N-CSR 1 malvern_final.htm VANGUARD MALVERN FUNDS malvern_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:
Anne E. Robinson, 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 – September 30, 2016

Item 1: Reports to Shareholders



Annual Report | September 30, 2016

Vanguard U.S. Value Fund


 

A new format, unwavering commitment

As you begin reading this report, you’ll notice that we’ve made some improvements to the opening sections—based on feedback from you, our clients.

Page 1 starts with a new ”Your Fund’s Performance at a Glance,” a concise, handy summary of how your fund performed during the period.

In the renamed ”Chairman’s Perspective,” Bill McNabb will focus on enduring principles and investment insights.

We’ve modified some tables, and eliminated some redundancy, but we haven’t removed any information.

At Vanguard, we’re always looking for better ways to communicate and to help you make sound investment decisions. Thank you for entrusting your assets to us.

Contents  
Your Fund’s Performance at a Glance. 1
Chairman’s Perspective. 3
Advisor’s Report. 6
Fund Profile. 8
Performance Summary. 9
Financial Statements. 11
Your Fund’s After-Tax Returns. 23
About Your Fund’s Expenses. 24
Glossary. 26

 

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: No matter what language you speak, Vanguard has one consistent message and set of principles. Our primary focus is on you, our clients. We conduct our business with integrity as a faithful steward of your assets. This message is shown translated into seven languages, reflecting our expanding global presence.


 

Your Fund’s Performance at a Glance

• For the 12 months ended September 30, 2016, Vanguard U.S. Value Fund returned about 11%, trailing both its benchmark index and the average return of its peer group. In general, value stocks outpaced their growth counterparts.

• All but one of the fund’s industry sectors posted positive results. The advisor’s stock selection contributed to the fund’s underperformance relative to its benchmark.

• Energy, the fund’s second-largest sector holding, weighed most on its result.

Industrials, health care, and materials were among sectors that also detracted from relative performance. Information technology and telecommunication services were the only sectors to beat the benchmark.

• Over the decade ended September 30, the fund’s average annual return was in line with that of its benchmark and slightly ahead of the average return of its peers.

Total Returns: Fiscal Year Ended September 30, 2016  
  Total
  Returns
Vanguard U.S. Value Fund 11.09%
Russell 3000 Value Index 16.38
Multi-Cap Value Funds Average 12.39
Multi-Cap Value Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company.  
 
 
Total Returns: Ten Years Ended September 30, 2016  
  Average
  Annual Return
U.S. Value Fund 5.85%
Russell 3000 Value Index 5.84
Multi-Cap Value Funds Average 5.10
Multi-Cap Value Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company.  

 

The figures shown represent past performance, which is not a guarantee of future results. (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.

1


 

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 fiscal year ended September 30, 2016, the fund’s 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.

2


 

Chairman’s Perspective


Bill McNabb
Chairman and Chief Executive Officer

Dear Shareholder,

If you think you’ve had reason to feel uneasy about the investment environment lately, you’re not imagining things. In just the past few months, we’ve seen economic uncertainty, intense political polarization, and super-low bond yields. Yet at the same time, the stock market kept pushing higher.

In this confusing and sometimes contradictory climate, you may be asking yourself a question that I hear often: How do I make sense of all this, keep investing, and still get a good night’s sleep?

As with any problem, there are multiple ways to go at it. But there’s one approach in particular that is simple, straightforward, and nearly foolproof: Save more money. Not only can saving more give you a greater sense of control over your investment plan, it can help compensate for long-term returns that, in our estimation, could fall short of historical averages.

I love the way one of our investment pros put it. Fran Kinniry this summer told The Wall Street Journal, “Investing is always a partnership between you and the markets.” He explained that the markets carried more than their fair share of the weight for a couple of decades, through the 1990s, providing outsized returns that made the investor’s half of the partnership relatively light work. “But now you are going to have to be the majority partner.”

Sobering? Sure. Hopeless? Definitely not.

3


 

Over the 12 months since last September, U.S. stocks returned 15%, though the rise has not been a one-way ticket straight up. International markets have also posted strong returns, but lower than those of the broad U.S. market. The decision by United Kingdom voters in June to exit the European Union came as a surprise but caused market heartburn for only a few days.

In fixed income, yields remained extremely low—about 1.60% on the 10-year U.S. Treasury note at the end of September, after dipping below 1.40% over the summer. And bond yields in some international markets were negative.

Even this relatively small window of time illustrates a truism of the financial markets: There will always be segments that perform well and others that don’t. Saving more saves you from trying to control the uncontrollable—how economies and the markets perform. And it keeps you in control of one of the most vital parts of your investment program.

Although the “save more” logic is easy to grasp, it’s not always easy to follow. Bills, illness, the loss of a job—these can affect any of us.

But whatever our circumstances, figuring out how to save more is worth the effort. It requires that we make difficult decisions to forgo some consumption today to increase the likelihood of consuming (or consuming more) in the future. This is the very heart of investing. Sacrifices are never fun, so consider carrying them out systematically and in doses that you

Market Barometer      
    Average Annual Total Returns
    Periods Ended September 30, 2016
  One Three Five
  Year Years Years
Stocks      
Russell 1000 Index (Large-caps) 14.93% 10.78% 16.41%
Russell 2000 Index (Small-caps) 15.47 6.71 15.82
Russell 3000 Index (Broad U.S. market) 14.96 10.44 16.36
FTSE All-World ex US Index (International) 9.62 0.71 6.50
 
Bonds      
Bloomberg Barclays U.S. Aggregate Bond Index      
(Broad taxable market) 5.19% 4.03% 3.08%
Bloomberg Barclays Municipal Bond Index      
(Broad tax-exempt market) 5.58 5.54 4.48
Citigroup Three-Month U.S. Treasury Bill Index 0.20 0.06 0.06
 
CPI      
Consumer Price Index 1.46% 1.03% 1.25%

 

4


 

can be comfortable with—for instance, gradually getting up to the max in your IRA, or adding a percentage point or so to the amount you stash in your employer’s retirement plan. As a point of reference, we generally suggest that investors strive for a retirement savings rate of 12%–15%, including any employer contributions.

If you need more convincing about the wisdom of the “save more” course of action, it might be helpful to examine your alternatives. This list is by no means exhaustive, but it hits on a few of the big ones, and none are without risk.

• Reach for yield. With yields so low on many types of bonds, it’s tempting to find the corners of the fixed income market where payouts are juicier. But with the juice comes considerable risk. You need to be aware that you’d be taking on more risk—and how much more.

• Go all-in on a hot-performing asset class or fund. By now, you know better than that, right?

• Sit tight. This approach isn’t a terrible idea; it’s better than panicking and deciding to just “do something,” particularly if that means changing your approach in response to the market’s movements.

Here’s the inescapably challenging part of your partnership with the markets: In the short run, your “partner” is fickle, emotional, and wildly unpredictable. But in the long run, your partner is mostly rational and extremely helpful.

The best way to minimize your vulnerability to the market’s mood swings, and to maximize the benefit of your partner’s longer-term strengths, is to expect less and save more. Maybe the markets will deliver better-than-expected returns. Maybe they’ll be consistent with our more modest expectations. In either case, a higher savings rate can help put you in a better position to reach your goals.

As always, thank you for investing with Vanguard.


F. William McNabb III

Chairman and Chief Executive Officer October 18, 2016

5


 

Advisor’s Report

For the fiscal year ended September 30, 2016, the U.S. Value Fund returned 11.09%. It lagged the benchmark Russell 3000 Value Index by more than 5 percentage points.

The broad U.S. equity market was up 14.96%. U.S. growth stocks, which returned 13.64%, lagged the 16.38% result for their value counterparts. Small-capitalization stocks returned 15.47%, outperforming large- and mid-cap stocks, which returned 14.93%.

Globally, developed markets performed more weakly, with the MSCI EAFE Index returning 6.52%. In comparison, emerging markets, as measured by the MSCI Emerging Markets Index, rose 16.78%. Each of the 11 industry sectors in the Russell 3000 Value Index generated positive returns. Results were best among materials, information technology, and industrial companies, but they were only mildly positive among consumer discretionary and financial firms.

Growth around the globe remained subdued. The U.S. economy grew at an annual rate of 0.8% in the first quarter of 2016 and 1.4% in the second. The second-quarter increase reflected positive contributions from personal consumption expenditures, exports, and nonresidential fixed investments, but declines in private inventory investment and residential fixed investment weighed on the economy.

The International Monetary Fund estimated global growth at 2.9% for the first half of 2016, slightly weaker than for the second half of 2015. Brexit is still unfolding, as the long-term arrangements between the United Kingdom and the European Union will be uncertain for some time. Commodity prices have partly recovered. After hitting a ten-year low in January 2016, oil prices rallied by 50 percent to $45 in August, mostly because of production outages. Nonfuel commodity prices have also increased, with metals prices rising 12% and agricultural commodity prices up 9%.

Although 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 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 grow earnings year after year; strong market sentiment—market confirmation of our view; and reasonable valuation—avoidance of overpriced stocks.

The interaction of these themes generates an opinion on all the stocks in our universe each day. 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

6


 

research indicates do not improve returns, such as industry selection and other risks relative to our benchmark.

Our portfolio focuses on the attractive stocks identified by the model that we expect will exhibit future outperformance; however, as with any investment management process, there will be periods when our model does not perform as expected. Unfortunately, over the latest fiscal year, the stocks that outperformed had characteristics that our model does not pursue. Although we are disappointed with the performance results, it is important to remind our investors that through different market environments, we maintain our commitment to invest in stocks with attractive fundamentals that we believe will outperform in the long run.

For the 12-month period, our valuation and management decisions models helped performance, while our growth and quality models were weaker. However, our sentiment model was a large detractor from the fund’s performance. We always maintain a positive view of each of our five submodels, but we recently introduced a dynamic weighting process that shifts their relative importance through time. This process successfully underweighted the sentiment component and increased the weight of the management decisions component, which mitigated our underperformance over the period.

Our stock selection results across sectors were disappointing, as we were able to produce positive selections only in real estate, information technology, and telecommunication services. In real estate, our most successful positions included Government Properties Income Trust (+59.2%), Digital Realty Trust (+68.4%), and Communications Sales & Leasing (+82.1%). Performance in IT was driven by AMD (+191.6%), NeoPhotonics (+139.9%), and NVIDIA (+181.3%). Telecom benefited from our positions in Verizon (+25.1%) and Cincinnati Bell (+30.8%).

We were not able to match the outperformance across the remaining sectors, and our stock selection results were the most disappointing in energy, industrials, and financials. In energy, Alon USA Energy (–62.2%), Teekay Tankers (–56.2%), and Noble (–39.9%) significantly detracted. Industrial holdings JetBlue Airways (–33.1%), Alaska Air Group (–15.9%), and Spirit AeroSystems (–7.9%) similarly did not perform as expected. In financials, Santander (–42.4%), MGIC Investment (–37.9%), and Heritage Insurance (–25.9%) hurt results.

Portfolio Managers:

James P. Stetler, Principal

Anatoly Shtekhman, CFA

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

Vanguard Quantitative Equity Group

October 18, 2016

7


 

U.S. Value Fund    
 
 
Fund Profile      
As of September 30, 2016    
 
Portfolio Characteristics    
    Russell DJ
    3000 U.S. Total
    Value Market
  Fund Index FA Index
Number of Stocks 240 2,025 3,850
Median Market Cap $23.3B $48.8B $51.8B
Price/Earnings Ratio 16.3x 21.9x 23.7x
Price/Book Ratio 1.8x 1.8x 2.8x
Return on Equity 11.0% 12.4% 16.6%
Earnings Growth Rate 7.0% 3.0% 7.6%
Dividend Yield 2.6% 2.5% 2.0%
Foreign Holdings 1.0% 0.0% 0.0%
Turnover Rate 76%
Ticker Symbol VUVLX
Expense Ratio1 0.26%
30-Day SEC Yield 2.49%
Short-Term Reserves 0.0%

 

Sector Diversification (% of equity exposure)

      DJ
      U.S.
    Russell Total
    3000 Market
    Value FA
  Fund Index Index
Consumer      
Discretionary 5.3% 5.3% 12.8%
Consumer Staples 8.5 8.4 8.7
Energy 12.8 12.8 6.7
Financials 23.8 23.9 13.3
Health Care 11.1 11.0 14.2
Industrials 9.7 9.7 10.3
Information      
Technology 10.2 10.1 20.7
Materials 3.0 3.0 3.3
Real Estate 5.5 5.6 4.3
Telecommunication      
Services 3.6 3.7 2.4
Utilities 6.5 6.5 3.3

 

Volatility Measures    
  Russell DJ
  3000 U.S. Total
  Value Market
  Index FA Index
R-Squared 0.97 0.95
Beta 0.95 0.93

 

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)

Exxon Mobil Corp. Integrated Oil & Gas 3.4%
Johnson & Johnson Pharmaceuticals 2.9
JPMorgan Chase & Co. Diversified Banks 2.7
General Electric Co. Industrial  
  Conglomerates 2.4
Bank of America Corp. Diversified Banks 2.0
Berkshire Hathaway Inc. Multi-Sector Holdings 1.9
Citigroup Inc. Diversified Banks 1.8
AT&T Inc. Integrated  
  Telecommunication  
  Services 1.7
Procter & Gamble Co. Household Products 1.6
Merck & Co. Inc. Pharmaceuticals 1.5
Top Ten   21.9%

 

The holdings listed exclude any temporary cash investments and equity index products.


1 The expense ratio shown is from the prospectus dated January 27, 2016, and represents estimated costs for the current fiscal year. For the fiscal year ended September 30, 2016, the expense ratio was 0.23%.

8


 

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.

Cumulative Performance: September 30, 2006, Through September 30, 2016

Initial Investment of $10,000


    Average Annual Total Returns  
    Periods Ended September 30, 2016  
          Final Value
    One Five Ten of a $10,000
    Year Years Years Investment
  U.S. Value Fund 11.09% 16.64% 5.85% $17,655
•••••••• Russell 3000 Value Index 16.38 16.09 5.84 17,647
 
– – – – Dow Multi-Cap Jones Value U.S. Funds Total Stock Average Market 12.39 14.24 5.10 16,443
  Float Adjusted Index 14.93 16.30 7.49 20,592
Multi-Cap Value Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company.    

 

See Financial Highlights for dividend and capital gains information.

9


 

U.S. Value Fund

Fiscal-Year Total Returns (%): September 30, 2006, Through September 30, 2016


U.S. Value Fund

Russell 3000 Value Index

10


 

U.S. Value Fund

Financial Statements

Statement of Net Assets
As of September 30, 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 (99.6%)1    
Consumer Discretionary (5.3%)    
  Target Corp. 128,262 8,809
  Lear Corp. 64,472 7,815
  Whirlpool Corp. 42,946 6,964
  Best Buy Co. Inc. 178,889 6,830
  International Game    
  Technology plc 196,228 4,784
* Liberty SiriusXM Group    
  Class A 134,387 4,567
* Cooper-Standard Holding    
  Inc. 41,879 4,138
  Darden Restaurants Inc. 66,735 4,092
  News Corp. Class B 271,403 3,859
  PVH Corp. 30,420 3,361
* Discovery Communications    
  Inc. Class A 108,622 2,924
  Carnival Corp. 50,461 2,464
  Ford Motor Co. 193,509 2,336
  Cooper Tire & Rubber Co. 50,061 1,903
* MSG Networks Inc. 89,867 1,672
  Children’s Place Inc. 20,317 1,623
  Rent-A-Center Inc. 84,459 1,068
  Barnes & Noble Inc. 62,888 711
  Dana Inc. 44,583 695
* Liberty SiriusXM Group    
  Class C 20,395 681
  General Motors Co. 16,842 535
  Nordstrom Inc. 7,400 384
      72,215
Consumer Staples (8.4%)    
^ Procter & Gamble Co. 243,404 21,845
  Wal-Mart Stores Inc. 276,872 19,968
  Philip Morris International    
  Inc. 97,887 9,517
  Tyson Foods Inc. Class A 116,937 8,732
  ConAgra Foods Inc. 167,966 7,913
  Energizer Holdings Inc. 148,671 7,428
^,* Herbalife Ltd. 116,326 7,211

 

      Market
      Value
    Shares ($000)
  Dean Foods Co. 396,467 6,502
  JM Smucker Co. 38,700 5,245
  Ingredion Inc. 29,460 3,920
  Universal Corp. 59,514 3,465
* Post Holdings Inc. 36,095 2,785
  Fresh Del Monte Produce    
  Inc. 41,372 2,478
  PepsiCo Inc. 21,590 2,348
  Ingles Markets Inc. Class A 53,005 2,096
* Omega Protein Corp. 48,477 1,133
  Mondelez International Inc.    
  Class A 21,801 957
  SpartanNash Co. 27,582 798
  Nu Skin Enterprises Inc.    
  Class A 10,895 706
  Avon Products Inc. 120,312 681
      115,728
Energy (12.9%)    
  Exxon Mobil Corp. 528,020 46,086
  Chevron Corp. 159,169 16,382
  Devon Energy Corp. 218,356 9,632
  Apache Corp. 136,602 8,725
  Ensco plc Class A 974,604 8,284
* Newfield Exploration Co. 189,330 8,228
  Rowan Cos. plc Class A 541,316 8,206
  Energen Corp. 137,158 7,917
  Valero Energy Corp. 149,173 7,906
  Tesoro Corp. 86,319 6,867
^ Ship Finance International    
  Ltd. 443,204 6,528
  Schlumberger Ltd. 76,777 6,038
* Transocean Ltd. 468,686 4,996
^,* EP Energy Corp. Class A 1,023,365 4,482
  Cimarex Energy Co. 25,065 3,368
  Diamond Offshore    
  Drilling Inc. 188,112 3,313
^ Nordic American Tankers    
  Ltd. 264,069 2,670
  Baker Hughes Inc. 44,148 2,228
* Denbury Resources Inc. 632,122 2,042

 

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U.S. Value Fund    
 
 
 
      Market
      Value
    Shares ($000)
  Spectra Energy Corp. 43,259 1,849
  DHT Holdings Inc. 439,907 1,843
  Scorpio Tankers Inc. 369,702 1,712
* Overseas Shipholding    
  Group Inc. Class A 154,160 1,629
* Laredo Petroleum Inc. 87,229 1,125
^,* Seadrill Ltd. 440,832 1,045
* Sanchez Energy Corp. 111,781 988
  Noble Corp. plc 125,659 797
* RPC Inc. 44,973 756
* McDermott International    
  Inc. 145,119 727
      176,369
Financials (23.8%)    
  JPMorgan Chase & Co. 551,781 36,743
  Bank of America Corp. 1,717,469 26,878
* Berkshire Hathaway Inc.    
  Class B 180,935 26,140
  Citigroup Inc. 514,133 24,282
  Wells Fargo & Co. 423,950 18,773
  American Express Co. 201,487 12,903
  Prudential Financial Inc. 145,879 11,911
  Capital One Financial Corp. 163,427 11,739
  Bank of New York Mellon    
  Corp. 289,405 11,541
  Travelers Cos. Inc. 95,600 10,951
  Aflac Inc. 149,667 10,757
  SunTrust Banks Inc. 213,745 9,362
  Fifth Third Bancorp 452,104 9,250
  Discover Financial Services 162,805 9,207
  Ameriprise Financial Inc. 86,845 8,665
  PNC Financial Services    
  Group Inc. 93,141 8,391
  Navient Corp. 570,454 8,254
  Unum Group 220,137 7,773
  Assured Guaranty Ltd. 263,118 7,302
  Universal Insurance    
  Holdings Inc. 269,680 6,796
  US Bancorp 141,686 6,077
* Walker & Dunlop Inc. 236,382 5,971
* INTL. FCStone Inc. 147,113 5,715
  State Street Corp. 80,074 5,576
  Heritage Insurance    
  Holdings Inc. 291,905 4,206
  Goldman Sachs Group Inc. 25,096 4,047
* Flagstar Bancorp Inc. 124,030 3,442
  Regions Financial Corp. 259,420 2,560
* KCG Holdings Inc. Class A 146,980 2,283
  Primerica Inc. 39,153 2,076
  Maiden Holdings Ltd. 137,547 1,745
  Reinsurance Group of    
  America Inc. Class A 14,058 1,517
  Ally Financial Inc. 62,229 1,212
  Torchmark Corp. 15,113 966

 

      Market
      Value
    Shares ($000)
  Popular Inc. 20,736 793
* World Acceptance Corp. 12,400 608
  American International    
  Group Inc. 8,017 476
      326,888
Health Care (11.0%)    
  Johnson & Johnson 335,926 39,683
  Merck & Co. Inc. 339,768 21,205
  Pfizer Inc. 477,662 16,178
  Baxter International Inc. 205,379 9,776
* HCA Holdings Inc. 106,713 8,071
  Aetna Inc. 67,438 7,786
* Express Scripts Holding Co. 106,366 7,502
  Medtronic plc 86,443 7,469
* WellCare Health Plans Inc. 59,951 7,020
* Quintiles Transnational    
  Holdings Inc. 66,196 5,366
  Anthem Inc. 41,972 5,259
  Bristol-Myers Squibb Co. 91,216 4,918
  Eli Lilly & Co. 51,929 4,168
* INC Research Holdings Inc.    
  Class A 55,800 2,487
* Charles River Laboratories    
  International Inc. 26,153 2,180
* Healthways Inc. 39,530 1,046
  Abbott Laboratories 16,493 697
  Universal American Corp. 25,000 191
      151,002
Industrials (9.6%)    
  General Electric Co. 1,124,086 33,295
  Delta Air Lines Inc. 212,701 8,372
  BWX Technologies Inc. 191,732 7,357
  Owens Corning 136,188 7,271
  Global Brass & Copper    
  Holdings Inc. 249,871 7,219
  Masco Corp. 202,787 6,958
  SkyWest Inc. 260,632 6,883
  General Cable Corp. 453,807 6,798
  Huntington Ingalls    
  Industries Inc. 38,489 5,905
  Alaska Air Group Inc. 88,215 5,810
  L-3 Communications    
  Holdings Inc. 29,277 4,413
* JetBlue Airways Corp. 244,319 4,212
  GATX Corp. 90,927 4,051
* Wabash National Corp. 238,647 3,398
* ACCO Brands Corp. 349,183 3,366
  United Technologies Corp. 27,219 2,766
* United Rentals Inc. 32,937 2,585
  Quad/Graphics Inc. 96,108 2,568
* Spirit AeroSystems    
  Holdings Inc. Class A 52,094 2,320
  Universal Forest Products    
  Inc. 19,890 1,959

 

12


 

U.S. Value Fund    
 
 
 
      Market
      Value
    Shares ($000)
  Comfort Systems USA Inc. 42,042 1,232
  Union Pacific Corp. 7,758 757
  Briggs & Stratton Corp. 40,278 751
  West Corp. 33,879 748
  Southwest Airlines Co. 18,384 715
  Ennis Inc. 40,828 688
      132,397
Information Technology (10.0%)  
  Intel Corp. 322,367 12,169
  Cisco Systems Inc. 379,527 12,039
  HP Inc. 706,845 10,977
  Computer Sciences Corp. 161,180 8,415
* Advanced Micro Devices    
  Inc. 1,175,692 8,124
  SYNNEX Corp. 68,718 7,841
* Tech Data Corp. 90,788 7,691
  Booz Allen Hamilton    
  Holding Corp. Class A 233,000 7,365
  NVIDIA Corp. 99,859 6,842
  CDW Corp. 144,824 6,623
* NeoPhotonics Corp. 396,790 6,484
* Sykes Enterprises Inc. 212,762 5,985
  Oracle Corp. 143,966 5,655
* Sigma Designs Inc. 694,160 5,407
  EarthLink Holdings Corp. 514,300 3,189
* Extreme Networks Inc. 638,887 2,869
* NETGEAR Inc. 41,239 2,495
  Leidos Holdings Inc. 57,170 2,474
* First Data Corp. Class A 164,927 2,170
  Avnet Inc. 48,712 2,000
* TTM Technologies Inc. 164,896 1,888
  QUALCOMM Inc. 23,381 1,602
* VMware Inc. Class A 20,449 1,500
* CACI International Inc.    
  Class A 14,039 1,417
* NCR Corp. 39,289 1,265
* Cirrus Logic Inc. 19,477 1,035
* Alpha & Omega    
  Semiconductor Ltd. 40,622 882
  Applied Materials Inc. 22,197 669
* Amkor Technology Inc. 43,300 421
      137,493
Materials (3.0%)    
  Steel Dynamics Inc. 300,178 7,501
  Commercial Metals Co. 444,528 7,197
* AK Steel Holding Corp. 1,347,512 6,509
  Cabot Corp. 120,468 6,314
  Rayonier Advanced    
  Materials Inc. 251,740 3,366
  Dow Chemical Co. 55,580 2,881
  Schnitzer Steel Industries    
  Inc. 82,575 1,726
* Coeur Mining Inc. 129,864 1,536
  LyondellBasell Industries    
  NV Class A 18,743 1,512

 

      Market
      Value
    Shares ($000)
  Avery Dennison Corp. 10,765 837
  United States Steel Corp. 37,908 715
  Greif Inc. Class A 13,936 691
* Ryerson Holding Corp. 57,407 648
      41,433
Real Estate (5.5%)    
  Hospitality Properties Trust 256,239 7,615
  Government Properties    
  Income Trust 322,912 7,304
  Lexington Realty Trust 675,609 6,959
  CBL & Associates    
  Properties Inc. 565,875 6,870
  Washington Prime Group    
  Inc. 533,909 6,610
  DuPont Fabros Technology    
  Inc. 116,570 4,809
  Senior Housing Properties    
  Trust 200,451 4,552
  Select Income REIT 147,878 3,978
  Communications Sales &    
  Leasing Inc. 123,920 3,892
  Apple Hospitality REIT Inc. 200,051 3,703
  Macerich Co. 41,243 3,335
  VEREIT Inc. 305,670 3,170
  NorthStar Realty Finance    
  Corp. 128,377 1,691
  GEO Group Inc. 68,794 1,636
  Summit Hotel Properties    
  Inc. 122,604 1,613
  Omega Healthcare    
  Investors Inc. 43,238 1,533
  Piedmont Office Realty    
  Trust Inc. Class A 56,019 1,220
  Brandywine Realty Trust 65,561 1,024
  Global Net Lease Inc. 117,266 957
  WP Carey Inc. 14,000 903
  Care Capital Properties Inc. 29,299 835
  Sabra Health Care REIT Inc. 29,210 735
  Sunstone Hotel Investors    
  Inc. 49,267 630
      75,574
Telecommunication Services (3.6%)  
  AT&T Inc. 574,846 23,345
  Verizon Communications    
  Inc. 274,648 14,276
  CenturyLink Inc. 316,926 8,693
* Cincinnati Bell Inc. 636,851 2,599
^ Windstream Holdings Inc. 71,277 716
      49,629
Utilities (6.5%)    
  Edison International 130,795 9,450
  PPL Corp. 270,908 9,365
  FirstEnergy Corp. 264,203 8,740
  Entergy Corp. 109,979 8,439
  CenterPoint Energy Inc. 341,938 7,943

 

13


 

U.S. Value Fund    
 
 
 
      Market
      Value
    Shares ($000)
  UGI Corp. 168,004 7,601
  NiSource Inc. 312,840 7,543
  MDU Resources Group Inc. 294,043 7,480
  Great Plains Energy Inc. 151,039 4,122
  AES Corp. 319,849 4,110
  National Fuel Gas Co. 62,335 3,370
  Southwest Gas Corp. 37,180 2,597
  ONE Gas Inc. 40,905 2,530
  NRG Energy Inc. 211,551 2,371
  DTE Energy Co. 10,622 995
  Ameren Corp. 16,080 791
  NRG Yield Inc. 39,053 662
  NextEra Energy Inc. 5,004 612
      88,721
Total Common Stocks    
(Cost $1,218,339)   1,367,449
Temporary Cash Investments (1.7%)1  
Money Market Fund (1.7%)    
2,3 Vanguard Market Liquidity    
  Fund, 0.640% 230,400 23,042
 
    Face  
    Amount  
    ($000)  
U.S. Government and Agency Obligations (0.0%)
4,5 Federal Home Loan    
  Bank Discount Notes,    
  0.339%, 11/4/16 300 300
5 United States Treasury Bill,    
  0.341%, 12/8/16 100 100
      400
Total Temporary Cash Investments  
(Cost $23,440)   23,442
Total Investments (101.3%)    
(Cost $1,241,779)   1,390,891

 

  Amount
  ($000)
Other Assets and Liabilities (-1.3%)  
Other Assets  
Receivables for Investment Securities Sold 3,295
Investment in Vanguard 106
Receivables for Accrued Income 1,844
Receivables for Capital Shares Issued 798
Other Assets 145
Total Other Assets 6,188
Liabilities  
Payables for Investment Securities  
Purchased (655)
Collateral for Securities on Loan (17,706)
Payables for Capital Shares Redeemed (1,126)
Payables to Vanguard (1,278)
Other Liabilities (2,657)
Total Liabilities (23,422)
Net Assets (100%)  
Applicable to 79,611,907 outstanding  
$.001 par value shares of beneficial  
interest (unlimited authorization) 1,373,657
Net Asset Value Per Share $17.25
 
 
At September 30, 2016, net assets consisted of:
  Amount
  ($000)
Paid-in Capital 1,183,106
Undistributed Net Investment Income 20,151
Accumulated Net Realized Gains 21,272
Unrealized Appreciation (Depreciation)  
Investment Securities 149,112
Futures Contracts 16
Net Assets 1,373,657

 

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 $16,588,000.
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 100.0% and 1.3%, 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 $17,706,000 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 $400,000 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.

14


 

U.S. Value Fund  
 
 
Statement of Operations  
 
  Year Ended
  September 30, 2016
  ($000)
Investment Income  
Income  
Dividends 36,211
Interest1 29
Securities Lending—Net 1,369
Total Income 37,609
Expenses  
The Vanguard Group—Note B  
Investment Advisory Services 722
Management and Administrative 2,014
Marketing and Distribution 247
Custodian Fees 21
Auditing Fees 34
Shareholders’ Reports 24
Trustees’ Fees and Expenses 1
Total Expenses 3,063
Net Investment Income 34,546
Realized Net Gain (Loss)  
Investment Securities Sold1 22,402
Futures Contracts 688
Realized Net Gain (Loss) 23,090
Change in Unrealized Appreciation (Depreciation)  
Investment Securities 81,399
Futures Contracts 127
Change in Unrealized Appreciation (Depreciation) 81,526
Net Increase (Decrease) in Net Assets Resulting from Operations 139,162

 

1 Interest income and realized net gain (loss) from an affiliated company of the fund were $27,000 and $0, respectively.

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

15


 

U.S. Value Fund    
 
 
Statement of Changes in Net Assets    
 
  Year Ended September 30,
  2016 2015
  ($000) ($000)
Increase (Decrease) in Net Assets    
Operations    
Net Investment Income 34,546 25,998
Realized Net Gain (Loss) 23,090 63,327
Change in Unrealized Appreciation (Depreciation) 81,526 (107,756)
Net Increase (Decrease) in Net Assets Resulting from Operations 139,162 (18,431)
Distributions    
Net Investment Income (26,754) (19,263)
Realized Capital Gain1 (48,800)
Total Distributions (75,554) (19,263)
Capital Share Transactions    
Issued 306,212 436,088
Issued in Lieu of Cash Distributions 71,550 18,266
Redeemed (282,648) (318,266)
Net Increase (Decrease) from Capital Share Transactions 95,114 136,088
Total Increase (Decrease) 158,722 98,394
Net Assets    
Beginning of Period 1,214,935 1,116,541
End of Period2 1,373,657 1,214,935

 

1 Includes fiscal 2016 short-term gain distributions totaling $0. 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 $20,151,000 and $15,799,000.

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

16


 

U.S. Value Fund          
 
 
Financial Highlights          
 
 
For a Share Outstanding     Year Ended September 30,
Throughout Each Period 2016 2015 2014 2013 2012
Net Asset Value, Beginning of Period $16.48 $16.95 $14.41 $11.89 $9.20
Investment Operations          
Net Investment Income .440 .355 .299 .304 .2761
Net Realized and Unrealized Gain (Loss)          
on Investments 1.341 (.543) 2.531 2.506 2.632
Total from Investment Operations 1.781 (.188) 2.830 2.810 2.908
Distributions          
Dividends from Net Investment Income (. 358) (. 282) (. 290) (. 290) (. 218)
Distributions from Realized Capital Gains (.653)
Total Distributions (1.011) (. 282) (. 290) (. 290) (. 218)
Net Asset Value, End of Period $17.25 $16.48 $16.95 $14.41 $11.89
 
Total Return2 11.09% -1.18% 19.89% 24.16% 32.10%
 
Ratios/Supplemental Data          
Net Assets, End of Period (Millions) $1,374 $1,215 $1,117 $829 $602
Ratio of Total Expenses to Average Net Assets 0.23% 0.26% 0.29% 0.29% 0.29%
Ratio of Net Investment Income to          
Average Net Assets 2.63% 2.10% 1.92% 2.26% 2.54%
Portfolio Turnover Rate 76% 66% 57% 75% 69%

 

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.

17


 

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 year ended September 30, 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, 2013–2016), 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.

18


 

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. During the term of the loan, the fund is entitled to all distributions made on or in respect of the loaned securities.

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 September 30, 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.

19


 

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 September 30, 2016, the fund had contributed to Vanguard capital in the amount of $106,000, 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 1—Quoted prices in active markets for identical securities.

Level 2—Other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.).

Level 3—Significant 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 September 30, 2016, based on the inputs used to value them:

  Level 1 Level 2 Level 3
Investments ($000) ($000) ($000)
Common Stocks 1,367,449
Temporary Cash Investments 23,042 400
Futures Contracts—Assets1 40
Futures Contracts—Liabilities1 (3)
Total 1,390,528 400
1 Represents variation margin on the last day of the reporting period.      

 

D. At September 30, 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 December 2016 56 6,049 16

 

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

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.

20


 

U.S. Value Fund

The fund used a tax accounting practice to treat a portion of the price of capital shares redeemed during the year as distributions from net investment income and realized capital gains. Accordingly, the fund has reclassified $3,447,000 from undistributed net investment income, and $2,415,000 from accumulated net realized gains, to paid-in capital.

For tax purposes, at September 30, 2016, the fund had $21,845,000 of ordinary income and $20,894,000 of long-term capital gains available for distribution.

At September 30, 2016, the cost of investment securities for tax purposes was $1,241,840,000. Net unrealized appreciation of investment securities for tax purposes was $149,051,000, consisting of unrealized gains of $175,851,000 on securities that had risen in value since their purchase and $26,800,000 in unrealized losses on securities that had fallen in value since their purchase.

F. During the year ended September 30, 2016, the fund purchased $1,050,186,000 of investment securities and sold $993,559,000 of investment securities, other than temporary cash investments.

G. Capital shares issued and redeemed were:    
  Year Ended September 30,
  2016 2015
  Shares Shares
  (000) (000)
Issued 18,669 24,986
Issued in Lieu of Cash Distributions 4,339 1,064
Redeemed (17,113) (18,195)
Net Increase (Decrease) in Shares Outstanding 5,895 7,855

 

H. Management has determined that no material events or transactions occurred subsequent to September 30, 2016, that would require recognition or disclosure in these financial statements.

21


 

Report of Independent Registered Public Accounting Firm

To the Board of Trustees of Vanguard Malvern Funds and the Shareholders of Vanguard U.S. Value Fund:

In our opinion, the accompanying statement of net assets and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Vanguard U.S. Value Fund (constituting a separate portfolio of Vanguard Malvern Funds, hereafter referred to as the “Fund”) at September 30, 2016, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as “financial statements”) are the responsibility of the Fund’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at September 30, 2016 by correspondence with the custodian and brokers and by agreement to the underlying ownership records of the transfer agent, provide a reasonable basis for our opinion.

/s/PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
November 10, 2016

Special 2016 tax information (unaudited) for Vanguard U.S. Value Fund

This information for the fiscal year ended September 30, 2016, is included pursuant to provisions of the Internal Revenue Code.

The fund distributed $51,216,000 as capital gain dividends (20% rate gain distributions) to shareholders during the fiscal year.

The fund distributed $26,754,000 of qualified dividend income to shareholders during the fiscal year.

For corporate shareholders, 81.8% of investment income (dividend income plus short-term gains, if any) qualifies for the dividends-received deduction.

22


 

Your Fund’s After-Tax Returns

This table presents returns for your fund both before and after taxes. The after-tax returns are shown in two ways: (1) assuming that an investor owned the fund during the entire period and paid taxes on the fund’s distributions, and (2) assuming that an investor paid taxes on the fund’s distributions and sold all shares at the end of each period.

Calculations are based on the highest individual federal income tax and capital gains tax rates in effect at the times of the distributions and the hypothetical sales. State and local taxes were not considered. After-tax returns reflect any qualified dividend income, using actual prior-year figures and estimates for 2016. (In the example, returns after the sale of fund shares may be higher than those assuming no sale. This occurs when the sale would have produced a capital loss. The calculation assumes that the investor received a tax deduction for the loss.)

Please note that your actual after-tax returns will depend on your tax situation and may differ from those shown. Also note that if you own the fund in a tax-deferred account, such as an individual retirement account or a 401(k) plan, this information does not apply to you. Such accounts are not subject to current taxes.

Finally, keep in mind that a fund’s performance—whether before or after taxes—does not guarantee future results.

Average Annual Total Returns: U.S. Value Fund      
Periods Ended September 30, 2016      
  One Five Ten
  Year Years Years
Returns Before Taxes 11.09% 16.64% 5.85%
Returns After Taxes on Distributions 9.56 15.96 5.05
Returns After Taxes on Distributions and Sale of Fund Shares 7.44 13.45 4.57

 

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 September 30, 2016      
  Beginning Ending Expenses
  Account Value Account Value Paid During
U.S. Value Fund 3/31/2016 9/30/2016 Period
Based on Actual Fund Return $1,000.00 $1,060.23 $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


 

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.

26


 

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.

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. The mailing address of the trustees and officers is P.O. Box 876, Valley Forge, PA 19482. 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

F. William McNabb III

Born 1957. Trustee Since July 2009. Chairman of the Board. Principal Occupation(s) During the Past Five Years and Other Experience: Chairman of the Board of The Vanguard Group, Inc., and of each of the investment companies served by The Vanguard Group, since January 2010; Director of The Vanguard Group since 2008; Chief Executive Officer and President of The Vanguard Group, and of each of the investment companies served by The Vanguard Group, since 2008; Director of Vanguard Marketing Corporation; Managing Director of The Vanguard Group (1995–2008).

IndependentTrustees

Emerson U. Fullwood

Born 1948. Trustee Since January 2008. Principal Occupation(s) During the Past Five Years and Other Experience: Executive Chief Staff and Marketing Officer for North America and Corporate Vice President (retired 2008) of Xerox Corporation (document management products and services); Executive in Residence and 2009–2010 Distinguished Minett Professor at the Rochester Institute of Technology; Lead Director of SPX FLOW, Inc. (multi-industry manufacturing); Director of the United Way of Rochester, the University of Rochester Medical Center, Monroe Community College Foundation, North Carolina A&T University, and Roberts Wesleyan College.

Rajiv L. Gupta

Born 1945. Trustee Since December 2001.2 Principal Occupation(s) During the Past Five Years and Other Experience: Chairman and Chief Executive Officer (retired 2009) and President (2006–2008) of Rohm and Haas Co. (chemicals); Director of Tyco International plc (diversified manufacturing and services), HP Inc. (printer and personal computer manufacturing), and Delphi Automotive plc (automotive components); Senior Advisor at New Mountain Capital.

Amy Gutmann

Born 1949. Trustee Since June 2006. Principal Occupation(s) During the Past Five Years and Other Experience: President of the University of Pennsylvania; Christopher H. Browne Distinguished Professor of Political Science, School of Arts and Sciences, and Professor of Communication, Annenberg School for Communication, with secondary faculty appointments in the Department of Philosophy, School of Arts and Sciences, and at the Graduate School of Education, University of Pennsylvania; Trustee of the National Constitution Center; Chair of the Presidential Commission for the Study of Bioethical Issues.

JoAnn Heffernan Heisen

Born 1950. Trustee Since July 1998. Principal Occupation(s) During the Past Five Years and Other Experience: Corporate Vice President and Chief Global Diversity Officer (retired 2008) and 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

Born 1949. Trustee Since October 2009. Principal Occupation(s) During the Past Five Years and Other Experience: President and Chief Operating Officer (retired 2009) of Cummins Inc. (industrial machinery); Chairman of the Board of Hillenbrand, Inc. (specialized consumer services), and of Oxfam America; Director of SKF AB (industrial machinery), Hyster-Yale Materials Handling, Inc. (forklift trucks), the Lumina Foundation for Education, and the V Foundation for Cancer Research; Member of the Advisory Council for the College of Arts and Letters and of the Advisory Board to the Kellogg Institute for International Studies, both at the University of Notre Dame.

Mark Loughridge

Born 1953. Trustee Since March 2012. Principal Occupation(s) During the Past Five Years and Other Experience: Senior Vice President and Chief Financial Officer (retired 2013) at IBM (information technology services); Fiduciary Member of IBM’s Retirement Plan Committee (2004–2013); Director of the Dow Chemical Company; Member of the Council on Chicago Booth.

Scott C. Malpass

Born 1962. Trustee Since March 2012. Principal Occupation(s) During the Past Five Years and Other Experience: Chief Investment Officer and Vice President at the University of Notre Dame; Assistant Professor of Finance at the Mendoza College of Business at Notre Dame; Member of the Notre Dame 403(b) Investment Committee, the Board of Advisors for Spruceview Capital Partners, and the Investment Advisory Committee of Major League Baseball; Board Member of TIFF Advisory Services, Inc., and Catholic Investment Services, Inc. (investment advisors).

André F. Perold

Born 1952. Trustee Since December 2004. Principal Occupation(s) During the Past Five Years and Other Experience: George Gund Professor of Finance and Banking, Emeritus at the Harvard Business School (retired 2011); Chief Investment Officer and Managing Partner of HighVista Strategies LLC (private investment firm); Director of Rand Merchant Bank; Overseer of the Museum of Fine Arts Boston.

Peter F. Volanakis

Born 1955. Trustee Since July 2009. Principal Occupation(s) During the Past Five Years and Other Experience: President and Chief Operating Officer (retired 2010) of Corning Incorporated (communications equipment); Chairman of the Board of Trustees of Colby-Sawyer College; Member of the Advisory Board of the Norris Cotton Cancer Center.

Executive Officers

Glenn Booraem

Born 1967. Treasurer Since May 2015. Principal Occupation(s) During the Past Five Years and Other Experience: Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies served by The Vanguard Group; Controller of each of the investment companies served by The Vanguard Group (2010–2015); Assistant Controller of each of the investment companies served by The Vanguard Group (2001–2010).

Thomas J. Higgins

Born 1957. Chief Financial Officer Since September 2008. Principal Occupation(s) During the Past Five Years and Other Experience: Principal of The Vanguard Group, Inc.; Chief Financial Officer of each of the investment companies served by The Vanguard Group; Treasurer of each of the investment companies served by The Vanguard Group (1998–2008).

Peter Mahoney

Born 1974. Controller Since May 2015. Principal Occupation(s) During the Past Five Years and Other Experience: Head of Global Fund Accounting at The Vanguard Group, Inc.; Controller of each of the investment companies served by The Vanguard Group; Head of International Fund Services at The Vanguard Group (2008–2014).

Anne E. Robinson

Born 1970. Secretary Since September 2016. Principal Occupation(s) During the Past Five Years and Other Experience: Managing Director of The Vanguard Group, Inc.; General Counsel of The Vanguard Group; Secretary of The Vanguard Group and of each of the investment companies served by The Vanguard Group; Director and Senior Vice President of Vanguard Marketing Corporation; Managing Director and General Counsel of Global Cards and Consumer Services at Citigroup (2014–2016); Counsel at American Express (2003–2014).

Vanguard Senior Management Team

Mortimer J. Buckley Kathleen C. Gubanich Martha G. King John T. Marcante Chris D. McIsaac

James M. Norris Thomas M. Rampulla Glenn W. Reed Karin A. Risi Michael Rollings

 

Chairman Emeritus and Senior Advisor John J. Brennan

Chairman, 1996–2009

Chief Executive Officer and President, 1996–2008

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
Valley Forge, PA 19482-2600

 

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.
 
  Q1240 112016

 



Annual Report | September 30, 2016

Vanguard Capital Value Fund


 

A new format, unwavering commitment

As you begin reading this report, you’ll notice that we’ve made some improvements to the opening sections—based on feedback from you, our clients.

Page 1 starts with a new ”Your Fund’s Performance at a Glance,” a concise, handy summary of how your fund performed during the period.

In the renamed ”Chairman’s Perspective,” Bill McNabb will focus on enduring principles and investment insights.

We’ve modified some tables, and eliminated some redundancy, but we haven’t removed any information.

At Vanguard, we’re always looking for better ways to communicate and to help you make sound investment decisions. Thank you for entrusting your assets to us.

Contents  
Your Fund’s Performance at a Glance. 1
Chairman’s Perspective. 3
Advisor’s Report. 6
Fund Profile. 9
Performance Summary. 10
Financial Statements. 12
Your Fund’s After-Tax Returns. 24
About Your Fund’s Expenses. 25
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: No matter what language you speak, Vanguard has one consistent message and set of principles. Our primary focus is on you, our clients. We conduct our business with integrity as a faithful steward of your assets. This message is shown translated into seven languages, reflecting our expanding global presence.


 

Your Fund’s Performance at a Glance

• The fund returned 11.36% for the 12 months ended September 30, 2016, trailing its
benchmark (+16.38%) and the average return of its peers (+12.39%).

• All industry sectors represented in the fund posted positive results.

• The fund’s information technology (+14%) and health care (+2%) stocks underperformed
compared with their benchmark counterparts, pulling down its relative performance.
In health care, the shortfall was driven mainly by some of the fund’s pharmaceutical
holdings, which declined amid regulatory and drug market issues.

• The fund’s materials portfolio (+32%) outperformed because of the advisor’s
overweighting of the sector. Its consumer discretionary stocks (+18%) also bested those
in the benchmark.

• Financial stocks returned a modest 4% for the fund, trailing their counterparts in the
benchmark. However, an underweighting of this sector—the fund’s largest—helped its
relative performance.

• The fund’s average annual return for the ten years ended September 30, 2016, closely
trailed that of its benchmark index and outdistanced that of its fund peers.

Total Returns: Fiscal Year Ended September 30, 2016  
  Total
  Returns
Vanguard Capital Value Fund 11.36%
Russell 3000 Value Index 16.38
Multi-Cap Value Funds Average 12.39
Multi-Cap Value Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company.  
 
 
Total Returns: Ten Years Ended September 30, 2016  
  Average
  Annual Return
Capital Value Fund 5.72%
Russell 3000 Value Index 5.84
Multi-Cap Value Funds Average 5.10
Multi-Cap Value Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company.  

 

The figures shown represent past performance, which is not a guarantee of future results. (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.

1


 

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 fiscal year ended September 30, 2016, the fund’s expense ratio was 0.25%. 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.

2


 

Chairman’s Perspective


Bill McNabb
Chairman and Chief Executive Officer

Dear Shareholder,

If you think you’ve had reason to feel uneasy about the investment environment lately, you’re not imagining things. In just the past few months, we’ve seen economic uncertainty, intense political polarization, and super-low bond yields. Yet at the same time, the stock market kept pushing higher.

In this confusing and sometimes contradictory climate, you may be asking yourself a question that I hear often: How do I make sense of all this, keep investing, and still get a good night’s sleep?

As with any problem, there are multiple ways to go at it. But there’s one approach in particular that is simple, straightforward, and nearly foolproof: Save more money. Not only can saving more give you a greater sense of control over your investment plan, it can help compensate for long-term returns that, in our estimation, could fall short of historical averages.

I love the way one of our investment pros put it. Fran Kinniry this summer told The Wall Street Journal, “Investing is always a partnership between you and the markets.” He explained that the markets carried more than their fair share of the weight for a couple of decades, through the 1990s, providing outsized returns that made the investor’s half of the partnership relatively light work. “But now you are going to have to be the majority partner.”

Sobering? Sure. Hopeless? Definitely not.

3


 

Over the 12 months since last September, U.S. stocks returned 15%, though the rise has not been a one-way ticket straight up. International markets have also posted strong returns, but lower than those of the broad U.S. market. The decision by United Kingdom voters in June to exit the European Union came as a surprise but caused market heartburn for only a few days.

In fixed income, yields remained extremely low—about 1.60% on the 10-year U.S. Treasury note at the end of September, after dipping below 1.40% over the summer. And bond yields in some international markets were negative.

Even this relatively small window of time illustrates a truism of the financial markets: There will always be segments that perform well and others that don’t. Saving more saves you from trying to control the uncontrollable—how economies and the markets perform. And it keeps you in control of one of the most vital parts of your investment program.

Although the “save more” logic is easy to grasp, it’s not always easy to follow. Bills, illness, the loss of a job—these can affect any of us.

But whatever our circumstances, figuring out how to save more is worth the effort. It requires that we make difficult decisions to forgo some consumption today to increase the likelihood of consuming (or consuming more) in the future. This is the very heart of investing. Sacrifices are never fun, so consider carrying them out systematically and in doses that you

Market Barometer      
    Average Annual Total Returns
    Periods Ended September 30, 2016
  One Three Five
  Year Years Years
Stocks      
Russell 1000 Index (Large-caps) 14.93% 10.78% 16.41%
Russell 2000 Index (Small-caps) 15.47 6.71 15.82
Russell 3000 Index (Broad U.S. market) 14.96 10.44 16.36
FTSE All-World ex US Index (International) 9.62 0.71 6.50
 
Bonds      
Bloomberg Barclays U.S. Aggregate Bond Index      
(Broad taxable market) 5.19% 4.03% 3.08%
Bloomberg Barclays Municipal Bond Index      
(Broad tax-exempt market) 5.58 5.54 4.48
Citigroup Three-Month U.S. Treasury Bill Index 0.20 0.06 0.06
 
CPI      
Consumer Price Index 1.46% 1.03% 1.25%

 

4


 

can be comfortable with—for instance, gradually getting up to the max in your IRA, or adding a percentage point or so to the amount you stash in your employer’s retirement plan. As a point of reference, we generally suggest that investors strive for a retirement savings rate of 12%–15%, including any employer contributions.

If you need more convincing about the wisdom of the “save more” course of action, it might be helpful to examine your alternatives. This list is by no means exhaustive, but it hits on a few of the big ones, and none are without risk.

• Reach for yield. With yields so low on many types of bonds, it’s tempting to find the corners of the fixed income market where payouts are juicier. But with the juice comes considerable risk. You need to be aware that you’d be taking on more risk—and how much more.

• Go all-in on a hot-performing asset class or fund. By now, you know better than that, right?

• Sit tight. This approach isn’t a terrible idea; it’s better than panicking and deciding to just “do something,” particularly if that means changing your approach in response to the market’s movements.

Here’s the inescapably challenging part of your partnership with the markets: In the short run, your “partner” is fickle, emotional, and wildly unpredictable. But in the long run, your partner is mostly rational and extremely helpful.

The best way to minimize your vulnerability to the market’s mood swings, and to maximize the benefit of your partner’s longer-term strengths, is to expect less and save more. Maybe the markets will deliver better-than-expected returns. Maybe they’ll be consistent with our more modest expectations. In either case, a higher savings rate can help put you in a better position to reach your goals.

As always, thank you for investing with Vanguard.

Sincerely,


F. William McNabb III
Chairman and Chief Executive Officer
October 18, 2016

5


 

Advisor’s Report

For the fiscal year ended September 30, 2016, the Capital Value Fund returned 11.36%. The fund’s performance reflects the management of the fund by Wellington Management Company llp, which will mark its 15th anniversary as the fund’s advisor in December.

As was announced in July, Peter Higgins, one of the two Wellington managers who had independently overseen a portion of the portfolio, no longer serves as an advisor. The remaining manager, David W. Palmer, now has sole responsibility for the portfolio.

Mr. Palmer has prepared the following discussion of the investment environment that existed during the 12-month period and of how the portfolio positioning reflects his assessment. These comments were prepared on October 17, 2016.

Portfolio Manager: David W. Palmer, CFA Senior Managing Director

We focus on stocks that trade at a discounted multiple to the broad market, based on current earnings or those we expect to materialize within a reasonable time horizon. Our approach searches for companies with pronounced negative sentiment, controversy, or perceived event risk that we believe, as a result of fundamental research and analysis, 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.

Investors experienced a wide range of economic and market ups and downs over the 12 months, culminating in a double-digit total return. The year included many mixed messages on the pace of global activity, such as when the European Central Bank and the Bank of Japan felt the need to push through additional policy easing—including negative interest rates and purchases of domestic securities—to encourage borrowing and spending in those regions.

Meanwhile, the U.S. Federal Reserve initiated its first interest rate increase in December, a move that was well-telegraphed. Stock prices started calendar 2016 on shaky footing, particularly for cyclical industries and financials, as investors worried about news from China, including the potential for a significant devaluation of the nation’s currency, the renminbi. Those concerns have abated since the February lows, and despite the temporary shock to equities from the June vote by the United Kingdom to exit the European Union, improving sentiment helped lift stocks nicely through the end of September.

In recent months, as the two separately managed portfolios were consolidated into one, we reduced the total number of holdings from 150 to 87.

6


 

The primary driver of the fund’s performance gap versus the Russell 3000 Value Index was security selection in the information technology, health care, and energy sectors. Strong stock selection in the consumer discretionary and materials sectors helped to offset some of the drag. Sector allocation helped relative returns, particularly the underweight allocation to financials and overweight allocations to materials and information technology. (Note that for the attribution analysis, real estate was included in the financial sector through August 31, when a new real estate sector was created under the Global Industry Classification Standard, bringing the number of GICS sectors to 11.)

Among individual stocks, Cobalt International Energy, an offshore energy explorer; SunEdison, a renewable energy producer; and Portola Pharmaceuticals, a developer of hematology-focused drugs, were the primary detractors from relative results. SunEdison and Portola Pharmaceuticals were eliminated from the portfolio. Top contributors to relative performance included Las Vegas Sands, the casino operator; Pioneer Natural Resources, a Permian Basin energy producer; and Tesaro, a developer of oncology drugs. Avoiding Wells Fargo, a large benchmark constituent, also benefited results; the banking and financial services provider has been scrutinized lately for its sales tactics.

Portfolio positioning shifted during the year, in part because of the fund structure changes, although we have also pivoted weightings to track where we see the greatest value emerging. At period-end, the largest portfolio overweights relative to the Russell 3000 Value benchmark were in the health care, consumer discretionary, and materials sectors. Health care stocks, in particular many in the pharmaceutical and biotech subsectors, have fallen notably out of favor with investors in 2016 as market participants have focused on industry-wide pricing pressures and as volume benefits from implementation of the Affordable Care Act have tailed off.

In addition, a more skeptical attitude toward future innovation potential has taken hold as some high-profile clinical trials have produced more nuanced or, in some cases, unexpected negative results. Our team’s outlook for health care is that companies demonstrating real innovation and those who can reduce systemic costs will reap benefits, to the detriment of companies offering me-too solutions or purely pricing-driven earnings growth.

Amid sharp swings in stock prices, we have built up our larger health care exposures along these twin fronts, favoring companies such as Bristol-Myers Squibb, Tesaro, Biogen, and Regeneron on the drug discovery side. On the cost-savings theme, we have identified attractive risk-reward balance in generics producers such as Teva Pharmaceutical and the recently controversial Mylan, and in urgent care outsourcer Envision Healthcare.

7


 

Within the consumer discretionary area, we have initiated holdings in several stocks, all of which have declined to attractively discounted valuation multiples for reasons we consider to be only temporary. For example, SES, the Luxembourg-based satellite communications concern, has come under pressure from sellers worried about the future of broadcast video and overcapacity in certain segments of the broadband data transmission market. We see the company as a good value for its legacy business, with high-growth potential coming out of its unique medium Earth orbit satellites, which are closer to the ground than geostationary satellites for TV. This technology provides fast broadband to cruise ships, offshore energy platforms, and other remote locations.

Delphi Automotive, an auto parts and systems supplier, also declined off its highs amid concerns about slowing global car sales. We believe that Delphi, which is trading at a wide discount to the market on consensus 2017 earnings, is attractively positioned in next-generation technologies for assisted driving and fully autonomous vehicles. The company’s balance sheet and cash generation capabilities, as a result of restructuring its legacy liabilities during the financial crisis, leave Delphi in solid shape to weather a downturn if current softness is a harbinger of lower industry demand. Ultimately, we believe Delphi stacks up well against other cyclicals, many of which have seen their year-to-date share price performance run well ahead of their earnings-growth prospects.

Our base case outlook for the coming year, in consultation with Wellington’s macroeconomics team, is for modest positive near-term growth, with incremental acceleration to a more constructive environment in 2017. At this late stage of the economic expansion, however, we acknowledge the many potential global shocks, policy missteps, and risk-off sentiment swings that could pop up at any time to derail this more favorable scenario.

For those reasons, we continue to monitor the debt levels and access to liquidity of the companies in the portfolio, with the goal of steering away from the market’s more highly levered companies. In the same way, we are also less charitable in our thinking toward those stocks that require significant sales volume recovery to navigate their way through any current difficulties.

We firmly believe that the portfolio today attractively balances an appropriate level of downside risk with a highly appealing level of upside revaluation potential, and we are grateful to the Capital Value shareholders for the opportunity to prove that balance will be a winning one in the future.

8


 

Capital Value Fund    
 
 
Fund Profile      
As of September 30, 2016    
 
 
Portfolio Characteristics    
      DJ
      U.S.
    Russell Total
    3000 Market
    Value FA
  Fund Index Index
Number of Stocks 87 2,025 3,850
Median Market Cap $26.7B $48.8B $51.8B
Price/Earnings Ratio 28.0x 21.9x 23.7x
Price/Book Ratio 1.7x 1.8x 2.8x
Return on Equity 13.2% 12.4% 16.6%
Earnings Growth      
Rate 5.6% 3.0% 7.6%
Dividend Yield 2.1% 2.5% 2.0%
Foreign Holdings 9.8% 0.0% 0.0%
Turnover Rate 134%
Ticker Symbol VCVLX
Expense Ratio1 0.50%
30-Day SEC Yield 1.76%
Short-Term Reserves 1.4%

 

Sector Diversification (% of equity exposure)

      DJ
      U.S.
    Russell Total
    3000 Market
    Value FA
  Fund Index Index
Consumer Discretionary 7.9% 5.3% 12.8%
Consumer Staples 1.2 8.4 8.7
Energy 13.6 12.8 6.7
Financials 22.3 23.9 13.3
Health Care 14.9 11.0 14.2
Industrials 8.0 9.7 10.3
Information Technology 11.2 10.1 20.7
Materials 5.7 3.0 3.3
Other 0.9 0.0 0.0
Real Estate 6.7 5.6 4.3
Telecommunication      
Services 1.6 3.7 2.4
Utilities 6.0 6.5 3.3

 

Volatility Measures    
  Russell DJ
  3000 U.S. Total
  Value Market
  Index FA Index
R-Squared 0.83 0.81
Beta 1.31 1.28

 

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)

MetLife Inc. Life & Health  
  Insurance 3.8%
Citigroup Inc. Diversified Banks 3.1
PNC Financial Services    
Group Inc. Regional Banks 2.5
Principal Financial Group Life & Health  
Inc. Insurance 2.4
Raymond James Investment Banking  
Financial Inc. & Brokerage 2.3
Cisco Systems Inc. Communications  
  Equipment 2.3
American Tower Corp. Specialized REITs 2.3
Mylan NV Pharmaceuticals 2.2
Anadarko Petroleum Oil & Gas Exploration  
Corp. & Production 2.2
CSX Corp. Railroads 2.1
Top Ten   25.2%

 

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 fiscal year ended September 30, 2016, the expense ratio was 0.25%.

9


 

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.

Cumulative Performance: September 30, 2006, Through September 30, 2016

Initial Investment of $10,000


See Financial Highlights for dividend and capital gains information.

10


 

Capital Value Fund

Fiscal-Year Total Returns (%): September 30, 2006, Through September 30, 2016


Capital Value Fund

Russell 3000 Value Index

11


 

Capital Value Fund

Financial Statements

Statement of Net Assets
As of September 30, 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 (98.5%)    
Consumer Discretionary (7.8%)  
  Las Vegas Sands Corp. 286,831 16,504
  SES SA Class A   555,506 13,626
  John Wiley & Sons Inc.    
  Class A   185,188 9,557
  Ralph Lauren Corp. Class A 89,928 9,095
  Delphi Automotive plc 117,100 8,352
* Toll Brothers Inc.   194,700 5,814
* Global Brands Group      
  Holding Ltd. 39,552,000 4,055
  Sky plc   300,240 3,479
  Melco Crown      
  Entertainment Ltd. ADR 146,200 2,355
        72,837
Consumer Staples (1.9%)    
  British American      
  Tobacco plc   168,732 10,791
  Coty Inc. Class A   279,094 6,559
        17,350
Energy (13.3%)      
  Anadarko Petroleum Corp. 320,427 20,302
  Halliburton Co.   366,220 16,436
  Canadian Natural      
  Resources Ltd.   378,491 12,127
  Marathon Oil Corp.   728,808 11,522
  Cabot Oil & Gas Corp. 436,232 11,255
  Pioneer Natural      
  Resources Co.   60,459 11,224
  Helmerich & Payne Inc. 115,018 7,741
* Diamondback Energy Inc. 72,732 7,022
* Southwestern Energy Co. 475,875 6,586
  HollyFrontier Corp.   215,572 5,281
  QEP Resources Inc.   262,026 5,117
  Hess Corp.   82,898 4,445
  National Oilwell Varco Inc. 65,051 2,390
*,^ Trican Well Service Ltd. 858,696 1,761
* Cobalt International      
  Energy Inc.   1,039,354 1,289
        124,498

 

      Market
      Value
    Shares ($000)
Financials (22.0%)    
  MetLife Inc. 796,736 35,399
  Citigroup Inc. 606,986 28,668
  PNC Financial Services    
  Group Inc. 262,635 23,661
  Principal Financial    
  Group Inc. 430,234 22,161
  Raymond James    
  Financial Inc. 374,745 21,814
  American International    
  Group Inc. 289,662 17,189
  Arthur J Gallagher & Co. 321,911 16,376
  M&T Bank Corp. 123,602 14,350
  JPMorgan Chase & Co. 198,086 13,191
  Unum Group 294,855 10,411
  Torchmark Corp. 32,172 2,055
      205,275
Health Care (14.7%)    
* Mylan NV 544,386 20,752
  McKesson Corp. 99,782 16,639
  Bristol-Myers Squibb Co. 292,326 15,762
* Allergan plc 62,252 14,337
  Teva Pharmaceutical    
  Industries Ltd. ADR 234,721 10,799
* Envision Healthcare    
  Holdings Inc. 473,335 10,541
  Merck & Co. Inc. 168,846 10,538
* Biogen Inc. 28,058 8,783
* TESARO Inc. 78,370 7,856
* Regeneron    
  Pharmaceuticals Inc. 15,000 6,030
  Eli Lilly & Co. 60,100 4,824
* MEDNAX Inc. 65,361 4,330
* Alder    
  Biopharmaceuticals Inc. 125,258 4,105
*,^ Novavax Inc. 852,396 1,773
      137,069

 

12


 

Capital Value Fund    
 
 
 
      Market
      Value
    Shares ($000)
Industrials (7.9%)    
  CSX Corp. 639,039 19,491
* IHS Markit Ltd. 403,947 15,168
* Genesee & Wyoming Inc.    
  Class A 194,660 13,422
  Eaton Corp. plc 139,691 9,179
  Sanwa Holdings Corp. 789,600 7,640
* Generac Holdings Inc. 122,935 4,463
  United Parcel Service Inc.    
  Class B 35,893 3,925
      73,288
Information Technology (11.0%)  
  Cisco Systems Inc. 677,382 21,486
* Alphabet Inc. Class A 20,640 16,596
  Skyworks Solutions Inc. 202,744 15,437
  Western Digital Corp. 182,006 10,642
  Samsung Electronics    
  Co. Ltd. 6,300 9,182
* ARRIS International plc 277,859 7,872
* Envestnet Inc. 205,167 7,478
  Silicon Motion Technology    
  Corp. ADR 95,129 4,927
  Lam Research Corp. 50,545 4,787
* Genpact Ltd. 195,700 4,687
      103,094
Materials (5.6%)    
  Celanese Corp. Class A 242,968 16,172
  Reliance Steel    
  & Aluminum Co. 178,631 12,867
  CF Industries Holdings Inc. 359,034 8,742
  CRH plc 214,974 7,128
  Bemis Co. Inc. 76,983 3,927
* Constellium NV Class A 520,383 3,747
      52,583
Other (0.2%)    
*,1 Allstar Co-Invest LLC    
  Private Placement NA 1,861
 
Real Estate (6.6%)    
  American Tower Corp. 189,567 21,484
  Columbia Property    
  Trust Inc. 533,512 11,945
  Host Hotels & Resorts Inc. 741,759 11,549
  STORE Capital Corp. 345,235 10,174
* Gores Holdings Inc.    
  Class A 448,300 4,842
  Boston Properties Inc. 12,000 1,636
      61,630

 

    Market
    Value
  Shares ($000)
Telecommunication Services (1.6%)  
Verizon    
Communications Inc. 284,840 14,806
 
Utilities (5.9%)    
PG&E Corp. 305,950 18,715
Exelon Corp. 496,609 16,532
OGE Energy Corp. 346,168 10,946
Sempra Energy 80,000 8,575
    54,768
Total Common Stocks    
(Cost $844,073)   919,059
Preferred Stocks (0.7%)    
*,2 Lithium Technologies    
Inc. Pfd. (Cost $5,828) 1,195,700 6,600
Temporary Cash Investments (1.6%)  
Money Market Fund (0.2%)    
3,4 Vanguard Market    
Liquidity Fund,    
0.640% 17,419 1,742
 
  Face  
  Amount  
  ($000)  
Repurchase Agreement (1.4%)  
RBS Securities, Inc.    
0.460%, 10/3/16 (Dated    
9/30/16, Repurchase Value  
$13,101,000, collateralized  
by U.S. Treasury Note/Bond  
0.500%, 1/31/17, with a    
value of $13,365,000) 13,100 13,100
Total Temporary Cash Investments  
(Cost $14,842)   14,842
Total Investments (100.8%)    
(Cost $864,743)   940,501

 

13


 

Capital Value Fund  
 
 
 
 
  Amount
  ($000)
Other Assets and Liabilities (-0.8%)  
Other Assets  
Investment in Vanguard 72
Receivables for Investment Securities Sold 6,897
Receivables for Accrued Income 1,485
Receivables for Capital Shares Issued 331
Other Assets 210
Total Other Assets 8,995
Liabilities  
Payables for Investment Securities  
Purchased (11,642)
Collateral for Securities on Loan (1,742)
Payables to Investment Advisor (45)
Payables for Capital Shares Redeemed (726)
Payables to Vanguard (2,143)
Other Liabilities (41)
Total Liabilities (16,339)
Net Assets (100%)  
Applicable to 81,151,995 outstanding  
$.001 par value shares of beneficial  
interest (unlimited authorization) 933,157
Net Asset Value Per Share $11.50

 

At September 30, 2016, net assets consisted of:
  Amount
  ($000)
Paid-in Capital 1,015,394
Undistributed Net Investment Income 9,068
Accumulated Net Realized Losses (167,195)
Unrealized Appreciation (Depreciation)  
Investment Securities 75,758
Forward Currency Contracts 143
Foreign Currencies (11)
Net Assets 933,157

 

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 $1,196,000.

1 Restricted security represents 0.2% of net assets. Shares not applicable for this private placement.

2 Restricted security represents 0.7% 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 $1,742,000 of collateral received for securities on loan. ADR—American Depositary Receipt.

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

14


 

Capital Value Fund  
 
 
Statement of Operations  
 
  Year Ended
  September 30, 2016
  ($000)
Investment Income  
Income  
Dividends1 16,139
Interest 7
Securities Lending—Net 1,278
Total Income 17,424
Expenses  
Investment Advisory Fees—Note B  
Basic Fee 2,203
Performance Adjustment (1,956)
The Vanguard Group—Note C  
Management and Administrative 1,914
Marketing and Distribution 219
Custodian Fees 73
Auditing Fees 35
Shareholders’ Reports 18
Trustees’ Fees and Expenses 2
Total Expenses 2,508
Expenses Paid Indirectly (16)
Net Expenses 2,492
Net Investment Income 14,932
Realized Net Gain (Loss)  
Investment Securities Sold (165,668)
Foreign Currencies and Forward Currency Contracts 820
Realized Net Gain (Loss) (164,848)
Change in Unrealized Appreciation (Depreciation)  
Investment Securities 254,347
Foreign Currencies and Forward Currency Contracts (45)
Change in Unrealized Appreciation (Depreciation) 254,302
Net Increase (Decrease) in Net Assets Resulting from Operations 104,386
1 Dividends are net of foreign withholding taxes of $248,000.  

 

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

15


 

Capital Value Fund    
 
 
Statement of Changes in Net Assets    
 
  Year Ended September 30,
  2016 2015
  ($000) ($000)
Increase (Decrease) in Net Assets    
Operations    
Net Investment Income 14,932 13,256
Realized Net Gain (Loss) (164,848) 130,824
Change in Unrealized Appreciation (Depreciation) 254,302 (352,612)
Net Increase (Decrease) in Net Assets Resulting from Operations 104,386 (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 100,481 216,336
Issued in Lieu of Cash Distributions 99,619 162,455
Redeemed (323,723) (723,255)
Net Increase (Decrease) from Capital Share Transactions (123,623) (344,464)
Total Increase (Decrease) (125,393) (725,259)
Net Assets    
Beginning of Period 1,058,550 1,783,809
End of Period2 933,157 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 $9,068,000 and $6,757,000.

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

16


 

Capital Value Fund          
 
 
Financial Highlights          
 
 
For a Share Outstanding     Year Ended September 30,
Throughout Each Period 2016 2015 2014 2013 2012
Net Asset Value, Beginning of Period $11.45 $15.32 $14.57 $10.58 $8.59
Investment Operations          
Net Investment Income .180 .1291 .1782 .138 .155
Net Realized and Unrealized Gain (Loss)          
on Investments 1.060 (2.330) 2.055 4.051 2.075
Total from Investment Operations 1.240 (2.201) 2.233 4.189 2.230
Distributions          
Dividends from Net Investment Income (.144) (.175) (.111) (.199) (.100)
Distributions from Realized Capital Gains (1.046) (1.494) (1.372) (.140)
Total Distributions (1.190) (1.669) (1.483) (.199) (.240)
Net Asset Value, End of Period $11.50 $11.45 $15.32 $14.57 $10.58
 
Total Return3 11.36% -15.67% 16.50% 40.21% 26.50%
 
Ratios/Supplemental Data          
Net Assets, End of Period (Millions) $933 $1,059 $1,784 $1,249 $659
Ratio of Total Expenses to Average Net Assets4 0.25% 0.50% 0.47% 0.41% 0.47%
Ratio of Net Investment Income to          
Average Net Assets 1.51% 0.93% 1.19%2 1.03% 1.42%
Portfolio Turnover Rate 134% 90% 90% 132% 123%

 

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 (0.20%), 0.06%, 0.02%, (0.05%), and 0.01%.

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

17


 

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. In the absence of a default, the collateral pledged or received by the fund cannot be repledged, resold or rehypothecated. 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 counter-party 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

18


 

Capital Value Fund

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 year ended September 30, 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, and in the absence of a default, such collateral cannot be repledged, resold or rehypothecated. 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 counter-parties. The master repurchase agreements provide that, in the event of a counterparty’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, 2013–2016), 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), 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

19


 

Capital Value Fund

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. During the term of the loan, the fund is entitled to all distributions made on or in respect of the loaned securities.

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 September 30, 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 year ended September 30, 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 $1,956,000 (0.20%) 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 September 30, 2016, the fund had contributed to Vanguard capital in the amount of $72,000, 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.

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 year ended September 30, 2016, these arrangements reduced the fund’s expenses by $16,000 (an annual rate of 0.00% of average net assets).

20


 

Capital Value Fund

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 1—Quoted prices in active markets for identical securities.

Level 2—Other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.).

Level 3—Significant 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 September 30, 2016, based on the inputs used to value them:

  Level 1 Level 2 Level 3
Investments ($000) ($000) ($000)
Common Stocks 861,297 55,901 1,861
Preferred Stocks 6,600
Temporary Cash Investments 1,742 13,100
Forward Currency Contracts—Assets 153
Forward Currency Contracts—Liabilities (10)
Total 863,039 69,144 8,461

 

F. At September 30, 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     Contract Amount (000)  Appreciation
  Settlement         (Depreciation)
Counterparty Date   Receive   Deliver ($000)
Deutsche Bank AG 12/21/16 USD 7,109 EUR 6,310 (8)
Barclays Bank plc 12/21/16 USD 5,788 GBP 4,340 153
Credit Suisse International 12/21/16 USD 2,369 EUR 2,103 (2)
            143
EUR—Euro.            
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.

21


 

Capital Value Fund

During the year ended September 30, 2016, the fund realized net foreign currency losses of $51,000, which decreased distributable net income for tax purposes; accordingly, such losses have been reclassified from accumulated net realized losses to undistributed net investment income. Certain of the fund’s investments are in securities considered to be passive foreign investment companies, for which any unrealized appreciation and/or realized gains are required to be included in distributable net income for tax purposes. During the year ended September 30, 2016, the fund realized gains on the sale of passive foreign investment companies of $276,000, which have been included in current and prior periods’ taxable income; accordingly, such gains have been reclassified from accumulated net realized losses to undistributed net investment income.

For tax purposes, at September 30, 2016, the fund had $11,307,000 of ordinary income available for distribution. The fund had available capital losses totaling $167,264,000 that may be carried forward indefinitely to offset future net capital gains.

At September 30, 2016, the cost of investment securities for tax purposes was $864,743,000. Net unrealized appreciation of investment securities for tax purposes was $75,758,000, consisting of unrealized gains of $112,450,000 on securities that had risen in value since their purchase and $36,692,000 in unrealized losses on securities that had fallen in value since their purchase.

H. During the year ended September 30, 2016, the fund purchased $1,317,966,000 of investment securities and sold $1,526,808,000 of investment securities, other than temporary cash investments.

I. Capital shares issued and redeemed were:    
  Year Ended September 30,
  2016 2015
  Shares Shares
  (000) (000)
Issued 9,076 15,385
Issued in Lieu of Cash Distributions 9,106 12,497
Redeemed (29,458) (51,913)
Net Increase (Decrease) in Shares Outstanding (11,276) (24,031)

 

J. Management has determined that no material events or transactions occurred subsequent to September 30, 2016, that would require recognition or disclosure in these financial statements.

22


 

Report of Independent Registered Public Accounting Firm

To the Board of Trustees of Vanguard Malvern Funds and the Shareholders of Vanguard Capital Value Fund: In our opinion, the accompanying statement of net assets and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Vanguard Capital Value Fund (constituting a separate portfolio of Vanguard Malvern Funds, hereafter referred to as the “Fund”) at September 30, 2016, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as “financial statements”) are the responsibility of the Fund’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at September 30, 2016 by correspondence with the custodians and brokers and by agreement to the underlying ownership records of the transfer agent, provide a reasonable basis for our opinion.

/s/PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
November 10, 2016

Special 2016 tax information (unaudited) for Vanguard Capital Value Fund

This information for the fiscal year ended September 30, 2016, is included pursuant to provisions of the Internal Revenue Code.

The fund distributed $66,042,000 as capital gain dividends (20% rate gain distributions) to shareholders during the fiscal year.

For nonresident alien shareholders, 100% of short-term capital gain dividends distributed by the fund are qualified short-term capital gains.

The fund distributed $14,768,000 of qualified dividend income to shareholders during the fiscal year.

For corporate shareholders, 78.9% of investment income (dividend income plus short-term gains, if any) qualifies for the dividends-received deduction.

23


 

Your Fund’s After-Tax Returns

This table presents returns for your fund both before and after taxes. The after-tax returns are shown in two ways: (1) assuming that an investor owned the fund during the entire period and paid taxes on the fund’s distributions, and (2) assuming that an investor paid taxes on the fund’s distributions and sold all shares at the end of each period.

Calculations are based on the highest individual federal income tax and capital gains tax rates in effect at the times of the distributions and the hypothetical sales. State and local taxes were not considered. After-tax returns reflect any qualified dividend income, using actual prior-year figures and estimates for 2016. (In the example, returns after the sale of fund shares may be higher than those assuming no sale. This occurs when the sale would have produced a capital loss. The calculation assumes that the investor received a tax deduction for the loss.)

Please note that your actual after-tax returns will depend on your tax situation and may differ from those shown. Also note that if you own the fund in a tax-deferred account, such as an individual retirement account or a 401(k) plan, this information does not apply to you. Such accounts are not subject to current taxes.

Finally, keep in mind that a fund’s performance—whether before or after taxes—does not guarantee future results.

Average Annual Total Returns: Capital Value Fund      
Periods Ended September 30, 2016      
  One Five Ten
  Year Years Years
Returns Before Taxes 11.36% 14.18% 5.72%
Returns After Taxes on Distributions 8.25 11.65 4.08
Returns After Taxes on Distributions and Sale of Fund Shares 7.89 10.64 4.20

 

24


 

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.

25


 

Six Months Ended September 30, 2016      
  Beginning Ending Expenses
  Account Value Account Value Paid During
Capital Value Fund 3/31/2016 9/30/2016 Period
Based on Actual Fund Return $1,000.00 $1,100.48 $1.47
Based on Hypothetical 5% Yearly Return 1,000.00 1,023.60 1.42

 

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 0.28%. 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).

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.

28


 

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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. The mailing address of the trustees and officers is P.O. Box 876, Valley Forge, PA 19482. 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

F. William McNabb III

Born 1957. Trustee Since July 2009. Chairman of the Board. Principal Occupation(s) During the Past Five Years and Other Experience: Chairman of the Board of The Vanguard Group, Inc., and of each of the investment companies served by The Vanguard Group, since January 2010; Director of The Vanguard Group since 2008; Chief Executive Officer and President of The Vanguard Group, and of each of the investment companies served by The Vanguard Group, since 2008; Director of Vanguard Marketing Corporation; Managing Director of The Vanguard Group (1995–2008).

IndependentTrustees

Emerson U. Fullwood

Born 1948. Trustee Since January 2008. Principal Occupation(s) During the Past Five Years and Other Experience: Executive Chief Staff and Marketing Officer for North America and Corporate Vice President (retired 2008) of Xerox Corporation (document management products and services); Executive in Residence and 2009–2010 Distinguished Minett Professor at the Rochester Institute of Technology; Lead Director of SPX FLOW, Inc. (multi-industry manufacturing); Director of the United Way of Rochester, the University of Rochester Medical Center, Monroe Community College Foundation, North Carolina A&T University, and Roberts Wesleyan College.

Rajiv L. Gupta

Born 1945. Trustee Since December 2001.2 Principal Occupation(s) During the Past Five Years and Other Experience: Chairman and Chief Executive Officer (retired 2009) and President (2006–2008) of Rohm and Haas Co. (chemicals); Director of Tyco International plc (diversified manufacturing and services), HP Inc. (printer and personal computer manufacturing), and Delphi Automotive plc (automotive components); Senior Advisor at New Mountain Capital.

Amy Gutmann

Born 1949. Trustee Since June 2006. Principal Occupation(s) During the Past Five Years and Other Experience: President of the University of Pennsylvania; Christopher H. Browne Distinguished Professor of Political Science, School of Arts and Sciences, and Professor of Communication, Annenberg School for Communication, with secondary faculty appointments in the Department of Philosophy, School of Arts and Sciences, and at the Graduate School of Education, University of Pennsylvania; Trustee of the National Constitution Center; Chair of the Presidential Commission for the Study of Bioethical Issues.

JoAnn Heffernan Heisen

Born 1950. Trustee Since July 1998. Principal Occupation(s) During the Past Five Years and Other Experience: Corporate Vice President and Chief Global Diversity Officer (retired 2008) and 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

Born 1949. Trustee Since October 2009. Principal Occupation(s) During the Past Five Years and Other Experience: President and Chief Operating Officer (retired 2009) of Cummins Inc. (industrial machinery); Chairman of the Board of Hillenbrand, Inc. (specialized consumer services), and of Oxfam America; Director of SKF AB (industrial machinery), Hyster-Yale Materials Handling, Inc. (forklift trucks), the Lumina Foundation for Education, and the V Foundation for Cancer Research; Member of the Advisory Council for the College of Arts and Letters and of the Advisory Board to the Kellogg Institute for International Studies, both at the University of Notre Dame.

Mark Loughridge

Born 1953. Trustee Since March 2012. Principal Occupation(s) During the Past Five Years and Other Experience: Senior Vice President and Chief Financial Officer (retired 2013) at IBM (information technology services); Fiduciary Member of IBM’s Retirement Plan Committee (2004–2013); Director of the Dow Chemical Company; Member of the Council on Chicago Booth.

Scott C. Malpass

Born 1962. Trustee Since March 2012. Principal Occupation(s) During the Past Five Years and Other Experience: Chief Investment Officer and Vice President at the University of Notre Dame; Assistant Professor of Finance at the Mendoza College of Business at Notre Dame; Member of the Notre Dame 403(b) Investment Committee, the Board of Advisors for Spruceview Capital Partners, and the Investment Advisory Committee of Major League Baseball; Board Member of TIFF Advisory Services, Inc., and Catholic Investment Services, Inc. (investment advisors).

André F. Perold

Born 1952. Trustee Since December 2004. Principal Occupation(s) During the Past Five Years and Other Experience: George Gund Professor of Finance and Banking, Emeritus at the Harvard Business School (retired 2011); Chief Investment Officer and Managing Partner of HighVista Strategies LLC (private investment firm); Director of Rand Merchant Bank; Overseer of the Museum of Fine Arts Boston.

Peter F. Volanakis

Born 1955. Trustee Since July 2009. Principal Occupation(s) During the Past Five Years and Other Experience: President and Chief Operating Officer (retired 2010) of Corning Incorporated (communications equipment); Chairman of the Board of Trustees of Colby-Sawyer College; Member of the Advisory Board of the Norris Cotton Cancer Center.

Executive Officers

Glenn Booraem

Born 1967. Treasurer Since May 2015. Principal Occupation(s) During the Past Five Years and Other Experience: Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies served by The Vanguard Group; Controller of each of the investment companies served by The Vanguard Group (2010–2015); Assistant Controller of each of the investment companies served by The Vanguard Group (2001–2010).

Thomas J. Higgins

Born 1957. Chief Financial Officer Since September 2008. Principal Occupation(s) During the Past Five Years and Other Experience: Principal of The Vanguard Group, Inc.; Chief Financial Officer of each of the investment companies served by The Vanguard Group; Treasurer of each of the investment companies served by The Vanguard Group (1998–2008).

Peter Mahoney

Born 1974. Controller Since May 2015. Principal Occupation(s) During the Past Five Years and Other Experience: Head of Global Fund Accounting at The Vanguard Group, Inc.; Controller of each of the investment companies served by The Vanguard Group; Head of International Fund Services at The Vanguard Group (2008–2014).

Anne E. Robinson

Born 1970. Secretary Since September 2016. Principal Occupation(s) During the Past Five Years and Other Experience: Managing Director of The Vanguard Group, Inc.; General Counsel of The Vanguard Group; Secretary of The Vanguard Group and of each of the investment companies served by The Vanguard Group; Director and Senior Vice President of Vanguard Marketing Corporation; Managing Director and General Counsel of Global Cards and Consumer Services at Citigroup (2014–2016); Counsel at American Express (2003–2014).

Vanguard Senior Management Team

Mortimer J. Buckley Kathleen C. Gubanich Martha G. King John T. Marcante Chris D. McIsaac

James M. Norris Thomas M. Rampulla Glenn W. Reed Karin A. Risi Michael Rollings

 

Chairman Emeritus and Senior Advisor John J. Brennan

Chairman, 1996–2009

Chief Executive Officer and President, 1996–2008

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
Valley Forge, PA 19482-2600

 

Connect with Vanguard® > vanguard.com

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Direct Investor Account Services > 800-662-2739  
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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.
 
  Q3280 112016

 



Annual Report | September 30, 2016

Vanguard Short-Term Inflation-Protected

Securities Index Fund


 

A new format, unwavering commitment

As you begin reading this report, you’ll notice that we’ve made some improvements to the opening sections—based on feedback from you, our clients.

Page 1 starts with a new ”Your Fund’s Performance at a Glance,” a concise, handy summary of how your fund performed during the period.

In the renamed ”Chairman’s Perspective,” Bill McNabb will focus on enduring principles and investment insights.

We’ve modified some tables, and eliminated some redundancy, but we haven’t removed any information.

At Vanguard, we’re always looking for better ways to communicate and to help you make sound investment decisions. Thank you for entrusting your assets to us.

Contents  
Your Fund’s Performance at a Glance. 1
Chairman’s Perspective. 3
Fund Profile. 6
Performance Summary. 7
Financial Statements. 10
About Your Fund’s Expenses. 24
Glossary. 26

 

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: No matter what language you speak, Vanguard has one consistent message and set of principles. Our primary focus is on you, our clients. We conduct our business with integrity as a faithful steward of your assets. This message is shown translated into seven languages, reflecting our expanding global presence.


 

Your Fund’s Performance at a Glance

• For the year ended September 30, 2016, Vanguard Short-Term Inflation-Protected Securities Index Fund returned 2.48% for Investor Shares, slightly behind its benchmark (+2.62%). The fund’s return was behind that of peer funds, a group that includes longer-maturity holdings, which returned more than shorter-maturity Treasury inflation-protected securities (TIPS).

• Global investors sought higher yields from U.S.-backed bonds, compared with those from sovereign bonds in other developed nations. TIPS’ popularity lifted their prices and lowered their yields. Investor Shares’ 30-day SEC yield began the fiscal year at 0.37% and ended at –0.40%.

• A measure of expected inflation over the next five years (the gap between nominal and TIPS yields) widened from 1.12% to 1.42%.

• To minimize the risk of overdistributing income—a recordkeeping headache for investors—the fund has withheld income distributions since December 2014. Distributions will resume when sufficient income is available.

Total Returns: Fiscal Year Ended September 30, 2016        
  30-Day SEC Income Capital Total
  Yield Returns Returns Returns
Vanguard Short-Term Inflation-Protected Securities Index Fund      
Investor Shares -0.40% 0.43% 2.05% 2.48%
ETF Shares -0.29      
Market Price       2.56
Net Asset Value       2.54
Admiral™ Shares -0.31 0.51 2.00 2.51
Institutional Shares -0.27 0.53 2.02 2.55
Bloomberg Barclays U.S. Treasury Inflation-Protected        
Securities (TIPS) 0–5 Year Index       2.62
Inflation-Protected Bond Funds Average       5.78

 

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.

1


 

Total Returns: Inception Through September 30, 2016  
  Average
  Annual Return
Short-Term Inflation-Protected Securities Index Fund Investor Shares (Returns since inception:  
10/16/2012) 0.04%
Bloomberg Barclays U.S. Treasury Inflation-Protected Securities (TIPS) 0–5 Year Index 0.10
Inflation-Protected Bond Funds Average -0.64
Inflation-Protected Bond Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company.  

 

The figures shown represent past performance, which is not a guarantee of future results. (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.

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 fiscal year ended September 30, 2016, the expense ratios were 0.16% for Investor Shares, 0.07% for ETF Shares, 0.07% for Admiral Shares, and 0.04% 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.

2


 

Chairman’s Perspective


Bill McNabb
Chairman and Chief Executive Officer

Dear Shareholder,

If you think you’ve had reason to feel uneasy about the investment environment lately, you’re not imagining things. In just the past few months, we’ve seen economic uncertainty, intense political polarization, and super-low bond yields. Yet at the same time, the stock market kept pushing higher.

In this confusing and sometimes contradictory climate, you may be asking yourself a question that I hear often: How do I make sense of all this, keep investing, and still get a good night’s sleep?

As with any problem, there are multiple ways to go at it. But there’s one approach in particular that is simple, straightforward, and nearly foolproof: Save more money. Not only can saving more give you a greater sense of control over your investment plan, it can help compensate for long-term returns that, in our estimation, could fall short of historical averages.

I love the way one of our investment pros put it. Fran Kinniry this summer told The Wall Street Journal, “Investing is always a partnership between you and the markets.” He explained that the markets carried more than their fair share of the weight for a couple of decades, through the 1990s, providing outsized returns that made the investor’s half of the partnership relatively light work. “But now you are going to have to be the majority partner.”

Sobering? Sure. Hopeless? Definitely not.

3


 

Over the 12 months since last September, U.S. stocks returned 15%, though the rise has not been a one-way ticket straight up. International markets have also posted strong returns, but lower than those of the broad U.S. market. The decision by United Kingdom voters in June to exit the European Union came as a surprise but caused market heartburn for only a few days.

In fixed income, yields remained extremely low—about 1.60% on the 10-year U.S. Treasury note at the end of September, after dipping below 1.40% over the summer. And bond yields in some international markets were negative.

Even this relatively small window of time illustrates a truism of the financial markets: There will always be segments that perform well and others that don’t. Saving more saves you from trying to control the uncontrollable—how economies and the markets perform. And it keeps you in control of one of the most vital parts of your investment program.

Although the “save more” logic is easy to grasp, it’s not always easy to follow. Bills, illness, the loss of a job—these can affect any of us.

But whatever our circumstances, figuring out how to save more is worth the effort. It requires that we make difficult decisions to forgo some consumption today to increase the likelihood of consuming (or consuming more) in the future. This is the very heart of investing. Sacrifices are never fun, so consider carrying them out systematically and in doses that you

Market Barometer      
    Average Annual Total Returns
    Periods Ended September 30, 2016
  One Three Five
  Year Years Years
Stocks      
Russell 1000 Index (Large-caps) 14.93% 10.78% 16.41%
Russell 2000 Index (Small-caps) 15.47 6.71 15.82
Russell 3000 Index (Broad U.S. market) 14.96 10.44 16.36
FTSE All-World ex US Index (International) 9.62 0.71 6.50
 
Bonds      
Bloomberg Barclays U.S. Aggregate Bond Index      
(Broad taxable market) 5.19% 4.03% 3.08%
Bloomberg Barclays Municipal Bond Index      
(Broad tax-exempt market) 5.58 5.54 4.48
Citigroup Three-Month U.S. Treasury Bill Index 0.20 0.06 0.06
 
CPI      
Consumer Price Index 1.46% 1.03% 1.25%

 

4


 

can be comfortable with—for instance, gradually getting up to the max in your IRA, or adding a percentage point or so to the amount you stash in your employer’s retirement plan. As a point of reference, we generally suggest that investors strive for a retirement savings rate of 12%–15%, including any employer contributions.

If you need more convincing about the wisdom of the “save more” course of action, it might be helpful to examine your alternatives. This list is by no means exhaustive, but it hits on a few of the big ones, and none are without risk.

• Reach for yield. With yields so low on many types of bonds, it’s tempting to find the corners of the fixed income market where payouts are juicier. But with the juice comes considerable risk. You need to be aware that you’d be taking on more risk—and how much more.

• Go all-in on a hot-performing asset class or fund. By now, you know better than that, right?

• Sit tight. This approach isn’t a terrible idea; it’s better than panicking and deciding to just “do something,” particularly if that means changing your approach in response to the market’s movements.

Here’s the inescapably challenging part of your partnership with the markets: In the short run, your “partner” is fickle, emotional, and wildly unpredictable. But in the long run, your partner is mostly rational and extremely helpful.

The best way to minimize your vulnerability to the market’s mood swings, and to maximize the benefit of your partner’s longer-term strengths, is to expect less and save more. Maybe the markets will deliver better-than-expected returns. Maybe they’ll be consistent with our more modest expectations. In either case, a higher savings rate can help put you in a better position to reach your goals.

As always, thank you for investing with Vanguard.

Sincerely,


F. William McNabb III
Chairman and Chief Executive Officer
October 18, 2016

5


 

Short-Term Inflation-Protected Securities Index Fund

Fund Profile
As of September 30, 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 -0.40% -0.29% -0.31% -0.27%

 

Financial Attributes    
    Bloomberg  
    Barclays Bloomberg
    TIPS Barclays
    0-5 Year Aggregate
  Fund Index Bond Index
Number of Bonds 15 15 9,908
Yield to Maturity      
(before expenses) 1.1% 0.9% 2.0%
Average Coupon 0.8% 0.8% 3.1%
Average Duration 2.7 years 2.7 years 5.5 years
Average Effective      
Maturity 2.7 years 2.7 years 7.7 years
Short-Term      
Reserves 0.0%
 
Sector Diversification (% of portfolio)  
Treasury/Agency     100.0%

 

Volatility Measures    
  Bloomberg  
  Barclays Bloomberg
  TIPS Barclays
  0-5 Year Aggregate Bond
  Index Index
R-Squared 0.99 0.31
Beta 1.00 0.37

 

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.

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 17.7%
1 - 3 Years 36.5
3 - 5 Years 45.8

 

 

 

 

 

 

1 The expense ratios shown are from the prospectus dated January 27, 2016, and represent estimated costs for the current fiscal year. For the fiscal
year ended September 30, 2016, the expense ratios were 0.16% for Investor Shares, 0.07% for ETF Shares, 0.07% for Admiral Shares, and 0.04% 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.

6


 

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.


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

"Since Inception" performance is calculated from the Investor Shares’ inception date for both the fund and its comparative standards.

    Since Final Value
  One Inception of a $10,000
  Year (10/12/2012) Investment
Short-Term Inflation-Protected Securities      
Index Fund ETF Shares Net Asset Value 2.54% 0.12% $10,048
Bloomberg Barclays U.S. Treasury      
Inflation-Protected Securities (TIPS) 0–5 Year      
Index 2.62 0.09 10,037
Bloomberg Barclays U.S. Aggregate Bond      
Index 5.19 2.55 11,050

 

"Since Inception" performance is calculated from the ETF Shares’ inception date for both the fund and its comparative standards.

See Financial Highlights for dividend and capital gains information.

7


 

Short-Term Inflation-Protected Securities Index Fund      
 
 
 
 
  Average Annual Total Returns  
  Periods Ended September 30, 2016  
    Since Final Value
  One Inception of a $10,000
  Year (10/16/2012) Investment
Short-Term Inflation-Protected Securities      
Index Fund Admiral Shares 2.51% 0.12% $10,049
Bloomberg Barclays U.S. Treasury      
Inflation-Protected Securities (TIPS) 0–5 Year      
Index 2.62 0.10 10,039
Bloomberg Barclays U.S. Aggregate Bond      
Index 5.19 2.59 11,066

 

"Since Inception" performance is calculated from the Admiral Shares’ inception date for both the fund and its comparative standards.

    Since Final Value
  One Inception of a $5,000,000
  Year (10/17/2012) Investment
Short-Term Inflation-Protected Securities      
Index Fund Institutional Shares 2.55% 0.16% $5,032,606
Bloomberg Barclays U.S. Treasury      
Inflation-Protected Securities (TIPS) 0–5 Year      
Index 2.62 0.12 5,022,804
Bloomberg Barclays U.S. Aggregate Bond      
Index 5.19 2.65 5,545,592

 

"Since Inception" performance is calculated from the Institutional Shares’ inception date for both the fund and its comparative standards.

Cumulative Returns of ETF Shares: October 12, 2012, Through September 30, 2016  
 
    Since
  One Inception
  Year (10/12/2012)
Short-Term Inflation-Protected Securities Index Fund    
ETF Shares Market Price 2.56% 0.60%
Short-Term Inflation-Protected Securities Index Fund    
ETF Shares Net Asset Value 2.54 0.48
Bloomberg Barclays U.S. Treasury    
Inflation-Protected Securities (TIPS) 0–5 Year Index 2.62 0.37

 

"Since Inception" performance is calculated from the ETF Shares’ inception date for both the fund and its comparative standards.

8


 

Short-Term Inflation-Protected Securities Index Fund      
 
 
 
Fiscal-Year Total Returns (%): October 16, 2012, Through September 30, 2016  
        Bloomberg
        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 0.43 2.05 2.48 2.62

 

9


 

Short-Term Inflation-Protected Securities Index Fund

Financial Statements

Statement of Net Assets
As of September 30, 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 (99.8%)        
U.S. Government Securities (99.8%)        
United States Treasury Inflation Indexed Bonds 2.375% 1/15/17 515,943 621,062
United States Treasury Inflation Indexed Bonds 0.125% 4/15/17 1,554,295 1,651,172
United States Treasury Inflation Indexed Bonds 2.625% 7/15/17 455,252 544,783
United States Treasury Inflation Indexed Bonds 1.625% 1/15/18 486,113 575,407
United States Treasury Inflation Indexed Bonds 0.125% 4/15/18 1,759,586 1,851,253
United States Treasury Inflation Indexed Bonds 1.375% 7/15/18 493,055 573,361
United States Treasury Inflation Indexed Bonds 2.125% 1/15/19 456,791 545,115
United States Treasury Inflation Indexed Bonds 0.125% 4/15/19 1,766,730 1,845,331
United States Treasury Inflation Indexed Bonds 1.875% 7/15/19 517,381 626,125
United States Treasury Inflation Indexed Bonds 1.375% 1/15/20 633,560 748,567
United States Treasury Inflation Indexed Bonds 0.125% 4/15/20 1,766,486 1,850,711
United States Treasury Inflation Indexed Bonds 1.250% 7/15/20 986,839 1,163,791
United States Treasury Inflation Indexed Bonds 1.125% 1/15/21 1,131,429 1,325,192
United States Treasury Inflation Indexed Bonds 0.125% 4/15/21 1,057,995 1,097,406
United States Treasury Inflation Indexed Bonds 0.625% 7/15/21 1,236,985 1,387,201
Total U.S. Government and Agency Obligations (Cost $16,283,343)     16,406,477
 
      Shares  
Temporary Cash Investment (0.0%)        
Money Market Fund (0.0%)        
1 Vanguard Market Liquidity Fund (Cost $7,332) 0.640%   73,315 7,332
Total Investments (99.8%) (Cost $16,290,675)       16,413,809

 

10


 

Short-Term Inflation-Protected Securities Index Fund  
 
 
 
  Amount
  ($000)
Other Assets and Liabilities (0.2%)  
Other Assets  
Investment in VGI 1,240
Receivables for Accrued Income 28,578
Receivables for Capital Shares Issued 66,966
Total Other Assets 96,784
Liabilities  
Payables for Investment Securities Purchased (54,904)
Payables for Capital Shares Redeemed (9,121)
Payables to Vanguard (3,472)
Other Liabilities (3,820)
Total Liabilities (71,317)
Net Assets (100%) 16,439,276
 
 
At September 30, 2016, net assets consisted of:  
  Amount
  ($000)
Paid-in Capital 16,343,344
Undistributed Net Investment Income 60,698
Accumulated Net Realized Losses (87,900)
Unrealized Appreciation (Depreciation) 123,134
Net Assets 16,439,276
 
Investor Shares—Net Assets  
Applicable to 204,971,094 outstanding $.001 par value shares of  
beneficial interest (unlimited authorization) 5,088,425
Net Asset Value Per Share—Investor Shares $24.83
 
ETF Shares—Net Assets  
Applicable to 49,966,620 outstanding $.001 par value shares of  
beneficial interest (unlimited authorization) 2,477,915
Net Asset Value Per Share—ETF Shares $49.59
 
Admiral Shares—Net Assets  
Applicable to 135,582,158 outstanding $.001 par value shares of  
beneficial interest (unlimited authorization) 3,373,410
Net Asset Value Per Share—Admiral Shares $24.88

 

11


 

Short-Term Inflation-Protected Securities Index Fund  
 
 
 
  Amount
  ($000)
Institutional Shares—Net Assets  
Applicable to 220,862,912 outstanding $.001 par value shares of  
beneficial interest (unlimited authorization) 5,499,526
Net Asset Value Per Share—Institutional Shares $24.90

 

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.

12


 

Short-Term Inflation-Protected Securities Index Fund  
 
 
Statement of Operations  
 
  Year Ended
  September 30, 2016
  ($000)
Investment Income  
Income  
Interest1 83,024
Total Income 83,024
Expenses  
The Vanguard Group—Note B  
Investment Advisory Services 391
Management and Administrative—Investor Shares 6,298
Management and Administrative—ETF Shares 1,127
Management and Administrative—Admiral Shares 1,585
Management and Administrative—Institutional Shares 1,552
Marketing and Distribution—Investor Shares 970
Marketing and Distribution—ETF Shares 165
Marketing and Distribution—Admiral Shares 304
Marketing and Distribution—Institutional Shares 128
Custodian Fees 81
Auditing Fees 76
Shareholders’ Reports—Investor Shares 54
Shareholders’ Reports—ETF Shares 58
Shareholders’ Reports—Admiral Shares 43
Shareholders’ Reports—Institutional Shares 5
Trustees’ Fees and Expenses 7
Total Expenses 12,844
Net Investment Income 70,180
Realized Net Gain (Loss)  
Investment Securities Sold1 (8,553)
Futures Contracts (3,611)
Realized Net Gain (Loss) (12,164)
Change in Unrealized Appreciation (Depreciation) of Investment Securities 307,524
Net Increase (Decrease) in Net Assets Resulting from Operations 365,540

 

1 Interest income and realized net gain (loss) from an affiliated company of the fund were $671,000 and $1,000, respectively.

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

13


 

Short-Term Inflation-Protected Securities Index Fund    
 
 
Statement of Changes in Net Assets    
 
  Year Ended September 30,
  2016 2015
  ($000) ($000)
Increase (Decrease) in Net Assets    
Operations    
Net Investment Income 70,180 (52,791)
Realized Net Gain (Loss) (12,164) (12,913)
Change in Unrealized Appreciation (Depreciation) 307,524 (73,400)
Net Increase (Decrease) in Net Assets Resulting from Operations 365,540 (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 443,641 110,230
ETF Shares 583,428 532,047
Admiral Shares 1,173,766 640,240
Institutional Shares 1,539,781 1,193,894
Net Increase (Decrease) from Capital Share Transactions 3,740,616 2,476,411
Total Increase (Decrease) 4,106,156 2,256,469
Net Assets    
Beginning of Period 12,333,120 10,076,651
End of Period1 16,439,276 12,333,120

 

1 Net Assets—End of Period includes undistributed (overdistributed) net investment income of $60,698,000 and ($11,083,000).

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

14


 

Short-Term Inflation-Protected Securities Index Fund        
 
 
Financial Highlights        
 
 
Investor Shares        
        Oct. 16,
        20121 to
  Year Ended 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 . 080 2 (.131) .183 .015
Net Realized and Unrealized Gain (Loss) on Investments .520 (.206) (.189) (.241)
Total from Investment Operations .600 (.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 $24.83 $24.23 $24.74 $24.75
 
Total Return 3 2.48% -1.36% -0.02% -0.91%
 
Ratios/Supplemental Data        
Net Assets, End of Period (Millions) $5,088 $4,532 $4,517 $3,702
Ratio of Total Expenses to Average Net Assets 0.16% 0.17% 0.20% 0.20%4
Ratio of Net Investment Income to Average Net Assets 0.42% (0.53%) 0.88% 0.01%4
Portfolio Turnover Rate5 28% 26% 18% 13%

 

1      Inception.
2      Calculated based on average shares outstanding.
3      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.
4      Annualized.
5      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        
 
 
ETF Shares        
        Oct. 12,
        20121 to
  Year Ended 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 . 2512 (.210) .414 .065
Net Realized and Unrealized Gain (Loss) on Investments .979 (.415) (.371) (.483)
Total from Investment Operations 1.230 (.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 $49.59 $48.36 $49.38 $49.36
 
Total Return 2.54% -1.26% 0.09% -0.84%
 
Ratios/Supplemental Data        
Net Assets, End of Period (Millions) $2,478 $1,838 $1,336 $967
Ratio of Total Expenses to Average Net Assets 0.07% 0.08% 0.10% 0.10%3
Ratio of Net Investment Income to Average Net Assets 0.51% (0.44%) 0.98% 0.11%3
Portfolio Turnover Rate4 28% 26% 18% 13%

 

1      Inception.
2      Calculated based on average shares outstanding.
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        
 
 
Admiral Shares        
        Oct. 16,
        20121 to
  Year Ended 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 .149 2 (.105) .209 .025
Net Realized and Unrealized Gain (Loss) on Investments .461 (.197) (.195) (.229)
Total from Investment Operations .610 (.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 $24.88 $24.27 $24.77 $24.77
 
Total Return 3 2.51% -1.22% 0.06% -0.82%
 
Ratios/Supplemental Data        
Net Assets, End of Period (Millions) $3,373 $2,126 $1,518 $776
Ratio of Total Expenses to Average Net Assets 0.07% 0.08% 0.10% 0.10%4
Ratio of Net Investment Income to Average Net Assets 0.51% (0.44%) 0.98% 0.11%4
Portfolio Turnover Rate5 28% 26% 18% 13%

 

1      Inception.
2      Calculated based on average shares outstanding.
3      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.
4      Annualized.
5      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        
 
 
Financial Highlights        
 
 
Institutional Shares        
        Oct. 17,
        20121 to
  Year Ended 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 .139 2 (.099) .215 .026
Net Realized and Unrealized Gain (Loss) on Investments .481 (.196) (.189) (.220)
Total from Investment Operations .620 (.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 $24.90 $24.28 $24.78 $24.77
 
Total Return 3 2.55% -1.19% 0.11% -0.78%
 
Ratios/Supplemental Data        
Net Assets, End of Period (Millions) $5,500 $3,837 $2,706 $1,262
Ratio of Total Expenses to Average Net Assets 0.04% 0.05% 0.07% 0.07%4
Ratio of Net Investment Income to Average Net Assets 0.54% (0.41%) 1.01% 0.14%4
Portfolio Turnover Rate5 28% 26% 18% 13%

 

1      Inception.
2      Calculated based on average shares outstanding.
3      Total returns do not include transaction fees that may have applied in the periods shown. Fund prospectuses provide information about any applicable transaction fees.
4      Annualized.
5      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.

18


 

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 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 year ended September 30, 2016, the fund’s average investments in long and short futures contracts 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 September 30, 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, 2013–2016), and has concluded that no provision for federal income tax is required in the fund’s financial statements.

19


 

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 September 30, 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 September 30, 2016, the fund had contributed to Vanguard capital in the amount of $1,240,000, representing 0.01% of the fund’s net assets and 0.50% of Vanguard’s capitalization. The fund’s trustees and officers are also directors and employees, respectively, of Vanguard.

20


 

Short-Term Inflation-Protected Securities Index Fund

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 1—Quoted prices in active markets for identical securities.

Level 2—Other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.).

Level 3—Significant 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 September 30, 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 16,406,477
Temporary Cash Investments 7,332
Total 7,332 16,406,477

 

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 year ended September 30, 2016, the fund realized gains of $1,585,000 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 undistributed net investment income. Deferred inflation and amortization adjustments to securities held at September 30, 2016, totaling $3,759,000 are reflected as a reduction of the amount of tax-basis unrealized appreciation of investment securities.

During the year ended September 30, 2016, the fund realized $27,979,000 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.

21


 

Short-Term Inflation-Protected Securities Index Fund

For tax purposes, at September 30, 2016, the fund had $67,282,000 of ordinary income available for distribution and available capital losses totaling $85,072,000 that may be carried forward indefinitely to offset future net capital gains.

At September 30, 2016, the cost of investment securities for tax purposes was $16,297,230,000. Net unrealized appreciation of investment securities for tax purposes was $116,579,000, consisting of unrealized gains of $122,385,000 on securities that had risen in value since their purchase and $5,806,000 in unrealized losses on securities that had fallen in value since their purchase.

E. During the year ended September 30, 2016, the fund purchased $7,861,740,000 of investment securities and sold $4,318,089,000 of investment securities, other than temporary cash investments. Purchases and sales include $912,178,000 and $321,172,000, 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:      
      Year Ended September 30,
    2016   2015
  Amount Shares Amount Shares
  ($000) (000) ($000) (000)
Investor Shares        
Issued 873,920 35,645 829,293 34,019
Issued in Lieu of Cash Distributions 31,998 1,322
Redeemed (430,279) (17,713) (751,061) (30,890)
Net Increase (Decrease)—Investor Shares 443,641 17,932 110,230 4,451
ETF Shares        
Issued 955,615 19,579 738,501 15,206
Issued in Lieu of Cash Distributions
Redeemed (372,187) (7,625) (206,454) (4,250)
Net Increase (Decrease)—ETF Shares 583,428 11,954 532,047 10,956
Admiral Shares        
Issued 1,743,525 71,273 1,106,772 45,451
Issued in Lieu of Cash Distributions 10,779 445
Redeemed (569,759) (23,298) (477,311) (19,565)
Net Increase (Decrease)—Admiral Shares 1,173,766 47,975 640,240 26,331
Institutional Shares        
Issued 2,316,657 94,659 1,866,248 76,449
Issued in Lieu of Cash Distributions 24,697 1,019
Redeemed (776,876) (31,833) (697,051) (28,609)
Net Increase (Decrease)—Institutional Shares 1,539,781 62,826 1,193,894 48,859

 

G. Management has determined that no material events or transactions occurred subsequent to September 30, 2016, that would require recognition or disclosure in these financial statements.

22


 

Report of Independent Registered Public Accounting Firm

To the Board of Trustees of Vanguard Malvern Funds and the Shareholders of Vanguard Short-Term Inflation-Protected Securities Index Fund: In our opinion, the accompanying statement of net assets and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Vanguard Short-Term Inflation-Protected Securities Index Fund (constituting a separate portfolio of Vanguard Malvern Funds, hereafter referred to as the “Fund”) at September 30, 2016, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the periods indicated, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as “financial statements”) are the responsibility of the Fund’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at September 30, 2016 by correspondence with the custodian and brokers and by agreement to the underlying ownership records of the transfer agent, provide a reasonable basis for our opinion.

/s/PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
November 15, 2016

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 September 30, 2016      
  Beginning Ending Expenses
  Account Value Account Value Paid During
Short-Term Inflation-Protected Securities Index Fund 3/31/2016 9/30/2016 Period
Based on Actual Fund Return      
Investor Shares $1,000.00 $1,010.58 $0.85
ETF Shares 1,000.00 1,011.01 0.30
Admiral Shares 1,000.00 1,010.97 0.35
Institutional Shares 1,000.00 1,011.37 0.15
Based on Hypothetical 5% Yearly Return      
Investor Shares $1,000.00 $1,024.15 $0.86
ETF Shares 1,000.00 1,024.70 0.30
Admiral Shares 1,000.00 1,024.65 0.35
Institutional Shares 1,000.00 1,024.85 0.15

 

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 0.17% for Investor Shares, 0.06% for ETF Shares, 0.07% for Admiral Shares, and 0.03% 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).

25


 

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.

26


 

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.)

27


 

Vanguard Short-Term Inflation-Protected Securities Index Fund is not sponsored, endorsed, issued, sold, or promoted by Barclays Risk Analytics and Index Solutions Limited 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 Bloomberg 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.

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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. The mailing address of the trustees and officers is P.O. Box 876, Valley Forge, PA 19482. 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

F. William McNabb III

Born 1957. Trustee Since July 2009. Chairman of the Board. Principal Occupation(s) During the Past Five Years and Other Experience: Chairman of the Board of The Vanguard Group, Inc., and of each of the investment companies served by The Vanguard Group, since January 2010; Director of The Vanguard Group since 2008; Chief Executive Officer and President of The Vanguard Group, and of each of the investment companies served by The Vanguard Group, since 2008; Director of Vanguard Marketing Corporation; Managing Director of The Vanguard Group (1995–2008).

IndependentTrustees

Emerson U. Fullwood

Born 1948. Trustee Since January 2008. Principal Occupation(s) During the Past Five Years and Other Experience: Executive Chief Staff and Marketing Officer for North America and Corporate Vice President (retired 2008) of Xerox Corporation (document management products and services); Executive in Residence and 2009–2010 Distinguished Minett Professor at the Rochester Institute of Technology; Lead Director of SPX FLOW, Inc. (multi-industry manufacturing); Director of the United Way of Rochester, the University of Rochester Medical Center, Monroe Community College Foundation, North Carolina A&T University, and Roberts Wesleyan College.

Rajiv L. Gupta

Born 1945. Trustee Since December 2001.2 Principal Occupation(s) During the Past Five Years and Other Experience: Chairman and Chief Executive Officer (retired 2009) and President (2006–2008) of Rohm and Haas Co. (chemicals); Director of Tyco International plc (diversified manufacturing and services), HP Inc. (printer and personal computer manufacturing), and Delphi Automotive plc (automotive components); Senior Advisor at New Mountain Capital.

Amy Gutmann

Born 1949. Trustee Since June 2006. Principal Occupation(s) During the Past Five Years and Other Experience: President of the University of Pennsylvania; Christopher H. Browne Distinguished Professor of Political Science, School of Arts and Sciences, and Professor of Communication, Annenberg School for Communication, with secondary faculty appointments in the Department of Philosophy, School of Arts and Sciences, and at the Graduate School of Education, University of Pennsylvania; Trustee of the National Constitution Center; Chair of the Presidential Commission for the Study of Bioethical Issues.

JoAnn Heffernan Heisen

Born 1950. Trustee Since July 1998. Principal Occupation(s) During the Past Five Years and Other Experience: Corporate Vice President and Chief Global Diversity Officer (retired 2008) and 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

Born 1949. Trustee Since October 2009. Principal Occupation(s) During the Past Five Years and Other Experience: President and Chief Operating Officer (retired 2009) of Cummins Inc. (industrial machinery); Chairman of the Board of Hillenbrand, Inc. (specialized consumer services), and of Oxfam America; Director of SKF AB (industrial machinery), Hyster-Yale Materials Handling, Inc. (forklift trucks), the Lumina Foundation for Education, and the V Foundation for Cancer Research; Member of the Advisory Council for the College of Arts and Letters and of the Advisory Board to the Kellogg Institute for International Studies, both at the University of Notre Dame.

Mark Loughridge

Born 1953. Trustee Since March 2012. Principal Occupation(s) During the Past Five Years and Other Experience: Senior Vice President and Chief Financial Officer (retired 2013) at IBM (information technology services); Fiduciary Member of IBM’s Retirement Plan Committee (2004–2013); Director of the Dow Chemical Company; Member of the Council on Chicago Booth.

Scott C. Malpass

Born 1962. Trustee Since March 2012. Principal Occupation(s) During the Past Five Years and Other Experience: Chief Investment Officer and Vice President at the University of Notre Dame; Assistant Professor of Finance at the Mendoza College of Business at Notre Dame; Member of the Notre Dame 403(b) Investment Committee, the Board of Advisors for Spruceview Capital Partners, and the Investment Advisory Committee of Major League Baseball; Board Member of TIFF Advisory Services, Inc., and Catholic Investment Services, Inc. (investment advisors).

André F. Perold

Born 1952. Trustee Since December 2004. Principal Occupation(s) During the Past Five Years and Other Experience: George Gund Professor of Finance and Banking, Emeritus at the Harvard Business School (retired 2011); Chief Investment Officer and Managing Partner of HighVista Strategies LLC (private investment firm); Director of Rand Merchant Bank; Overseer of the Museum of Fine Arts Boston.

Peter F. Volanakis

Born 1955. Trustee Since July 2009. Principal Occupation(s) During the Past Five Years and Other Experience: President and Chief Operating Officer (retired 2010) of Corning Incorporated (communications equipment); Chairman of the Board of Trustees of Colby-Sawyer College; Member of the Advisory Board of the Norris Cotton Cancer Center.

Executive Officers

Glenn Booraem

Born 1967. Treasurer Since May 2015. Principal Occupation(s) During the Past Five Years and Other Experience: Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies served by The Vanguard Group; Controller of each of the investment companies served by The Vanguard Group (2010–2015); Assistant Controller of each of the investment companies served by The Vanguard Group (2001–2010).

Thomas J. Higgins

Born 1957. Chief Financial Officer Since September 2008. Principal Occupation(s) During the Past Five Years and Other Experience: Principal of The Vanguard Group, Inc.; Chief Financial Officer of each of the investment companies served by The Vanguard Group; Treasurer of each of the investment companies served by The Vanguard Group (1998–2008).

Peter Mahoney

Born 1974. Controller Since May 2015. Principal Occupation(s) During the Past Five Years and Other Experience: Head of Global Fund Accounting at The Vanguard Group, Inc.; Controller of each of the investment companies served by The Vanguard Group; Head of International Fund Services at The Vanguard Group (2008–2014).

Anne E. Robinson

Born 1970. Secretary Since September 2016. Principal Occupation(s) During the Past Five Years and Other Experience: Managing Director of The Vanguard Group, Inc.; General Counsel of The Vanguard Group; Secretary of The Vanguard Group and of each of the investment companies served by The Vanguard Group; Director and Senior Vice President of Vanguard Marketing Corporation; Managing Director and General Counsel of Global Cards and Consumer Services at Citigroup (2014–2016); Counsel at American Express (2003–2014).

Vanguard Senior Management Team

Mortimer J. Buckley Kathleen C. Gubanich Martha G. King John T. Marcante Chris D. McIsaac

James M. Norris Thomas M. Rampulla Glenn W. Reed Karin A. Risi Michael Rollings

 

Chairman Emeritus and Senior Advisor John J. Brennan

Chairman, 1996–2009

Chief Executive Officer and President, 1996–2008

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
Valley Forge, PA 19482-2600

 

Connect with Vanguard® > vanguard.com

Fund Information > 800-662-7447  
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.
 
  Q19670 112016

 



Annual Report | September 30, 2016

Vanguard Core Bond Fund


 

A new format, unwavering commitment

As you begin reading this report, you’ll notice that we’ve made some improvements to the opening sections—based on feedback from you, our clients.

Page 1 starts with a new ”Your Fund’s Performance at a Glance,” a concise, handy summary of how your fund performed during the period.

In the renamed ”Chairman’s Perspective,” Bill McNabb will focus on enduring principles and investment insights.

We’ve modified some tables, and eliminated some redundancy, but we haven’t removed any information.

At Vanguard, we’re always looking for better ways to communicate and to help you make sound investment decisions. Thank you for entrusting your assets to us.

Contents  
Your Fund’s Performance at a Glance. 1
Chairman’s Perspective. 2
Advisor’s Report. 5
Fund Profile. 8
Performance Summary. 9
Financial Statements. 11
About Your Fund’s Expenses. 49
Glossary. 51

 

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: No matter what language you speak, Vanguard has one consistent message and set of principles. Our primary focus is on you, our clients. We conduct our business with integrity as a faithful steward of your assets. This message is shown translated into seven languages, reflecting our expanding global presence.


 

Your Fund’s Performance at a Glance

• Vanguard Core Bond Fund has returned well over 3% since its launch this spring, outpacing its benchmark and edging ahead of the average return of its peers.

• Demand for U.S. taxable bonds benefited from concerns about global growth, the ability of central banks to lift inflation, and the “Brexit” vote. The Federal Reserve’s decision to leave rates unchanged and U.S. bonds’ comparatively high yields for international investors also helped.

• The fund’s holdings in asset-backed securities and commercial mortgage-backed securities boosted relative performance.

• Its favoring of BBB-rated bonds also contributed.

• Corporate bonds did well as yields fell and credit spreads tightened. Selection among the bonds of banks, insurance companies, real estate investment trusts, and technology companies added value.

• The fund’s allocation to inflation-protected securities was modestly positive.

Total Returns: Period Ended September 30, 2016        
  30-Day SEC Income Capital Since
  Yield Returns Returns Inception
Vanguard Core Bond Fund        
Investor Shares (Inception: 3/28/2016) 1.81% 0.97% 2.60% 3.57%
Admiral™ Shares (Inception: 3/28/2016) 1.91 1.02 2.65 3.67
Bloomberg Barclays U.S. Aggregate Float Adjusted Index       3.31
Core Bond Funds Average       3.54

 

Core 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.

Benchmark returns are calculated from the fund's inception date.

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 September 30, 2016, the fund’s expense ratios were 0.25% for Investor Shares and 0.15% 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.

1


 

Chairman’s Perspective


Bill McNabb
Chairman and Chief Executive Officer

Dear Shareholder,

If you think you’ve had reason to feel uneasy about the investment environment lately, you’re not imagining things. In just the past few months, we’ve seen economic uncertainty, intense political polarization, and super-low bond yields. Yet at the same time, the stock market kept pushing higher.

In this confusing and sometimes contradictory climate, you may be asking yourself a question that I hear often: How do I make sense of all this, keep investing, and still get a good night’s sleep?

As with any problem, there are multiple ways to go at it. But there’s one approach in particular that is simple, straightforward, and nearly foolproof: Save more money. Not only can saving more give you a greater sense of control over your investment plan, it can help compensate for long-term returns that, in our estimation, could fall short of historical averages.

I love the way one of our investment pros put it. Fran Kinniry this summer told The Wall Street Journal, “Investing is always a partnership between you and the markets.” He explained that the markets carried more than their fair share of the weight for a couple of decades, through the 1990s, providing outsized returns that made the investor’s half of the partnership relatively light work. “But now you are going to have to be the majority partner.”

Sobering? Sure. Hopeless? Definitely not.

2


 

Over the 12 months since last September, U.S. stocks returned 15%, though the rise has not been a one-way ticket straight up. International markets have also posted strong returns, but lower than those of the broad U.S. market. The decision by United Kingdom voters in June to exit the European Union came as a surprise but caused market heartburn for only a few days.

In fixed income, yields remained extremely low—about 1.60% on the 10-year U.S. Treasury note at the end of September, after dipping below 1.40% over the summer. And bond yields in some international markets were negative.

Even this relatively small window of time illustrates a truism of the financial markets: There will always be segments that perform well and others that don’t. Saving more saves you from trying to control the uncontrollable—how economies and the markets perform. And it keeps you in control of one of the most vital parts of your investment program.

Although the “save more” logic is easy to grasp, it’s not always easy to follow. Bills, illness, the loss of a job—these can affect any of us.

But whatever our circumstances, figuring out how to save more is worth the effort. It requires that we make difficult decisions to forgo some consumption today to increase the likelihood of consuming (or consuming more) in the future. This is the very heart of investing. Sacrifices are never fun, so consider carrying them out systematically and in doses that you

Market Barometer      
    Average Annual Total Returns
    Periods Ended September 30, 2016
  One Three Five
  Year Years Years
Stocks      
Russell 1000 Index (Large-caps) 14.93% 10.78% 16.41%
Russell 2000 Index (Small-caps) 15.47 6.71 15.82
Russell 3000 Index (Broad U.S. market) 14.96 10.44 16.36
FTSE All-World ex US Index (International) 9.62 0.71 6.50
 
Bonds      
Bloomberg Barclays U.S. Aggregate Bond Index      
(Broad taxable market) 5.19% 4.03% 3.08%
Bloomberg Barclays Municipal Bond Index      
(Broad tax-exempt market) 5.58 5.54 4.48
Citigroup Three-Month U.S. Treasury Bill Index 0.20 0.06 0.06
 
CPI      
Consumer Price Index 1.46% 1.03% 1.25%

 

3


 

can be comfortable with—for instance, gradually getting up to the max in your IRA, or adding a percentage point or so to the amount you stash in your employer’s retirement plan. As a point of reference, we generally suggest that investors strive for a retirement savings rate of 12%–15%, including any employer contributions.

If you need more convincing about the wisdom of the “save more” course of action, it might be helpful to examine your alternatives. This list is by no means exhaustive, but it hits on a few of the big ones, and none are without risk.

• Reach for yield. With yields so low on many types of bonds, it’s tempting to find the corners of the fixed income market where payouts are juicier. But with the juice comes considerable risk. You need to be aware that you’d be taking on more risk—and how much more.

• Go all-in on a hot-performing asset class or fund. By now, you know better than that, right?

• Sit tight. This approach isn’t a terrible idea; it’s better than panicking and deciding to just “do something,” particularly if that means changing your approach in response to the market’s movements.

Here’s the inescapably challenging part of your partnership with the markets: In the short run, your “partner” is fickle, emotional, and wildly unpredictable. But in the long run, your partner is mostly rational and extremely helpful.

The best way to minimize your vulnerability to the market’s mood swings, and to maximize the benefit of your partner’s longer-term strengths, is to expect less and save more. Maybe the markets will deliver better-than-expected returns. Maybe they’ll be consistent with our more modest expectations. In either case, a higher savings rate can help put you in a better position to reach your goals.

As always, thank you for investing with Vanguard.

Sincerely,


F. William McNabb III
Chairman and Chief Executive Officer
October 18, 2016

4


 

Advisor’s Report

Since its launch on March 28, 2016, Vanguard Core Bond Fund returned 3.57% for Investor Shares and 3.67% for Admiral Shares. Those performances were a little better than the 3.31% return of the benchmark (the Bloomberg Barclays U.S. Aggregate Float Adjusted Index) and the average return of 3.54% for peer funds.

The investment environment

Britain’s vote to leave the European Union caught global capital markets off guard. Stocks showed some nervousness ahead of the referendum, then tumbled in the immediate aftermath of the vote, known as “Brexit,” before regaining much of their lost ground by the end of June. Despite credit rating agency downgrades, yields of U.K. government bonds headed lower. So did those of most developed-market government bonds as investors sought out assets perceived to be less risky.

Another support for bonds over the period was accommodative monetary policy. The European Central Bank kept its overnight interest rate on banks’ excess reserves below zero and continued buying sovereign and corporate bonds with the aim of keeping borrowing costs low. In July, the Bank of Japan increased its asset purchases. And in August, the Bank of England cut interest rates to an all-time low and expanded its bond-buying program.

Stateside, the Federal Reserve pushed out the timing of further short-term rate hikes. Ongoing concerns about weak growth abroad and uncertainty about the ramifications of Brexit helped stay the Fed’s hand in June. Although the markets thought rates might rise in September, policymakers again chose to stand pat, citing further scope for improvement in employment and inflation.

This environment was positive for U.S. government bonds. Demand from yield-starved investors—both domestic and international—drove U.S. Treasury yields lower, especially those of longer-dated securities. From the fund’s inception to the close of the period, the bellwether 10-year U.S. Treasury yield fell about 30 basis points to 1.60%.

Investment-grade corporate bonds also did well; the average spread between their yields and those of Treasuries ground 26 basis points tighter to 138 basis points. (A basis point is one-hundredth of a percentage point.) The spreads of bonds issued by companies in basic industries and energy in particular narrowed significantly.

Management of the fund

An overweighted allocation to securitized debt added value. Included in that category are commercial mortgage-backed securities—pooled mortgages on commercial properties, which performed well. Asset-backed securities, another segment of securitized debt typically backed by auto loans, credit-card debt, and student loans, made a smaller contribution.

5


 

The spread in yields between corporate bonds and Treasuries narrowed as investors grew comfortable with taking on higher risk for more yield. Lower-rated investment-grade bonds outperformed their higher-rated counterparts, which favored our tilt toward BBB-rated bonds.

Overall, our corporate bond holdings made a solid contribution. Security selection in financials was strong, notably among banks, insurance companies, and real estate investment trusts.

We also benefited from the strength in industrials early on by adding debt issued by energy and metals and mining companies. These became attractively valued because of the slump in commodity prices and the dimmer outlook for global growth. Although our timing was good, our underweighted allocation to industrials dragged on the relative performance of our corporate bond holdings. A slight overweighting of emerging-market bonds made a positive contribution even though their spreads had already tightened significantly before the launch of the fund.

Our portfolio also included Treasury Inflation-Protected Securities, which are not part of the benchmark index. Because we believed inflation would edge higher, we felt TIPS offered value relative to nominal Treasury bonds. Some of the factors supporting that view included the Fed’s holding rates lower for longer, wages ticking higher, some improvement in the price of oil, and the prospect of fiscal stimulus through infrastructure spending. The return from this allocation was modestly positive.

We kept the fund’s average duration close to that of the benchmark index. (Duration is a measure of sensitivity, measured in years, of a fund’s holdings to changes in interest rates.) It stood at 5.8 years at the end of the period.

Outlook

The U.S. economy looks set to remain on relatively solid footing. The labor market should achieve the Fed’s full employment target. Job creation has slowed from last year, but continuing wage gains could boost demand and push inflation higher. Current low mortgage rates and muted inflation are likely to support home buying, mortgage refinancing, and consumer spending. These trends should help the economy grow at a modest rate.

In formulating our inflation outlook, we remain positive about underlying trends when we exclude the highly volatile commodity prices from most measures. Oil market imbalances have depressed energy prices during the past two years but appear to be moving toward balance. They should provide a modest uplift to headline inflation in the coming year.

U.S. monetary policy should remain cautious and accommodative. No matter when the Fed makes its next rate hike, we believe its short-term rate target isn’t likely to go above 1% over the next few years.

6


 

Central bank policy in the United Kingdom, the Eurozone, and China looks set to remain accommodative in the face of weak or slowing growth. This should keep U.S. yields attractive to international investors. Given that, and our outlook for modest growth and inflation at home, we also don’t expect to see a material rise in government bond yields farther out along the curve.

With regard to corporate bonds, we continue to hold significant positions in very liquid assets. This should give us the flexibility to take advantage of any dislocations in pricing that may arise if volatility picks up.

Whatever the markets may bring, our experienced team of portfolio managers, traders, and credit analysts will continue to seek out opportunities to add to the fund’s performance.

Portfolio Managers:

Brian W. Quigley

Gemma Wright-Casparius, Principal

Gregory S. Nassour, CFA, Principal

Vanguard Fixed Income Group

October 25, 2016

7


 

Core Bond Fund  
 
 
Fund Profile    
As of September 30, 2016    
 
Share-Class Characteristics  
 
  Investor Admiral
  Shares Shares
Ticker Symbol VCORX VCOBX
Expense Ratio1 0.25% 0.15%
30-Day SEC Yield 1.81% 1.91%
 
 
Financial Attributes    
    Bloomberg
    Barclays U.S.
    Aggregate
    Float Adjusted
  Fund Index
Number of Bonds 789 9,908
Yield to Maturity    
(before expenses) 2.1% 2.0%
Average Coupon 3.0% 3.1%
Average Duration 5.8 years 5.8 years
Average Effective    
Maturity 7.6 years 8.0 years
Short-Term    
Reserves 5.9%

 

Sector Diversification (% of portfolio)  
Asset-Backed 7.5%
Commercial Mortgage-Backed 4.1
Finance 10.8
Foreign 3.5
Government Mortgage-Backed 22.2
Industrial 12.8
Treasury/Agency 36.3
Utilities 2.5
Other 0.3

 

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 4.1%
1 - 3 Years 17.9
3 - 5 Years 32.9
5 - 7 Years 12.5
7 - 10 Years 17.3
10 - 20 Years 5.1
20 - 30 Years 10.0
Over 30 Years 0.2

 

Distribution by Credit Quality (% of portfolio)

U.S. Government 51.2%
Aaa 10.2
Aa 3.9
A 10.2
Baa 17.1
Ba 0.4
B 0.2
Not Rated 6.8

 

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 September 30, 2016, the expense ratios were 0.25% for Investor Shares and 0.15% 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.


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

"Since Inception" performance is calculated from the Investor Shares’ inception date for both the fund and its comparative standards.

  Since Final Value
  Inception of a $50,000
  (3/28/2016) Investment
Core Bond Fund Admiral Shares 3.67% $51,837
Bloomberg Barclays U.S. Aggregate Float    
Adjusted Index 3.31 51,653

 

"Since Inception" performance is calculated from the Admiral Shares’ inception date for both the fund and its comparative standards.

See Financial Highlights for dividend and capital gains information.

9


 

Core Bond Fund

Fiscal-Period Total Returns (%): March 28, 2016, Through September 30, 2016

        Bloomberg
        Barclays U.S.
        Aggregate
        Float Adjusted
      Investor Shares Index
Fiscal Year Income Returns Capital Returns Total Returns Total Returns
2016 0.97% 2.60% 3.57% 3.31%

 

10


 

Core Bond Fund

Financial Statements

Statement of Net Assets
As of September 30, 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 (58.8%)        
U.S. Government Securities (26.4%)        
United States Treasury Inflation Indexed Bonds 0.125% 4/15/17 22,000 23,371
United States Treasury Inflation Indexed Bonds 2.625% 7/15/17 6,144 7,352
United States Treasury Inflation Indexed Bonds 0.125% 4/15/21 4,661 4,835
United States Treasury Inflation Indexed Bonds 0.625% 1/15/26 7,843 8,365
United States Treasury Inflation Indexed Bonds 0.125% 7/15/26 193 196
United States Treasury Note/Bond 0.875% 11/15/17 8,500 8,516
United States Treasury Note/Bond 0.875% 5/31/18 50 50
United States Treasury Note/Bond 2.250% 7/31/18 44 45
United States Treasury Note/Bond 0.750% 8/31/18 950 950
United States Treasury Note/Bond 1.500% 12/31/18 1,200 1,218
United States Treasury Note/Bond 1.125% 1/15/19 6,000 6,039
United States Treasury Note/Bond 1.500% 1/31/19 800 812
United States Treasury Note/Bond 0.750% 2/15/19 6,600 6,587
United States Treasury Note/Bond 1.375% 2/28/19 1,500 1,519
United States Treasury Note/Bond 1.000% 3/15/19 4,500 4,517
United States Treasury Note/Bond 1.625% 3/31/19 432 440
United States Treasury Note/Bond 0.875% 4/15/19 3,400 3,402
United States Treasury Note/Bond 1.375% 8/31/20 1,025 1,038
United States Treasury Note/Bond 1.375% 9/30/20 650 658
United States Treasury Note/Bond 2.000% 9/30/20 2,500 2,590
United States Treasury Note/Bond 1.375% 10/31/20 650 658
United States Treasury Note/Bond 1.750% 10/31/20 3,900 4,002
United States Treasury Note/Bond 1.625% 11/30/20 650 664
United States Treasury Note/Bond 2.000% 11/30/20 1,000 1,037
United States Treasury Note/Bond 1.750% 12/31/20 1,586 1,628
United States Treasury Note/Bond 1.375% 1/31/21 2,400 2,426
United States Treasury Note/Bond 2.125% 1/31/21 700 729
United States Treasury Note/Bond 2.000% 2/28/21 800 830
United States Treasury Note/Bond 1.250% 3/31/21 2,000 2,011
United States Treasury Note/Bond 2.250% 4/30/21 2,300 2,413
United States Treasury Note/Bond 2.000% 5/31/21 2,050 2,128
United States Treasury Note/Bond 2.125% 8/15/21 3,000 3,133
United States Treasury Note/Bond 1.750% 1/31/23 500 512
United States Treasury Note/Bond 1.500% 2/28/23 1,000 1,008
United States Treasury Note/Bond 1.500% 3/31/23 980 987
United States Treasury Note/Bond 1.750% 5/15/23 5,500 5,625
United States Treasury Note/Bond 1.625% 5/31/23 1,000 1,015

 

11


 

Core Bond Fund        
 
 
 
      Face Market
    Maturity Amount Value
  Coupon Date ($000) ($000)
United States Treasury Note/Bond 2.500% 8/15/23 6,500 6,966
United States Treasury Note/Bond 2.750% 11/15/23 244 266
United States Treasury Note/Bond 2.125% 5/15/25 1,650 1,726
United States Treasury Note/Bond 2.000% 8/15/25 500 518
United States Treasury Note/Bond 2.250% 11/15/25 4,560 4,817
United States Treasury Note/Bond 1.625% 2/15/26 2,468 2,474
United States Treasury Note/Bond 1.625% 5/15/26 4,735 4,745
United States Treasury Note/Bond 6.500% 11/15/26 200 292
United States Treasury Note/Bond 6.125% 8/15/29 1,000 1,505
United States Treasury Note/Bond 6.250% 5/15/30 400 618
United States Treasury Note/Bond 5.375% 2/15/31 400 584
United States Treasury Note/Bond 4.500% 2/15/36 1,450 2,044
1 United States Treasury Note/Bond 4.750% 2/15/37 2,850 4,143
United States Treasury Note/Bond 5.000% 5/15/37 608 912
United States Treasury Note/Bond 4.250% 5/15/39 600 824
United States Treasury Note/Bond 3.750% 8/15/41 650 838
United States Treasury Note/Bond 3.125% 11/15/41 600 700
United States Treasury Note/Bond 3.125% 2/15/42 650 759
United States Treasury Note/Bond 3.000% 5/15/42 6,600 7,545
United States Treasury Note/Bond 3.625% 8/15/43 200 255
United States Treasury Note/Bond 2.875% 8/15/45 1,550 1,732
United States Treasury Note/Bond 3.000% 11/15/45 2,742 3,139
2 United States Treasury Note/Bond 2.500% 2/15/46 4,150 4,305
United States Treasury Note/Bond 2.500% 5/15/46 2,800 2,908
United States Treasury Note/Bond 2.250% 8/15/46 1,900 1,872
        169,793
Agency Bonds and Notes (10.2%)        
† AID-Ukraine 1.471% 9/29/21 2,100 2,109
3 Federal Home Loan Banks 0.875% 6/29/18 2,200 2,201
3 Federal Home Loan Banks 0.625% 8/7/18 100 100
3 Federal Home Loan Banks 0.875% 10/1/18 2,500 2,499
3 Federal Home Loan Banks 0.875% 8/5/19 3,700 3,687
3 Federal Home Loan Banks 1.000% 9/26/19 3,250 3,248
3 Federal Home Loan Banks 1.125% 7/14/21 1,500 1,490
4 Federal Home Loan Mortgage Corp. 0.750% 4/9/18 300 300
4 Federal Home Loan Mortgage Corp. 0.875% 10/12/18 870 869
4 Federal Home Loan Mortgage Corp. 0.875% 7/19/19 6,050 6,031
4 Federal Home Loan Mortgage Corp. 1.125% 8/12/21 2,000 1,983
4 Federal National Mortgage Assn. 1.000% 2/26/19 2,500 2,504
4 Federal National Mortgage Assn. 1.000% 8/28/19 1,900 1,899
4 Federal National Mortgage Assn. 0.000% 10/9/19 9,600 9,240
4 Federal National Mortgage Assn. 1.875% 12/28/20 600 617
4 Federal National Mortgage Assn. 1.250% 8/17/21 2,900 2,892
4 Federal National Mortgage Assn. 1.875% 9/24/26 5,600 5,578
3 Financing Corp. 0.000% 11/11/17 3,000 2,973
Private Export Funding Corp. 5.450% 9/15/17 500 522
Private Export Funding Corp. 2.250% 12/15/17 3,000 3,048
Private Export Funding Corp. 4.375% 3/15/19 128 138
Private Export Funding Corp. 1.450% 8/15/19 2,715 2,741
Private Export Funding Corp. 2.300% 9/15/20 150 156
Private Export Funding Corp. 3.550% 1/15/24 1,300 1,446
Residual Funding Corp. Principal Strip 0.000% 10/15/20 2,000 1,900
Resolution Funding Corp. Interest Strip 0.000% 1/15/27 600 480
Resolution Funding Corp. Interest Strip 0.000% 4/15/27 1,800 1,427
Resolution Funding Corp. Interest Strip 0.000% 7/15/27 794 623

 

12


 

Core Bond Fund        
 
 
 
        Face Market
      Maturity Amount Value
    Coupon Date ($000) ($000)
  Resolution Funding Corp. Interest Strip 0.000% 10/15/27 794 619
  Resolution Funding Corp. Interest Strip 0.000% 4/15/28 3,000 2,289
          65,609
Conventional Mortgage-Backed Securities (20.3%)        
4,5,6 Fannie Mae Pool 2.000% 11/1/31 5,000 5,062
4,5,6 Fannie Mae Pool 2.500% 2/1/28–11/1/31 12,696 13,133
4,5,6 Fannie Mae Pool 3.000% 2/1/27–11/25/46 7,466 7,841
4,5 Fannie Mae Pool 3.500% 3/1/27–11/1/46 14,031 14,873
4,5 Fannie Mae Pool 4.000% 8/1/39–7/1/46 19,195 20,714
4,5,6 Fannie Mae Pool 4.500% 1/1/41–10/1/46 4,561 5,065
4,5 Fannie Mae Pool 5.000% 3/1/38–2/1/45 8,718 9,814
4,5 Fannie Mae Pool 6.000% 5/1/37 1,134 1,313
4,5,6 Freddie Mac Gold Pool 2.500% 11/1/31 2,550 2,637
4,5,6 Freddie Mac Gold Pool 3.000% 10/1/31–10/1/46 14,250 14,889
4,5,6 Freddie Mac Gold Pool 3.500% 10/1/46–11/1/46 1,750 1,844
4,5 Freddie Mac Gold Pool 4.000% 1/1/46 187 203
5 Ginnie Mae I Pool 4.000% 7/15/45–8/15/45 419 450
5,6 Ginnie Mae I Pool 4.500% 2/15/39–11/1/46 3,448 3,835
5 Ginnie Mae I Pool 5.000% 3/15/38–2/15/40 4,182 4,718
5,6 Ginnie Mae II Pool 3.000% 1/20/45–11/1/46 7,568 7,954
5 Ginnie Mae II Pool 3.500% 10/20/43–10/1/46 12,710 13,615
5 Ginnie Mae II Pool 4.000% 11/20/42 427 461
5 Ginnie Mae II Pool 4.500% 11/20/44 1,871 2,068
          130,489
Nonconventional Mortgage-Backed Securities (1.9%)        
4,5,7 Fannie Mae Pool 2.657% 9/1/37 1,798 1,902
4,5,7 Fannie Mae Pool 2.696% 8/1/35 411 434
4,5,7 Fannie Mae Pool 2.756% 12/1/40 243 257
4,5,7 Fannie Mae Pool 2.758% 4/1/40 1,534 1,637
4,5,7 Fannie Mae Pool 2.927% 8/1/36 519 548
4,5,7 Fannie Mae REMICS 0.775% 9/25/46 867 864
4,5,7 Fannie Mae REMICS 0.825% 9/25/41–4/25/45 464 462
4,5,7 Fannie Mae REMICS 0.845% 6/25/36 496 495
4,5,7 Fannie Mae REMICS 0.875% 5/25/43 250 249
4,5,7 Fannie Mae REMICS 0.895% 6/25/35 136 136
4,5,7 Fannie Mae REMICS 0.925% 11/25/42–9/25/46 1,005 1,007
4,5,7 Fannie Mae REMICS 0.935% 11/25/35 178 178
4,5,7 Fannie Mae REMICS 0.970% 2/25/37 103 103
4,5,7 Fannie Mae REMICS 1.025% 8/25/46 384 384
4,5,7 Freddie Mac Non Gold Pool 2.663% 11/1/35 738 785
4,5,7 Freddie Mac Non Gold Pool 2.745% 7/1/35–9/1/37 1,813 1,920
4,5 Freddie Mac Non Gold Pool 2.890% 7/1/33 119 126
4,5,7 Freddie Mac REMICS 0.874% 11/15/36–8/15/43 413 413
4,5,7 Freddie Mac REMICS 0.884% 11/15/36 136 136
4,5,7 Freddie Mac REMICS 0.974% 6/15/42 84 83
          12,119
Total U.S. Government and Agency Obligations (Cost $375,349)   378,010
Asset-Backed/Commercial Mortgage-Backed Securities (12.3%)    
5 Ally Master Owner Trust Series 2015-3 1.630% 5/15/20 1,500 1,509
5,8 American Homes 4 Rent 2014-SFR3 3.678% 12/17/36 97 104
5 AmeriCredit Automobile Receivables Trust 2014-1 2.150% 3/9/20 90 91
5 AmeriCredit Automobile Receivables Trust 2014-2 2.180% 6/8/20 60 61
5 AmeriCredit Automobile Receivables Trust 2015-3 3.340% 8/8/21 285 293

 

13


 

Core Bond Fund        
 
 
 
        Face Market
      Maturity Amount Value
    Coupon Date ($000) ($000)
5 AmeriCredit Automobile Receivables Trust 2016-2 1.600% 11/9/20 170 170
5 AmeriCredit Automobile Receivables Trust 2016-2 2.210% 5/10/21 30 30
5 AmeriCredit Automobile Receivables Trust 2016-2 2.870% 11/8/21 20 20
5 AmeriCredit Automobile Receivables Trust 2016-2 3.650% 5/9/22 125 130
5 AmeriCredit Automobile Receivables Trust 2016-3 1.460% 5/8/21 70 70
5 AmeriCredit Automobile Receivables Trust 2016-3 2.710% 9/8/22 200 201
5,8 Applebee’s Funding LLC/IHOP Funding LLC 2014-1  4.277% 9/5/44 60 61
5,8 ARL Second LLC 2014-1A 2.920% 6/15/44 77 75
5,8 Aventura Mall Trust 2013-AVM 3.867% 12/5/32 800 860
5,8 Avis Budget Rental Car Funding AESOP LLC        
  2013-2A 2.970% 2/20/20 575 587
5,8 Avis Budget Rental Car Funding AESOP LLC        
  2015-2A 2.630% 12/20/21 380 385
5,8 Avis Budget Rental Car Funding AESOP LLC        
  2016-1A 2.990% 6/20/22 200 205
5,8 Avis Budget Rental Car Funding AESOP LLC        
  2016-2 2.720% 11/20/22 420 425
8 Bank of Montreal 1.750% 6/15/21 305 305
  Bank of Nova Scotia 1.875% 4/26/21 330 332
8 Bank of Nova Scotia 1.875% 9/20/21 110 111
5,7,8 BMW Floorplan Master Owner Trust 2015-1A 1.024% 7/15/20 700 701
5,7 Cabela’s Credit Card Master Note Trust 2016-1 1.374% 6/15/22 1,100 1,100
5,8 California Republic Auto Receivables Trust 2015-4 2.580% 6/15/21 81 83
5 California Republic Auto Receivables Trust 2016-2 1.560% 7/15/20 160 161
5 California Republic Auto Receivables Trust 2016-2 1.830% 12/15/21 130 131
5 California Republic Auto Receivables Trust 2016-2 2.520% 5/16/22 210 211
5 California Republic Auto Receivables Trust 2016-2 3.510% 3/15/23 210 210
5 Capital Auto Receivables Asset Trust 2013-4 2.670% 2/20/19 360 364
5 Capital Auto Receivables Asset Trust 2016-2 1.630% 1/20/21 570 570
5 Capital Auto Receivables Asset Trust 2016-2 3.160% 11/20/23 220 224
5 Capital Auto Receivables Asset Trust 2016-3 1.540% 8/20/20 70 70
5 Capital Auto Receivables Asset Trust 2016-3 1.690% 3/20/21 20 20
5 Capital Auto Receivables Asset Trust 2016-3 2.350% 9/20/21 50 50
5 Capital Auto Receivables Asset Trust 2016-3 2.650% 1/20/24 40 40
5,7 Capital One Multi-Asset Execution Trust 2016-A1 0.974% 2/15/22 800 804
5,7 Capital One Multi-Asset Execution Trust 2016-A2 1.154% 2/15/24 410 412
5,7,8 CARDS II Trust 2016-1A 1.224% 7/15/21 750 751
5 CarMax Auto Owner Trust 2013-3 2.850% 2/18/20 750 755
5 CarMax Auto Owner Trust 2016-2 2.160% 12/15/21 100 101
5 CarMax Auto Owner Trust 2016-2 3.250% 11/15/22 100 101
5 CarMax Auto Owner Trust 2016-3 1.900% 4/15/22 200 199
5 CarMax Auto Owner Trust 2016-3 2.200% 6/15/22 190 189
5 CarMax Auto Owner Trust 2016-3 2.940% 1/17/23 190 189
5 CFCRE Commercial Mortgage Trust 2016-C4 3.283% 5/10/58 350 370
5,7 Chase Issuance Trust 2016-A1 0.934% 5/17/21 700 702
5,8 Chesapeake Funding II LLC 2016-2A 1.880% 6/15/28 610 612
5,8 Chrysler Capital Auto Receivables Trust 2014-BA 3.440% 8/16/21 200 202
5,8 Chrysler Capital Auto Receivables Trust 2016-AA 1.960% 1/18/22 600 601
5,8 Chrysler Capital Auto Receivables Trust 2016-AA 2.880% 2/15/22 90 90
5,8 Chrysler Capital Auto Receivables Trust 2016-AA 4.220% 2/15/23 90 90
5 Citigroup Commercial Mortgage Trust 2014-GC19 4.023% 3/10/47 350 389
5 Citigroup Commercial Mortgage Trust 2014-GC21 3.575% 5/10/47 350 380
5 Citigroup Commercial Mortgage Trust 2014-GC23 3.622% 7/10/47 350 381
5 Citigroup Commercial Mortgage Trust 2014-GC23 4.175% 7/10/47 230 252
5 Citigroup Commercial Mortgage Trust 2014-GC25 3.635% 10/10/47 350 378

 

14


 

Core Bond Fund        
 
 
 
        Face Market
      Maturity Amount Value
    Coupon Date ($000) ($000)
5 Citigroup Commercial Mortgage Trust 2014-GC25 4.345% 10/10/47 140 151
5 Citigroup Commercial Mortgage Trust 2014-GC25 4.683% 10/10/47 175 181
5 Citigroup Commercial Mortgage Trust 2015-GC27 3.137% 2/10/48 350 366
5 Citigroup Commercial Mortgage Trust 2016-C1 3.209% 5/10/49 450 476
5,8 CKE Restaurant Holdings Inc. 2013-1A 4.474% 3/20/43 82 82
5 CNH Equipment Trust 2016-B 1.970% 11/15/21 600 605
5,7,8 Colony American Homes 2015-1 2.031% 7/17/32 70 70
5,7,8 Colony American Homes 2015-1A 1.731% 7/17/32 184 183
5,7,8 Colony Starwood Homes 2016-1A Trust 2.031% 7/17/33 494 500
5,7,8 Colony Starwood Homes 2016-1A Trust 2.681% 7/17/33 185 187
5 COMM 2012-CCRE4 Mortgage Trust 3.251% 10/15/45 500 523
5 COMM 2013-CCRE12 Mortgage Trust 4.046% 10/10/46 500 557
5,8 COMM 2013-CCRE6 Mortgage Trust 3.397% 3/10/46 210 218
5,8 COMM 2013-CCRE9 Mortgage Trust 4.398% 7/10/45 230 243
5 COMM 2014-CCRE15 Mortgage Trust 4.074% 2/10/47 350 392
5 COMM 2014-CCRE17 Mortgage Trust 3.977% 5/10/47 350 389
5 COMM 2014-CCRE17 Mortgage Trust 4.895% 5/10/47 190 206
5 COMM 2014-CCRE20 Mortgage Trust 3.590% 11/10/47 350 380
5 COMM 2015-CCRE22 Mortgage Trust 3.309% 3/10/48 350 373
5 COMM 2015-LC19 Mortgage Trust 3.183% 2/10/48 350 371
5 CSAIL 2015-C1 Commercial Mortgage Trust 3.505% 4/15/50 350 378
5 CSAIL 2015-C4 Commercial Mortgage Trust 3.808% 11/15/48 350 384
5,8 DB Master Finance LLC 2015-1A 3.980% 2/20/45 59 60
5 DBJPM 16-C1 Mortgage Trust 3.505% 5/10/49 140 135
5,8 Drive Auto Receivables Trust 2015-AA 3.060% 5/17/21 500 505
5,8 Drive Auto Receivables Trust 2015-DA 4.590% 1/17/23 132 136
5,8 Drive Auto Receivables Trust 2016-BA 1.670% 7/15/19 1,000 1,000
5,8 Drive Auto Receivables Trust 2016-BA 2.560% 6/15/20 420 424
5,8 Drive Auto Receivables Trust 2016-BA 3.190% 7/15/22 270 273
5,8 Drive Auto Receivables Trust 2016-BA 4.530% 8/15/23 200 204
5,8 Enterprise Fleet Financing LLC Series 2016-2 2.040% 2/22/22 450 451
5,7,8 Evergreen Credit Card Trust 2016-1 1.244% 4/15/20 1,175 1,178
4,5,7 Fannie Mae Connecticut Avenue Securities        
  2016-C04 1.975% 1/25/29 183 184
4,5,7 Fannie Mae Connecticut Avenue Securities        
  2016-C05 1.875% 1/25/29 495 497
5,8 Ford Credit Auto Owner Trust 2014-REV1 2.260% 11/15/25 190 194
5,8 Ford Credit Auto Owner Trust 2014-REV1 2.410% 11/15/25 250 253
5,8 Ford Credit Auto Owner Trust 2014-REV2 2.310% 4/15/26 1,050 1,074
5,8 Ford Credit Auto Owner Trust 2014-REV2 2.510% 4/15/26 200 203
5 Ford Credit Auto Owner Trust 2016-B 1.850% 9/15/21 200 201
5,8 Ford Credit Auto Owner Trust 2016-REV1 2.310% 8/15/27 100 102
5,8 Ford Credit Auto Owner Trust 2016-REV2 2.030% 12/15/27 200 202
5 Ford Credit Floorplan Master Owner Trust A        
  Series 2012-5 2.730% 9/15/19 600 603
5,7 Ford Credit Floorplan Master Owner Trust A        
  Series 2014-2 1.024% 2/15/21 1,000 1,002
5 Ford Credit Floorplan Master Owner Trust A        
  Series 2014-2 2.310% 2/15/21 200 203
5,7 Ford Credit Floorplan Master Owner Trust A        
  Series 2015-2 1.094% 1/15/22 630 633
5,7 Ford Credit Floorplan Master Owner Trust A        
  Series 2016-1 1.424% 2/15/21 400 404
5,7 Ford Credit Floorplan Master Owner Trust A        
  Series 2016-3 1.144% 7/15/21 50 50

 

15


 

Core Bond Fund        
 
 
 
        Face Market
      Maturity Amount Value
    Coupon Date ($000) ($000)
5,7 Ford Credit Floorplan Master Owner Trust A        
  Series 2016-4 1.054% 7/15/20 40 40
4,5,7 Freddie Mac Structured Agency Credit Risk        
  Debt Notes 2016-DNA2 1.775% 10/25/28 240 240
4,5,7 Freddie Mac Structured Agency Credit Risk        
  Debt Notes 2016-DNA3 1.625% 12/25/28 245 245
4,5,7 Freddie Mac Structured Agency Credit Risk        
  Debt Notes 2016-DNA3 2.525% 12/25/28 250 255
5,8 FRS I LLC 2013-1A 3.080% 4/15/43 184 181
5,7 GE Dealer Floorplan Master Note Trust Series        
  2015-2 1.182% 1/20/22 370 370
5 GM Financial Automobile Leasing Trust 2015-2 2.420% 7/22/19 420 425
5 GM Financial Automobile Leasing Trust 2015-2 2.990% 7/22/19 50 51
5 GM Financial Automobile Leasing Trust 2016-2 1.620% 9/20/19 130 131
5 GM Financial Automobile Leasing Trust 2016-2 1.760% 3/20/20 900 906
5 GM Financial Automobile Leasing Trust 2016-2 2.580% 3/20/20 190 192
5 GM Financial Automobile Leasing Trust 2016-3 1.610% 12/20/19 40 40
5 GM Financial Automobile Leasing Trust 2016-3 1.780% 5/20/20 40 40
5,8 GMF Floorplan Owner Revolving Trust 2015-1 1.970% 5/15/20 450 451
5,7,8 GMF Floorplan Owner Revolving Trust 2016-1 1.374% 5/17/21 800 802
5,8 GMF Floorplan Owner Revolving Trust 2016-1 2.410% 5/17/21 330 332
5,8 GMF Floorplan Owner Revolving Trust 2016-1 2.850% 5/17/21 330 331
5,7,8 Golden Credit Card Trust 2014-2A 0.974% 3/15/21 680 679
5,8 Golden Credit Card Trust 2016-5A 1.600% 9/15/21 270 271
5 GS Mortgage Securities Trust 2013-GCJ12 3.135% 6/10/46 350 368
5 GS Mortgage Securities Trust 2014-GC20 3.998% 4/10/47 350 387
5 GS Mortgage Securities Trust 2014-GC24 3.931% 9/10/47 350 386
5 GS Mortgage Securities Trust 2014-GC24 4.641% 9/10/47 170 187
5 GS Mortgage Securities Trust 2014-GC24 4.662% 9/10/47 150 159
5 GS Mortgage Securities Trust 2015-GC28 3.396% 2/10/48 350 372
5 GS Mortgage Securities Trust 2015-GC30 3.382% 5/10/50 350 373
5,8 Hertz Vehicle Financing LLC 2013-1A 1.830% 8/25/19 680 678
5,8 Hertz Vehicle Financing LLC 2015-1A 2.730% 3/25/21 850 861
5,8 Hertz Vehicle Financing LLC 2016-3 2.270% 7/25/20 120 120
5,8 Hertz Vehicle Financing LLC 2016-4 2.650% 7/25/22 290 293
5,8 Hyundai Auto Lease Securitization Trust 2016-B 1.680% 4/15/20 1,000 1,009
5,8 Hyundai Auto Lease Securitization Trust 2016-C 1.490% 2/18/20 50 50
5,8 Hyundai Auto Lease Securitization Trust 2016-C 1.650% 7/15/20 20 20
5,8 Hyundai Floorplan Master Owner Trust Series        
  2016-1A 1.810% 3/15/21 110 111
5,7,8 Invitation Homes 2014-SFR1 Trust 2.031% 6/17/31 275 274
5,7,8 Invitation Homes 2015-SFR2 Trust 2.177% 6/17/32 70 70
5,7,8 Invitation Homes 2015-SFR3 Trust 2.281% 8/17/32 70 70
5 John Deere Owner Trust 2016-B 1.490% 5/15/23 500 500
5,8 JP Morgan Chase Commercial Mortgage        
  Securities Trust 2011-C3 4.717% 2/15/46 1,700 1,877
5,8 JP Morgan Chase Commercial Mortgage        
  Securities Trust 2011-C5 5.562% 8/15/46 550 626
5,8 JP Morgan Chase Commercial Mortgage        
  Securities Trust 2012-C8 3.424% 10/15/45 90 95
5 JP Morgan Chase Commercial Mortgage        
  Securities Trust 2013-C13 4.189% 1/15/46 230 240
5 JPMBB Commercial Mortgage Securities Trust        
  2013-C12 3.363% 7/15/45 1,600 1,711

 

16


 

Core Bond Fund        
 
 
 
        Face Market
      Maturity Amount Value
    Coupon Date ($000) ($000)
5 JPMBB Commercial Mortgage Securities Trust        
  2013-C14 4.133% 8/15/46 30 34
5 JPMBB Commercial Mortgage Securities Trust        
  2013-C15 5.214% 11/15/45 30 33
5 JPMBB Commercial Mortgage Securities Trust        
  2014-C18 4.079% 2/15/47 350 391
5 JPMBB Commercial Mortgage Securities Trust        
  2014-C26 3.231% 1/15/48 350 370
5 JPMBB Commercial Mortgage Securities Trust        
  2014-C26 3.494% 1/15/48 350 376
5 JPMBB Commercial Mortgage Securities Trust        
  2015-C27 3.179% 2/15/48 350 368
5,7,8 Mercedes-Benz Master Owner Trust 2016-B 1.224% 5/17/21 800 804
5,8 MMAF Equipment Finance LLC 2016-AA 2.210% 12/15/32 290 291
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2012-C5 3.792% 8/15/45 100 108
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2013-C10 4.219% 7/15/46 200 210
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2013-C12 4.259% 10/15/46 400 451
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2014-C15 3.773% 4/15/47 350 384
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2014-C15 5.058% 4/15/47 150 163
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2014-C17 3.741% 8/15/47 350 382
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2014-C18 3.923% 10/15/47 350 390
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2014-C19 3.526% 12/15/47 450 488
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2015-C20 3.249% 2/15/48 350 371
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2015-C22 3.306% 4/15/48 350 371
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2015-C24 3.732% 5/15/48 350 384
5 Morgan Stanley Bank of America Merrill Lynch        
  Trust 2016-C29 4.912% 5/15/49 160 167
5 Morgan Stanley Capital I Trust 2015-UBS8 3.809% 12/15/48 350 388
5,8 MSBAM Commercial Mortgage Securities Trust        
  2012-CKSV 3.277% 10/15/30 1,700 1,752
8 National Australia Bank Ltd. 2.250% 3/16/21 50 51
5,7,8 Navient Student Loan Trust 2016-2 1.575% 6/25/65 200 201
5,7,8 Navient Student Loan Trust 2016-3 1.375% 6/25/65 60 60
5,7,8 Navistar Financial Dealer Note Master Trust        
  2016-1A 0.000% 9/27/21 220 220
5,8 NextGear Floorplan Master Owner Trust 2016-1A 2.740% 4/15/21 580 581
5 Nissan Auto Lease Trust 2016-A 1.650% 10/15/21 1,000 1,004
5 Nissan Auto Lease Trust 2016-B 1.500% 7/15/19 140 140
5 Nissan Auto Lease Trust 2016-B 1.610% 1/18/22 30 30
5,7 Nissan Master Owner Trust Receivables Series        
  2016-A 1.164% 6/15/21 500 501
5,8 Palisades Center Trust 2016-PLSD 2.713% 4/13/33 700 714
5,8 Progress Residential 2015-SFR3 Trust 3.067% 11/12/32 414 425
5,7,8 Resimac Premier Series 2016-1A 1.908% 10/10/47 766 767

 

17


 

Core Bond Fund        
 
 
 
        Face Market
      Maturity Amount Value
    Coupon Date ($000) ($000)
  Royal Bank of Canada 2.100% 10/14/20 390 397
  Royal Bank of Canada 2.300% 3/22/21 600 616
5 Santander Drive Auto Receivables Trust 2016-2 1.560% 5/15/20 870 870
5 Santander Drive Auto Receivables Trust 2016-2 2.080% 2/16/21 215 216
5 Santander Drive Auto Receivables Trust 2016-2 2.660% 11/15/21 170 172
5 Santander Drive Auto Receivables Trust 2016-2 3.390% 4/15/22 140 144
5,8 SMB Private Education Loan Trust 2016-A 2.700% 5/15/31 440 448
5,7,8 SMB Private Education Loan Trust 2016-B 1.974% 2/17/32 280 283
5,8 SoFi Professional Loan Program 2016-B LLC 2.740% 10/25/32 470 482
5,8 SoFi Professional Loan Program 2016-C LLC 2.360% 12/27/32 500 505
5,8 SoFi Professional Loan Program 2016-D LLC 2.340% 4/25/33 100 100
5,7,8 SoFi Professional Loan Program 2016-D LLC 1.600% 1/25/39 100 100
5,8 SpareBank 1 Boligkreditt AS 1.750% 11/15/20 250 251
5 Synchrony Credit Card Master Note Trust 2015-1 2.370% 3/15/23 385 396
5 Synchrony Credit Card Master Note Trust 2015-4 2.380% 9/15/23 337 345
5 Synchrony Credit Card Master Note Trust 2016-1 2.390% 3/15/22 345 350
5 Synchrony Credit Card Master Note Trust 2016-2 2.210% 5/15/24 470 479
5 Synchrony Credit Card Master Note Trust 2016-3 1.580% 9/15/22 150 150
5 Synchrony Credit Card Master Note Trust 2016-3 1.910% 9/15/22 100 100
5,8 Taco Bell Funding LLC 2016-1A 3.832% 5/25/46 59 60
5,8 Taco Bell Funding LLC 2016-1A 4.377% 5/25/46 36 37
5,8 Taco Bell Funding LLC 2016-1A 4.970% 5/25/46 31 32
8 Toronto-Dominion Bank 2.250% 3/15/21 350 357
5,7,8 Trillium Credit Card Trust II 2016-1A 1.242% 5/26/21 760 762
5,8 Volkswagen Credit Auto Master Owner Trust        
  2014-1A 1.400% 7/22/19 300 300
5 Wells Fargo Commercial Mortgage Trust        
  2012-LC5 3.539% 10/15/45 40 43
5 Wells Fargo Commercial Mortgage Trust        
  2013-LC12 4.218% 7/15/46 350 393
5 Wells Fargo Commercial Mortgage Trust        
  2013-LC12 4.432% 7/15/46 450 499
5 Wells Fargo Commercial Mortgage Trust        
  2015-C26 3.166% 2/15/48 70 73
5 Wells Fargo Commercial Mortgage Trust        
  2015-C27 3.190% 2/15/48 350 369
5 Wells Fargo Commercial Mortgage Trust        
  2015-C30 4.646% 9/15/58 200 206
5 Wells Fargo Commercial Mortgage Trust        
  2015-LC22 4.691% 9/15/58 160 168
5,8 Wendys Funding LLC 2015-1A 3.371% 6/15/45 228 229
5,8 Wendys Funding LLC 2015-1A 4.080% 6/15/45 56 57
5,8 Wendys Funding LLC 2015-1A 4.497% 6/15/45 50 50
8 Westpac Banking Corp. 2.250% 11/9/20 365 373
5 WFRBS Commercial Mortgage Trust 2014-C20 3.995% 5/15/47 20 22
5 WFRBS Commercial Mortgage Trust 2014-C21 3.678% 8/15/47 350 381
5 WFRBS Commercial Mortgage Trust 2014-C24 3.607% 11/15/47 350 379
5 WFRBS Commercial Mortgage Trust 2014-LC14 4.045% 3/15/47 350 391
5 World Financial Network Credit Card Master Note        
  Trust Series 2012-D 2.150% 4/17/23 1,000 1,018
5 World Financial Network Credit Card Master Note        
  Trust Series 2015-B 2.550% 6/17/24 220 228
5 World Financial Network Credit Card Master Note        
  Trust Series 2016-A 2.030% 4/15/25 220 221
5 World Omni Auto Receivables Trust 2015-B 2.150% 8/15/22 175 176

 

18


 

Core Bond Fund        
 
 
 
        Face Market
      Maturity Amount Value
    Coupon Date ($000) ($000)
5 World Omni Auto Receivables Trust 2016-B 1.300% 2/15/22 100 100
5 World Omni Automobile Lease Securitization        
  Trust 2016-A 1.610% 1/15/22 575 574
Total Asset-Backed/Commercial Mortgage-Backed Securities (Cost $78,501)   79,385
Corporate Bonds (26.0%)        
Finance (10.6%)        
  Banking (4.7%)        
8 ABN AMRO Bank NV 4.750% 7/28/25 150 158
8 ABN AMRO Bank NV 4.800% 4/18/26 200 212
9 Bank of America Corp. 5.500% 11/22/21 138 207
  Bank of America Corp. 3.300% 1/11/23 546 566
  Bank of America Corp. 4.000% 4/1/24 500 539
  Bank of America Corp. 3.875% 8/1/25 400 428
8 Bank of Tokyo-Mitsubishi UFJ Ltd. 2.300% 3/5/20 450 454
9 BPCE SA 5.250% 4/16/29 100 149
  Citigroup Inc. 3.700% 1/12/26 450 474
  Citigroup Inc. 4.450% 9/29/27 1,000 1,043
8 Commonwealth Bank of Australia 2.000% 9/6/21 490 489
8 Commonwealth Bank of Australia 4.500% 12/9/25 200 213
8 Commonwealth Bank of Australia 2.850% 5/18/26 215 217
10 Coventry Building Society 2.500% 11/18/20 212 256
8 Credit Suisse Group Funding Guernsey Ltd. 3.800% 6/9/23 410 415
8 Danske Bank A/S 2.000% 9/8/21 660 658
  Discover Financial Services 5.200% 4/27/22 370 407
  First Republic Bank 2.375% 6/17/19 510 514
9 Goldman Sachs Group Inc. 6.125% 5/14/17 100 133
9 Goldman Sachs Group Inc. 5.500% 10/12/21 96 142
10 Goldman Sachs Group Inc. 2.125% 9/30/24 77 94
  Goldman Sachs Group Inc. 3.750% 5/22/25 1,050 1,103
9 Goldman Sachs Group Inc. 4.250% 1/29/26 450 666
  Goldman Sachs Group Inc. 6.125% 2/15/33 480 606
  Goldman Sachs Group Inc. 5.150% 5/22/45 550 602
5,10 HBOS plc 4.500% 3/18/30 40 50
  HSBC Holdings plc 3.400% 3/8/21 200 207
  HSBC Holdings plc 2.650% 1/5/22 710 708
  HSBC Holdings plc 3.600% 5/25/23 480 496
  HSBC Holdings plc 4.300% 3/8/26 1,000 1,071
  HSBC Holdings plc 3.900% 5/25/26 440 457
  HSBC USA Inc. 2.750% 8/7/20 600 608
  JPMorgan Chase & Co. 2.400% 6/7/21 250 253
  JPMorgan Chase & Co. 2.295% 8/15/21 1,495 1,496
  JPMorgan Chase & Co. 2.700% 5/18/23 182 184
  JPMorgan Chase & Co. 3.200% 6/15/26 340 349
  JPMorgan Chase & Co. 5.500% 10/15/40 216 275
10 Leeds Building Society 1.375% 5/5/22 325 366
  Lloyds Banking Group plc 4.650% 3/24/26 1,030 1,065
8 Macquarie Bank Ltd. 2.600% 6/24/19 78 79
  Mitsubishi UFJ Financial Group Inc. 2.950% 3/1/21 310 319
  Mitsubishi UFJ Financial Group Inc. 2.190% 9/13/21 430 428
8 Mitsubishi UFJ Trust & Banking Corp. 2.450% 10/16/19 285 289
  Morgan Stanley 3.875% 1/27/26 1,420 1,509
  Morgan Stanley 3.125% 7/27/26 675 679
  MUFG Americas Holdings Corp. 2.250% 2/10/20 570 576
5,10 Nationwide Building Society 4.125% 3/20/23 200 234

 

19


 

Core Bond Fund        
 
 
 
        Face Market
      Maturity Amount Value
    Coupon Date ($000) ($000)
9 Nationwide Building Society 3.250% 1/20/28 100 142
  Royal Bank of Canada 1.500% 7/29/19 340 340
8 Santander UK Group Holdings plc 4.750%