustees considered the factors discussed below, among others. However, no single factor determined whether the board approved the arrangement. Rather, it was the totality of the circumstances that drove the board’s decision.

Nature, extent, and quality of services
The board reviewed the quality of the investment management services provided to the fund since its inception in 2012, and took into account the organizational depth and stability of the advisor. The board considered that Vanguard has been managing investments for more than three decades. The Fixed Income Group adheres to a sound, disciplined investment management process; the team has considerable experience, stability, and depth.

The board concluded that Vanguard’s experience, stability, depth, and performance, among other factors, warranted continuation of the advisory arrangement.

Investment performance
The board considered the performance of the fund, including any periods of outperformance or

underperformance relative to a benchmark index and peer group. The board concluded that the performance was such that the advisory arrangement should continue. Information about the fund’s performance can be found in the Performance Summary section of this report.

Cost
The board concluded that the fund’s expense ratio was well below the average expense ratio charged by funds in its peer group and that the fund’s advisory fee rate was also well below its peer-group average. Information about the fund’s expenses appears in the About Your Fund’s Expenses section of the report as well as in the Financial Statements section.

The board does not conduct a profitability analysis of Vanguard because of Vanguard’s unique “at-cost” structure. Unlike most other mutual fund management companies, Vanguard is owned by the funds it oversees, and produces “profits” only in the form of reduced expenses for fund shareholders.

The benefit of economies of scale
The board concluded that the fund’s at-cost arrangement with Vanguard ensures that the fund will realize economies of scale as it grows, with the cost to shareholders declining as fund assets increase.

The board will consider whether to renew the advisory arrangement after a one-year period.

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Glossary

30-Day SEC Yield. A fund’s 30-day SEC yield is derived using a formula specified by the U.S. Securities and Exchange Commission. Under the formula, data related to the fund’s security holdings in the previous 30 days are used to calculate the fund’s hypothetical net income for that period, which is then annualized and divided by the fund’s estimated average net assets over the calculation period. For the purposes of this calculation, a security’s income is based on its current market yield to maturity (for bonds), its actual income (for asset-backed securities), or its projected dividend yield (for stocks). Because the SEC yield represents hypothetical annualized income, it will differ—at times significantly—from the fund’s actual experience. As a result, the fund’s income distributions may be higher or lower than implied by the SEC yield.

Average Coupon. The average interest rate paid on the fixed income securities held by a fund. It is expressed as a percentage of face value.

Average Duration. An estimate of how much the value of the fund’s bonds will fluctuate in response to a change in “real” interest rates—meaning rates without inflation expectations built in. Real interest rates are reflected in market yields for inflation-adjusted securities. To see how the fund’s bond values could change, multiply the average duration by the change in real rates. For example, if the average duration were five years, then the value of the fund’s bonds would decline by about 5% if real interest rates rose by 1 percentage point. Conversely, if real rates fell by a percentage point, the value of the bonds would rise about 5%.

Average Effective Maturity. The average length of time until fixed income securities held by a fund reach maturity and are repaid, taking into consideration the possibility that the issuer may call the bond before its maturity date. The figure reflects the proportion of fund assets represented by each security; it also reflects any futures contracts held. In general, the longer the average effective maturity, the more a fund’s share price will fluctuate in response to changes in market interest rates.

Credit Quality. Credit-quality ratings are measured on a scale that generally ranges from AAA (highest) to D (lowest). U.S. Treasury, U.S. Agency, and U.S. Agency mortgage-backed securities appear under “U.S. Government.” Credit-quality ratings are obtained from Barclays and are from Moody’s, Fitch, and S&P. When ratings from all three agencies are used, the median rating is shown. When ratings from two of the agencies are used, the lower rating for each issue is shown. “Not Rated” is used to classify securities for which a rating is not available.

Expense Ratio. A fund’s total annual operating expenses expressed as a percentage of the fund’s average net assets. The expense ratio includes management and administrative expenses, but does not include the transaction costs of buying and selling portfolio securities.

Inception Date. The date on which the assets of a fund (or one of its share classes) are first invested in accordance with the fund’s investment objective. For funds with a subscription period, the inception date is the day after that period ends. Investment performance is measured from the inception date.

Short-Term Reserves. The percentage of a fund invested in highly liquid, short-term securities that can be readily converted to cash.

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Yield to Maturity. This term generally refers to the rate of return an investor would receive if the fixed income securities held by a fund were held to their maturity dates. For the Short-Term Inflation-Protected Securities Index Fund, the calculation is modified by adding in the inflation adjustment made over the past 12 months. This change results in a figure more directly comparable to the yield-to-maturity figures for other types of bond funds. (An unmodified yield to maturity is used in calculating the fund’s 30-Day SEC Yield.)

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Vanguard Short-Term Inflation-Protected Securities Index Fund is not sponsored, endorsed, issued, sold, or promoted by Barclays Capital Inc. or any of its affiliates (“Barclays”). Barclays makes no representation or warranty, express or implied, to the owners or purchasers of the fund or any member of the public regarding the advisability of investing in securities generally or in the fund particularly or the ability of the Barclays index to track general bond market performance. Barclays has not passed on the legality or suitability of the fund with respect to any person or entity. Barclays’ only relationship to Vanguard and the fund is the licensing of the Barclays index, which is determined, composed, and calculated by Barclays without regard to Vanguard or the fund or any owners or purchasers of the fund. Barclays has no obligation to take the needs of Vanguard, the fund, or the owners of the fund into consideration in determining, composing, or calculating the Barclays index. Barclays is not responsible for and has not participated in the determination of the timing of, prices at, or quantities of the fund to be issued. Barclays has no obligation or liability in connection with the administration, marketing, or trading of the fund.

Barclays shall have no liability to third parties for the quality, accuracy, and/or completeness of the index or any data included therein or for interruptions in the delivery of the index. Barclays makes no warranty, express or implied, as to results to be obtained by owners of the fund or any other person or entity from the use of the index or any data included therein in connection with the rights licensed hereunder or for any other use. Barclays reserves the right to change the methods of calculation or publication, or to cease the calculation or publication of the Barclays U.S. Treasury Inflation-Protected Securities (TIPS) 0–5 Year Index, and Barclays shall not be liable for any miscalculation of or any incorrect, delayed, or interrupted publication with respect to the index. Barclays makes no express or implied warranties, and hereby expressly disclaims all warranties of merchantability or fitness for a particular purpose or use with respect to the index or any data included therein. Barclays shall not be liable for any damages, including, without limitation, any indirect or consequential damages resulting from the use of the index or any data included therein.

27


 

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’s 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. The independent board members have distinguished backgrounds in business, academia, and public service. Each of the trustees and executive officers oversees 198 Vanguard funds.

The following table provides information for each trustee and executive officer of the fund. More information about the trustees is in the Statement of Additional Information, which can be obtained, without charge, by contacting Vanguard at 800-662-7447, or online at vanguard.com.

InterestedTrustee1 Rajiv L. Gupta
  Born 1945. Trustee Since December 2001.2 Principal
F. William McNabb III Occupation(s) During the Past Five Years and Other
Born 1957. Trustee Since July 2009. Chairman of Experience: Chairman and Chief Executive Officer
the Board. Principal Occupation(s) During the Past (retired 2009) and President (2006–2008) of
Five Years and Other Experience: Chairman of the Rohm and Haas Co. (chemicals); Director of Tyco
Board of The Vanguard Group, Inc., and of each of International PLC (diversified manufacturing and
the investment companies served by The Vanguard services), HP Inc. (printer and personal computer
Group, since January 2010; Director of The Vanguard manufacturing), and Delphi Automotive PLC
Group since 2008; Chief Executive Officer and (automotive components); Senior Advisor at
President of The Vanguard Group, and of each of New Mountain Capital.
the investment companies served by The Vanguard
Group, since 2008; Director of Vanguard Marketing Amy Gutmann
Corporation; Managing Director of The Vanguard Born 1949. Trustee Since June 2006. Principal
Group (1995–2008). Occupation(s) During the Past Five Years and
Other Experience: President of the University of
Independent Trustees Pennsylvania; Christopher H. Browne Distinguished
Professor of Political Science, School of Arts and
Emerson U. Fullwood Sciences, and Professor of Communication, Annenberg
Born 1948. Trustee Since January 2008. Principal School for Communication, with secondary faculty
Occupation(s) During the Past Five Years and Other appointments in the Department of Philosophy, School
Experience: Executive Chief Staff and Marketing of Arts and Sciences, and at the Graduate School of
Officer for North America and Corporate Vice President Education, University of Pennsylvania; Trustee of the
(retired 2008) of Xerox Corporation (document manage- National Constitution Center; Chair of the Presidential
ment products and services); Executive in Residence Commission for the Study of Bioethical Issues.
and 2009–2010 Distinguished Minett Professor at
the Rochester Institute of Technology; Lead Director JoAnn Heffernan Heisen
of SPX FLOW, Inc. (multi-industry manufacturing); Born 1950. Trustee Since July 1998. Principal
Director of the United Way of Rochester, the University Occupation(s) During the Past Five Years and
of Rochester Medical Center, Monroe Community Other Experience: Corporate Vice President and
College Foundation, North Carolina A&T University, Chief Global Diversity Officer (retired 2008) and
and Roberts Wesleyan College. Member of the Executive Committee (1997–2008)
of Johnson & Johnson (pharmaceuticals/medical
devices/consumer products); Director of Skytop
Lodge Corporation (hotels) and the Robert Wood
Johnson Foundation; Member of the Advisory
Board of the Institute for Women’s Leadership
at Rutgers University.

 


 

F. Joseph Loughrey Executive Officers
Born 1949. Trustee Since October 2009. Principal
Occupation(s) During the Past Five Years and Other Glenn Booraem
Experience: President and Chief Operating Officer Born 1967. Treasurer Since May 2015. Principal
(retired 2009) of Cummins Inc. (industrial machinery); Occupation(s) During the Past Five Years and
Chairman of the Board of Hillenbrand, Inc. (specialized Other Experience: Principal of The Vanguard Group,
consumer services), and of Oxfam America; Director Inc.; Treasurer of each of the investment companies
of SKF AB (industrial machinery), Hyster-Yale Materials served by The Vanguard Group; Controller of each of
Handling, Inc. (forklift trucks), the Lumina Foundation the investment companies served by The Vanguard
for Education, and the V Foundation for Cancer Group (2010–2015); Assistant Controller of each of
Research; Member of the Advisory Council for the the investment companies served by The Vanguard
College of Arts and Letters and of the Advisory Board Group (2001–2010).
to the Kellogg Institute for International Studies, both
at the University of Notre Dame. Thomas J. Higgins
Born 1957. Chief Financial Officer Since September
Mark Loughridge 2008. Principal Occupation(s) During the Past Five
Born 1953. Trustee Since March 2012. Principal Years and Other Experience: Principal of The Vanguard
Occupation(s) During the Past Five Years and Other Group, Inc.; Chief Financial Officer of each of the
Experience: Senior Vice President and Chief Financial investment companies served by The Vanguard Group;
Officer (retired 2013) at IBM (information technology Treasurer of each of the investment companies served
services); Fiduciary Member of IBM’s Retirement Plan by The Vanguard Group (1998–2008).
Committee (2004–2013); Director of the Dow Chemical
Company; Member of the Council on Chicago Booth. Peter Mahoney
Born 1974. Controller Since May 2015. Principal
Scott C. Malpass Occupation(s) During the Past Five Years and
Born 1962. Trustee Since March 2012. Principal Other Experience: Head of Global Fund Accounting
Occupation(s) During the Past Five Years and Other at The Vanguard Group, Inc.; Controller of each of the
Experience: Chief Investment Officer and Vice investment companies served by The Vanguard Group;
President at the University of Notre Dame; Assistant Head of International Fund Services at The Vanguard
Professor of Finance at the Mendoza College of Group (2008–2014).
Business at Notre Dame; Member of the Notre Dame
403(b) Investment Committee, the Board of Advisors Heidi Stam
for Spruceview Capital Partners, and the Investment Born 1956. Secretary Since July 2005. Principal
Advisory Committee of Major League Baseball; Board Occupation(s) During the Past Five Years and Other
Member of TIFF Advisory Services, Inc., and Catholic Experience: Managing Director of The Vanguard
Investment Services, Inc. (investment advisors). Group, Inc.; General Counsel of The Vanguard Group;
Secretary of The Vanguard Group and of each of the
André F. Perold investment companies served by The Vanguard Group;
Born 1952. Trustee Since December 2004. Principal Director and Senior Vice President of Vanguard
Occupation(s) During the Past Five Years and Other Marketing Corporation.
Experience: George Gund Professor of Finance and
Banking, Emeritus at the Harvard Business School Vanguard Senior ManagementTeam
(retired 2011); Chief Investment Officer and Managing
Partner of HighVista Strategies LLC (private investment Mortimer J. Buckley James M. Norris
firm); Director of Rand Merchant Bank; Overseer of Kathleen C. Gubanich Thomas M. Rampulla
the Museum of Fine Arts Boston. Martha G. King Glenn W. Reed
John T. Marcante Karin A. Risi
Peter F. Volanakis Chris D. McIsaac
Born 1955. Trustee Since July 2009. Principal
Occupation(s) During the Past Five Years and Other Chairman Emeritus and Senior Advisor
Experience: President and Chief Operating Officer John J. Brennan
(retired 2010) of Corning Incorporated (communications Chairman, 1996–2009
equipment); Trustee of Colby-Sawyer College and Chief Executive Officer and President, 1996–2008
Chairman of its Finance and Enrollment Committee;
Member of the Advisory Board of the Norris Cotton Founder
Cancer Center. John C. Bogle
Chairman and Chief Executive Officer, 1974–1996

 

1 Mr. McNabb is considered an “interested person,” as defined in the Investment Company Act of 1940, because he is an officer of the Vanguard funds.
2 December 2002 for Vanguard Equity Income Fund, the Vanguard Municipal Bond Funds, and the Vanguard State Tax-Exempt Funds.


 

 

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guidelines by visiting vanguard.com/proxyreporting or by  
calling Vanguard at 800-662-2739. The guidelines are  
also available from the SEC’s website, sec.gov. In  
addition, you may obtain a free report on how your fund  
voted the proxies for securities it owned during the 12  
months ended June 30. To get the report, visit either  
vanguard.com/proxyreporting or sec.gov.  
 
You can review and copy information about your fund at  
the SEC’s Public Reference Room in Washington, D.C. To  
find out more about this public service, call the SEC at  
202-551-8090. Information about your fund is also  
available on the SEC’s website, and you can receive  
copies of this information, for a fee, by sending a  
request in either of two ways: via email addressed to  
publicinfo@sec.gov or via regular mail addressed to the  
Public Reference Section, Securities and Exchange  
Commission, Washington, DC 20549-1520.  
 
  © 2016 The Vanguard Group, Inc.
  All rights reserved.
  Vanguard Marketing Corporation, Distributor.
 
  Q19672 052016

 



Semiannual Report | March 31, 2016

Vanguard Core Bond Fund


 

Vanguard’s Principles for Investing Success

We want to give you the best chance of investment success. These principles, grounded in Vanguard’s research and experience, can put you on the right path.

Goals. Create clear, appropriate investment goals.

Balance. Develop a suitable asset allocation using broadly diversified funds. Cost. Minimize cost.

Discipline. Maintain perspective and long-term discipline.

A single theme unites these principles: Focus on the things you can control.

We believe there is no wiser course for any investor.

Contents  
Your Fund’s Total Returns. 1
Chairman’s Letter. 2
Advisor’s Report. 7
Fund Profile. 8
Performance Summary. 9
Financial Statements. 10
About Your Fund’s Expenses. 32
Trustees Approve Advisory Arrangement. 34
Glossary. 35

 

Please note: The opinions expressed in this report are just that—informed opinions. They should not be considered promises or advice. Also, please keep in mind that the information and opinions cover the period through the date on the front of this report. Of course, the risks of investing in your fund are spelled out in the prospectus.

See the Glossary for definitions of investment terms used in this report.

About the cover: Pictured is a sailing block on the Brilliant, a 1932 schooner docked in Mystic, Connecticut. A type of pulley, the sailing block helps coordinate the setting of the sails. At Vanguard, the intricate coordination of technology and people allows us to help millions of clients around the world reach their financial goals.


 

Your Fund’s Total Returns

Period Ended March 31, 2016        
        Returns
  30-Day SEC Income Capital Since
  Yield Returns Returns Inception
Vanguard Core Bond Fund        
Investor Shares (Inception: 3/28/2016) 0.00% 0.01% 0.40% 0.41%
Admiral™ Shares (Inception: 3/28/2016) 0.00 0.01 0.40 0.41
Barclays U.S. Aggregate Float Adjusted Index       0.51
Core Bond Funds Average       0.41

The fund's 30-day SEC yield is not reported until 30 days after the fund's inception.
Admiral Shares carry lower expenses and are available to investors who meet certain account-balance requirements.
Core Bond Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company.
Benchmark returns are calculated from the fund's inception date.

  
Your Fund’s Performance at a Glance        
Inception Through March 31, 2016        
      Distributions Per Share
  Starting Ending Income Capital
  Share Price Share Price Dividends Gains
Vanguard Core Bond Fund        
Investor Shares (Inception: 3/28/2016) $10.00 $10.04 $0.001 $0.000
Admiral Shares (Inception: 3/28/2016) 20.00 20.08 0.002 0.000

 

1


 


Chairman’s Letter

Dear Shareholder,

I am pleased to provide you with the first shareholder report for Vanguard Core Bond Fund, which we launched to further enhance Vanguard’s lineup of taxable bond funds. Specifically, this fund offers broad exposure to the U.S. investment-grade bond market for investors who prefer active management.

The subscription period for the fund ran from March 10 to March 24, 2016. The purpose of such a period is to allow a new fund to accumulate assets before it begins pursuing its investment objective. Doing so helps the managers of the fund construct a more diversified portfolio and helps keep initial trading costs down.

The fund began investing toward its objective on March 28, just a few days before the close of its fiscal half year, making comparisons with its benchmark and peer group premature. As you might expect, the return was modest (+0.41%) for both Investor and Admiral Shares.

This report includes a brief look at the financial markets over the full six months of the fiscal period, followed by a more detailed discussion of what the fund seeks to offer.


 

Bonds produced gains following a subpar start
After posting weak results for the first three months of the period, bonds managed solid gains in the final three. The broad U.S. taxable bond market returned 2.44% for the fiscal half year.

With stocks volatile and the Federal Reserve proceeding cautiously with interest rate hikes, bonds proved attractive. The yield of the 10-year U.S. Treasury note closed at 1.77% at the end of March, down from 2.05% six months earlier. (Bond prices and yields move in opposite directions.)

Returns for money market funds and savings accounts remained limited by the Fed’s short-term target rate of 0.25%–0.5%—still low despite rising a quarter of a percentage point in December.

International bond markets (as measured by the Barclays Global Aggregate Index ex USD) returned 6.90%, boosted by foreign currencies’ strength against the dollar, a turnabout from the trend of recent years. Even without this currency benefit, their returns were solidly positive.

 
Market Barometer      
      Total Returns
             Periods Ended March 31, 2016
  Six One Five Years
  Months Year (Annualized)
Bonds      
Barclays U.S. Aggregate Bond Index (Broad taxable      
market) 2.44% 1.96% 3.78%
Barclays Municipal Bond Index (Broad tax-exempt market) 3.20 3.98 5.59
Citigroup Three-Month U.S. Treasury Bill Index 0.06 0.08 0.04
 
Stocks      
Russell 1000 Index (Large-caps) 7.75% 0.50% 11.35%
Russell 2000 Index (Small-caps) 2.02 -9.76 7.20
Russell 3000 Index (Broad U.S. market) 7.30 -0.34 11.01
FTSE All-World ex US Index (International) 3.09 -8.53 0.70
 
CPI      
Consumer Price Index 0.08% 0.85% 1.28%

 

3


 

Stocks charted an uneven course en route to a solid outcome
The broad U.S. stock market returned about 7%. The period began and ended strongly, with fluctuations in the middle as China’s economic slowdown and falling oil and commodity prices worried investors.

Stocks rallied in March as investors again seemed encouraged by news about monetary policy. The Fed indicated after a mid-March meeting that it would raise interest rates fewer times in 2016 than previously anticipated. And central bankers in Europe and Asia kept up stimulus measures to combat weak growth and low inflation.

International stocks returned about 3% for the period after surging more than 8% in March. Stocks from emerging markets and from developed markets of the Pacific region outperformed European stocks, which were nearly flat.

What the Core Bond Fund brings that’s new to Vanguard’s lineup
Vanguard Core Bond Fund is a lot like Vanguard Total Bond Market Index Fund. Both funds are suitable as a key component in a fixed income portfolio. Both offer broadly diversified exposure to U.S. investment-grade bonds, including Treasuries, mortgage-backed securities, and corporate bonds with short, intermediate, and long maturities. They also use the same benchmark—the Barclays U.S. Aggregate Float Adjusted

 
Expense Ratios      
Your Fund Compared With Its Peer Group      
  Investor Admiral Peer Group
  Shares Shares Average
Core Bond Fund 0.25% 0.15% 0.80%

The fund expense ratios shown are from the prospectus dated March 10, 2016, and represent estimated costs for the current fiscal year. For the period from inception through March 31, 2016, the fund’s annualized expense ratios were 0.26% for Investor Shares and 0.16% for Admiral Shares. The peer-group expense ratio is derived from data provided by Lipper, a Thomson Reuters Company, and captures information through year-end 2015.

Peer group: Core Bond Funds. 

4


 

Index. And, like all Vanguard funds, they have low expense ratios because they are run at cost.

Where the two funds differ is in their investment strategies. Whereas the Total Bond Market Index Fund aims to track the performance of its benchmark by closely mirroring the index’s key risk characteristics, the Core Bond Fund aims to outperform its benchmark by deviating from it in terms of security selection, sector allocation, and, to a lesser extent, duration decisions.

For a more detailed discussion of how the fund is being managed, please see the Advisor’s Report that follows this letter.

 
Vanguard’s growth translates into lower costs for you
 
Research indicates that lower-cost investments have tended to outperform higher-cost ones.
So it’s little wonder that funds with lower expense ratios—including those at Vanguard—have
dominated the industry’s cash inflows in recent years.
 
Vanguard has long been a low-cost leader, with expenses well below those of many other
investment management companies. That cost difference remains a powerful advantage for
Vanguard clients. Why? Because a lower expense ratio allows a fund to pass along a greater
share of its returns to its investors.
 
What’s more, as you can see in the chart below, we’ve been able to lower our costs continually
as our assets under management have grown. Our steady growth has not been an explicit
business objective. Rather, we focus on putting our clients’ interests first at all times, and
giving them the best chance for investment success. But economies of scale—the cost
efficiencies that come with our growth—have allowed us to keep lowering our fund costs,
even as we invest in our people and technology.
 
The benefit of economies of scale

 


5


 

Rebalancing can be a way to manage your risk
Becoming a shareholder of Vanguard Core Bond Fund involved reallocating some of your investment dollars. Hopefully that shift has kept your portfolio in line with your target asset allocation—or helped you get back in line with it.

Over time, your portfolio can drift from its original asset allocation as financial markets rise and fall. And just one year of outsized returns can throw your allocation out of whack. Take 2013 as an example. That year, the broad stock market returned nearly 34% and the broad taxable bond market declined. A hypothetical simple portfolio that started the year with 60% stocks and 40% bonds would have ended with a more aggressive mix of 67% stocks and 33% bonds.

Rebalancing means shifting assets away from areas that have performed well toward those that have fallen behind. That isn’t easy or intuitive, but it helps to manage risk, because over time, riskier assets tend to grow faster. (You can read more about our approach in Best Practices for Portfolio Rebalancing at vanguard.com/research.)

You might consider, for example, monitoring your portfolio annually or semiannually and rebalancing when your allocations shift about 5 percentage points from their target. And be aware of the tax implications of selling.

Keeping your asset allocation from drifting too far off target can help you stay on track with the investment plan you’ve crafted to meet your financial goals.

As always, thank you for investing with Vanguard.

Sincerely,


F. William McNabb III
Chairman and Chief Executive Officer
April 19, 2016

6


 

Advisor’s Report

We are pleased to present this first Advisor’s Report for Vanguard Core Bond Fund. Over the few days from its March 28, 2016, inception to the close of its fiscal half year on March 31, the fund returned 0.41% for Investor Shares and Admiral Shares. Although the period was far too short to draw any meaningful comparisons, the return of its benchmark (the Barclays U.S. Aggregate Float Adjusted Index) was 0.51% and the average return of its peer funds was 0.41%.

Investment strategy
This fund seeks to outperform the broad U.S. investment-grade bond market, as measured by its benchmark, while staying within clearly defined constraints. Compared with its benchmark, the fund can own more securities rated BBB—the lowest rating for investment-grade bonds—up to a maximum of 30% of the portfolio. The fund can invest in high-yield bonds, which are not included in its benchmark, but only up to a maximum of 5% of its assets. We can also shorten or lengthen the duration of the fund by up to 0.5 years versus the benchmark, depending on where we think rates might be heading. (Duration, measured in years, is a gauge of the sensitivity of a bond or a bond fund to a change in interest rates.)

Working within those constraints, we hope to add value to the fund through security selection, sector allocation, and rate calls. Helping us in that endeavor is our deep bench of credit analysts and traders.

As with all Vanguard funds, costs will be key. The fund’s expense ratios are expected to be less than one-third of the industry average for intermediate-term bond funds. That significant cost advantage means we shouldn’t have to take on undue investment risks to produce competitive returns.

We look forward to managing the fund and to the investment opportunities the new fiscal year may offer.

Portfolio Managers:

Brian W. Quigley

Gregory S. Nassour, CFA, Principal

Gemma Wright-Casparius, Principal

Vanguard Fixed Income Group

April 25, 2016


 

Core Bond Fund

Fund Profile
As of March 31, 2016

 
Share-Class Characteristics  
 
  Investor Admiral
  Shares Shares
Ticker Symbol VCORX VCOBX
Expense Ratio1 0.25% 0.15%
30-Day SEC Yield 0.00% 0.00%
The fund's 30-day SEC yield is not reported until 30 days after the
fund's inception.    

 

 
Financial Attributes    
    Barclays
    Aggregate
    Float Adj
  Fund Index
Number of Bonds 307 9,703
Yield to Maturity    
(before expenses) 2.0% 2.1%
Average Coupon 4.2% 3.1%
Average Duration 5.6 years 5.7 years
Average Effective    
Maturity 6.5 years 7.9 years
Short-Term    
Reserves 29.3%

 

 
Sector Diversification (% of portfolio)  
Asset-Backed 3.1%
Commercial Mortgage-Backed 6.0
Finance 9.8
Foreign 4.7
Government Mortgage-Backed 24.5
Industrial 15.1
Treasury/Agency 34.0
Utilities 2.4
Other 0.4
The agency and mortgage-backed securities sectors may include issues from government-sponsored enterprises; such issues are generally not backed by the full faith and credit of the U.S. government.

 

 
Distribution by Effective Maturity  
(% of portfolio)  
Under 1 Year 8.1%
1 - 3 Years 23.5
3 - 5 Years 28.1
5 - 7 Years 13.5
7 - 10 Years 15.2
10 - 20 Years 3.9
20 - 30 Years 7.6
Over 30 Years 0.1

 

  
Distribution by Credit Quality (% of portfolio)
U.S. Government 23.9%
Aaa 8.0
Aa 3.9
A 11.9
Baa 13.5
Ba 0.7
B 0.2
Not Rated 37.9

Credit-quality ratings are obtained from Moody's and S&P, and the higher rating for each issue is shown. "Not Rated" is used to classify securities for which a rating is not available. Not rated securities include a fund's investment in Vanguard Market Liquidity Fund or Vanguard Municipal Cash Management Fund, each of which invests in high-quality money market instruments and may serve as a cash management vehicle for the Vanguard funds, trusts, and accounts. For more information about these ratings, see the Glossary entry for Credit Quality.

 

Investment Focus


1 The expense ratios shown are from the prospectus dated March 10, 2016, and represent estimated costs for the current fiscal year. For the period from inception through March 31, 2016, the annualized expense ratios were 0.26% for Investor Shares and 0.16% for Admiral Shares.
8


 

Core Bond Fund

Performance Summary

All of the returns in this report represent past performance, which is not a guarantee of future results that may be achieved by the fund. (Current performance may be lower or higher than the performance data cited. For performance data current to the most recent month-end, visit our website at vanguard.com/performance.) Note, too, that both investment returns and principal value can fluctuate widely, so an investor’s shares, when sold, 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 sale of fund shares.

  
Fiscal-Period Total Returns (%): March 28, 2016, Through March 31, 2016  
        Barclays
        Aggregate
        Float Adj
      Investor Shares Index
Fiscal Year Income Returns Capital Returns Total Returns Total Returns
2016 0.01% 0.40% 0.41% 0.51%

 

  
Average Annual Total Returns: Periods Ended March 31, 2016    
 
        Since Inception
  Inception Date Income Capital Total
Investor Shares 3/28/2016 0.01% 0.40% 0.41%
Admiral Shares 3/28/2016 0.01 0.40 0.41

 

See Financial Highlights for dividend and capital gains information.

9


 

Core Bond Fund

Financial Statements (unaudited)

Statement of Net Assets
As of March 31, 2016

The fund reports a complete list of its holdings in regulatory filings four times in each fiscal year, at the quarter-ends. For the second and fourth fiscal quarters, the lists appear in the fund’s semiannual and annual reports to shareholders. For the first and third fiscal quarters, the fund files the lists with the Securities and Exchange Commission on Form N-Q. Shareholders can look up the fund’s Forms N-Q on the SEC’s website at sec.gov. Forms N-Q may also be reviewed and copied at the SEC’s Public Reference Room (see the back cover of this report for further information).

      Face Market
    Maturity Amount Value
  Coupon Date ($000) ($000)
U.S. Government and Agency Obligations (53.5%)        
U.S. Government Securities (28.5%)        
1,2 United States Treasury Inflation Indexed Bonds 0.125% 4/15/17 12,500 13,189
United States Treasury Inflation Indexed Bonds 0.625% 1/15/26 4,200 4,378
United States Treasury Note/Bond 0.625% 5/31/17 14,900 14,891
United States Treasury Note/Bond 0.875% 8/15/17 6,000 6,014
United States Treasury Note/Bond 0.750% 2/28/18 5,000 5,002
United States Treasury Note/Bond 1.125% 1/15/19 8,000 8,064
United States Treasury Note/Bond 0.750% 2/15/19 10,900 10,869
United States Treasury Note/Bond 1.000% 3/15/19 1,400 1,406
United States Treasury Note/Bond 1.625% 3/31/19 1,500 1,533
United States Treasury Note/Bond 1.750% 12/31/20 1,000 1,025
United States Treasury Note/Bond 1.125% 2/28/21 1,400 1,395
United States Treasury Note/Bond 1.250% 3/31/21 2,600 2,604
United States Treasury Note/Bond 1.750% 1/31/23 500 507
United States Treasury Note/Bond 1.500% 2/28/23 1,000 997
United States Treasury Note/Bond 1.500% 3/31/23 500 499
United States Treasury Note/Bond 1.625% 2/15/26 1,300 1,282
United States Treasury Note/Bond 5.375% 2/15/31 3,000 4,303
United States Treasury Note/Bond 4.500% 2/15/36 1,300 1,784
United States Treasury Note/Bond 3.000% 11/15/45 1,000 1,080
United States Treasury Note/Bond 2.500% 2/15/46 6,200 6,045
        86,867
Agency Bonds and Notes (2.6%)        
3 Federal Home Loan Banks 1.375% 2/18/21 6,000 6,009
Residual Funding Corp. Principal Strip 0.000% 10/15/20 2,000 1,865
        7,874
Conventional Mortgage-Backed Securities (22.4%)        
4,5,6 Fannie Mae Pool 2.500% 5/1/30 2,475 2,536
4,5,6 Fannie Mae Pool 3.000% 5/1/30–4/1/46 8,570 8,859
4,5,6 Fannie Mae Pool 3.500% 4/1/31–4/1/46 17,355 18,214
4,5,6 Fannie Mae Pool 4.000% 4/1/46 6,200 6,624
4,5,6 Fannie Mae Pool 4.500% 4/1/45 3,250 3,536
4,5,6 Fannie Mae Pool 5.000% 4/1/46 4,900 5,421
4,5,6 Freddie Mac Gold Pool 2.500% 5/1/30 1,300 1,332
4,5,6 Freddie Mac Gold Pool 3.000% 5/1/30 1,000 1,044
4,5,6 Freddie Mac Gold Pool 3.500% 5/1/46 1,035 1,081
4,5,6 Freddie Mac Gold Pool 4.000% 5/1/45 680 725

 

10


 

Core Bond Fund

        Face Market
      Maturity Amount Value
    Coupon Date ($000) ($000)
5,6 Ginnie Mae I Pool 4.500% 4/1/46 2,300 2,500
5,6 Ginnie Mae I Pool 5.000% 4/1/46 2,000 2,205
5,6 Ginnie Mae II Pool 3.000% 5/1/45 2,900 2,998
5,6 Ginnie Mae II Pool 3.500% 5/1/46 6,865 7,240
5,6 Ginnie Mae II Pool 4.000% 4/1/46 3,600 3,849
          68,164
Total U.S. Government and Agency Obligations (Cost $162,284)     162,905
Asset-Backed/Commercial Mortgage-Backed Securities (8.5%)      
5 Ally Master Owner Trust Series 2015-3 1.630% 5/15/20 1,500 1,499
5,7 Avis Budget Rental Car Funding AESOP LLC        
  2013-2A 2.970% 2/20/20 575 584
5,7 Chrysler Capital Auto Receivables Trust 2014-BA 3.440% 8/16/21 200 194
5 Citigroup Commercial Mortgage Trust 2014-GC23 4.175% 7/10/47 230 244
5 Citigroup Commercial Mortgage Trust 2014-GC25 3.635% 10/10/47 1,400 1,479
5,7 COMM 2013-CCRE6 Mortgage Trust 3.397% 3/10/46 210 215
5 COMM 2014-CCRE15 Mortgage Trust 4.714% 2/10/47 240 267
5 COMM 2014-CR17 Mortgage Trust 4.735% 5/10/47 190 197
5 CSAIL Commercial Mortgage Trust 2015-C4 3.808% 11/15/48 1,200 1,288
5 DBJPM 16-C1 3.276% 5/10/49 350 360
5 DBJPM 16-C1 3.352% 5/10/49 140 123
5,7 Drive Auto Receivables Trust 2015-DA 4.590% 1/17/23 132 130
5,7 Ford Credit Auto Owner Trust 2014-1 2.410% 11/15/25 150 150
5,7 Ford Credit Auto Owner Trust 2014-2 2.310% 4/15/26 900 908
5 Ford Credit Floorplan Master Owner Trust        
  A Series 2014-1 2.310% 2/15/21 200 200
5,8 Ford Credit Floorplan Master Owner Trust        
  A Series 2014-2 0.936% 2/15/21 1,000 989
5,7 GMF Floorplan Owner Revolving Trust 2015-1 1.970% 5/15/20 250 247
5,7,8 Golden Credit Card Trust 2014-2A 0.886% 3/15/21 680 676
5 GS Mortgage Securities Trust 2014-GC20 3.998% 4/10/47 1,400 1,527
5 GS Mortgage Securities Trust 2014-GC24 3.931% 9/10/47 1,300 1,409
5 GS Mortgage Securities Trust 2014-GC24 4.508% 9/10/47 170 183
5,7 Hertz Vehicle Financing LLC 2015-1 2.730% 3/25/21 850 851
5,7,8 Invitation Homes 2014-SFR1 Trust 1.941% 6/17/31 100 97
5,7 JP Morgan Chase Commercial Mortgage        
  Securities Trust 2011-C3 4.717% 2/15/46 1,700 1,887
5 JPMBB Commercial Mortgage Securities Trust        
  2013-C12 3.363% 7/15/45 1,600 1,685
5 JPMBB Commercial Mortgage Securities Trust        
  2013-C15 5.067% 11/15/45 30 32
5,7 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2012-CKSV 3.277% 10/15/30 1,700 1,726
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2014-C15 4.896% 4/15/47 150 157
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2014-C18 3.923% 10/15/47 1,300 1,413
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2015-C24 3.732% 5/15/48 1,200 1,285
5 Morgan Stanley Capital I Trust 2015-UBS8 3.809% 12/15/48 1,200 1,290
5,7 Progress Residential 2015-SFR3 Trust 3.067% 11/12/32 415 420
  Royal Bank of Canada 2.100% 10/14/20 390 394
5,7 Wendys Funding LLC 2015-1 3.371% 6/15/45 179 176
7 Westpac Banking Corp. 2.250% 11/9/20 365 370

 

11


 

Core Bond Fund

      Face Market
    Maturity Amount Value
  Coupon Date ($000) ($000)
5 World Financial Network Credit Card Master Note        
Trust Series 2012-D 2.150% 4/17/23 1,000 1,010
5 World Omni Auto Receivables Trust 2015-B 2.150% 8/15/22 175 174
Total Asset-Backed/Commercial Mortgage-Backed Securities (Cost $25,691)   25,836
Corporate Bonds (24.7%)        
Finance (8.8%)        
Banking (5.0%)        
Bank of America Corp. 5.700% 1/24/22 370 425
Bank of America Corp. 3.300% 1/11/23 546 551
Bank of Nova Scotia 4.500% 12/16/25 240 240
Citigroup Inc. 3.875% 10/25/23 325 340
Citigroup Inc. 3.750% 6/16/24 275 284
7 Commonwealth Bank of Australia 4.500% 12/9/25 300 303
Cooperatieve Rabobank UA 3.950% 11/9/22 780 799
Discover Financial Services 5.200% 4/27/22 370 395
First Republic Bank 2.375% 6/17/19 510 509
Goldman Sachs Group Inc. 3.750% 2/25/26 822 842
Goldman Sachs Group Inc. 6.125% 2/15/33 480 581
HSBC USA Inc. 2.750% 8/7/20 600 601
JPMorgan Chase & Co. 2.550% 3/1/21 1,290 1,299
JPMorgan Chase & Co. 5.500% 10/15/40 216 259
Lloyds Bank plc 4.650% 3/24/26 750 742
7 Macquarie Bank Ltd. 2.600% 6/24/19 78 79
7 Macquarie Bank Ltd. 3.900% 1/15/26 360 363
Mitsubishi UFJ Financial Group Inc. 2.950% 3/1/21 510 521
Mitsubishi UFJ Financial Group Inc. 3.850% 3/1/26 200 208
Morgan Stanley 2.200% 12/7/18 1,134 1,142
Morgan Stanley 3.750% 2/25/23 500 521
Morgan Stanley 3.875% 1/27/26 820 856
MUFG Americas Holdings Corp. 2.250% 2/10/20 570 567
PNC Bank NA 3.250% 6/1/25 270 275
Royal Bank of Canada 2.300% 3/22/21 600 600
7 Santander UK Group Holdings plc 4.750% 9/15/25 750 714
7 Toronto-Dominion Bank 2.250% 3/15/21 350 355
Toronto-Dominion Bank 2.125% 4/7/21 440 439
Wells Fargo & Co. 2.600% 7/22/20 210 215
Wells Fargo & Co. 5.375% 2/7/35 150 181
Westpac Banking Corp. 2.600% 11/23/20 179 183
 
Brokerage (0.1%)        
Invesco Finance plc 4.000% 1/30/24 180 189
 
Finance Companies (0.7%)        
Air Lease Corp. 3.375% 1/15/19 1,824 1,822
7 GE Capital International Funding Co. 4.418% 11/15/35 300 325
 
Insurance (1.9%)        
Allied World Assurance Co. Holdings Ltd. 4.350% 10/29/25 367 368
Berkshire Hathaway Finance Corp. 4.400% 5/15/42 90 97
Berkshire Hathaway Inc. 2.750% 3/15/23 420 428
CNA Financial Corp. 4.500% 3/1/26 552 559
First American Financial Corp. 4.600% 11/15/24 290 296
7 Five Corners Funding Trust 4.419% 11/15/23 828 871
Infinity Property & Casualty Corp. 5.000% 9/19/22 520 548

 

12


 

Core Bond Fund

      Face Market
    Maturity Amount Value
  Coupon Date ($000) ($000)
Manulife Financial Corp. 4.150% 3/4/26 240 245
Marsh & McLennan Cos. Inc. 2.350% 9/10/19 180 182
Marsh & McLennan Cos. Inc. 3.500% 6/3/24 480 479
Prudential Financial Inc. 4.500% 11/15/20 20 22
7 Reliance Standard Life Global Funding II 2.375% 5/4/20 240 238
7 TIAA Asset Management Finance Co. LLC 4.125% 11/1/24 246 254
Trinity Acquisition plc 3.500% 9/15/21 610 620
Trinity Acquisition plc 4.625% 8/15/23 50 52
Trinity Acquisition plc 6.125% 8/15/43 102 113
XLIT Ltd.