-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BMG4B8jumjQoPGzNRF5joGA5XqyKl83KjSFzfJFOR/0w2xcT+GmuZAQh2rcEjb6B pR0U1mDMnNLvQDo5beSa4A== 0000932471-07-001663.txt : 20081008 0000932471-07-001663.hdr.sgml : 20081008 20071130123951 ACCESSION NUMBER: 0000932471-07-001663 CONFORMED SUBMISSION TYPE: 485APOS PUBLIC DOCUMENT COUNT: 7 FILED AS OF DATE: 20071130 DATE AS OF CHANGE: 20080826 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VANGUARD VALLEY FORGE FUNDS CENTRAL INDEX KEY: 0000889519 IRS NUMBER: 000000000 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 485APOS SEC ACT: 1933 Act SEC FILE NUMBER: 033-48863 FILM NUMBER: 071277080 BUSINESS ADDRESS: STREET 1: P O BOX 2600 STREET 2: V26 CITY: VALLEY FORGE STATE: PA ZIP: 19482 BUSINESS PHONE: 6106696295 MAIL ADDRESS: STREET 1: P.O. BOX 2600 STREET 2: V26 CITY: VALLEY FORGE STATE: PA ZIP: 19482 FORMER COMPANY: FORMER CONFORMED NAME: VANGUARD BALANCED INDEX FUNDS DATE OF NAME CHANGE: 20070223 FORMER COMPANY: FORMER CONFORMED NAME: VANGUARD BALANCED INDEX FUND DATE OF NAME CHANGE: 20011121 FORMER COMPANY: FORMER CONFORMED NAME: VANGUARD BALANCED INDEX FUND INC DATE OF NAME CHANGE: 19920715 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VANGUARD VALLEY FORGE FUNDS CENTRAL INDEX KEY: 0000889519 IRS NUMBER: 000000000 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 485APOS SEC ACT: 1940 Act SEC FILE NUMBER: 811-58431 FILM NUMBER: 071277081 BUSINESS ADDRESS: STREET 1: P O BOX 2600 STREET 2: V26 CITY: VALLEY FORGE STATE: PA ZIP: 19482 BUSINESS PHONE: 6106696295 MAIL ADDRESS: STREET 1: P.O. BOX 2600 STREET 2: V26 CITY: VALLEY FORGE STATE: PA ZIP: 19482 FORMER COMPANY: FORMER CONFORMED NAME: VANGUARD BALANCED INDEX FUNDS DATE OF NAME CHANGE: 20070223 FORMER COMPANY: FORMER CONFORMED NAME: VANGUARD BALANCED INDEX FUND DATE OF NAME CHANGE: 20011121 FORMER COMPANY: FORMER CONFORMED NAME: VANGUARD BALANCED INDEX FUND INC DATE OF NAME CHANGE: 19920715 0000889519 S000019760 Vanguard Managed Payout Real Growth Fund C000055411 Investor Shares 0000889519 S000019761 Vanguard Managed Payout Moderate Growth Fund C000055412 Investor Shares 0000889519 S000019762 Vanguard Managed Payout Capital Preservation Fund C000055413 Investor Shares 485APOS 1 valleyforge485a.txt VANGUARD VALLEY FORGE FUNDS 485A - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM N-1A REGISTRATION STATEMENT (NO. 33-48863) UNDER THE SECURITIES ACT OF 1933 PRE-EFFECTIVE AMENDMENT NO. POST-EFFECTIVE AMENDMENT NO. 34 AND REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 AMENDMENT NO. 36 VANGUARD VALLEY FORGE FUNDS (FORMERLY KNOWN AS VANGUARD BALANCED INDEX FUNDS) (EXACT NAME OF REGISTRANT AS SPECIFIED IN DECLARATION OF TRUST) P.O. BOX 2600, VALLEY FORGE, PA 19482 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) REGISTRANT'S TELEPHONE NUMBER (610) 669-1000 HEIDI STAM, ESQUIRE P.O. BOX 876 VALLEY FORGE, PA 19482 IT IS PROPOSED THAT THIS FILING BECOME EFFECTIVE ON DECEMBER 11, 2007, PURSUANT TO PARAGRAPH (A) OF RULE 485. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SUBJECT TO COMPLETION PRELIMINARY PROSPECTUS DATED NOVEMBER 30, 2007 Vanguard/(R)/ Managed Payout Funds* > Prospectus Investor Shares December 11, 2007 Vanguard Managed Payout Growth Focus Fund Vanguard Managed Payout Growth and Distribution Fund Vanguard Managed Payout Distribution Focus Fund [SHIP] [VANGUARD LOGO] INFORMATION CONTAINED IN THIS PROSPECTUS IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT FOR VANGUARD MANAGED PAYOUT FUNDS HAS BEEN FILED WITH THE U.S. SECURITIES AND EXCHANGE COMMISSION BUT HAS NOT YET BECOME EFFECTIVE. SHARES OF THE VANGUARD MANAGED PAYOUT FUNDS MAY NOT BE SOLD, NOR MAY OFFERS TO BUY BE ACCEPTED, PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS COMMUNICATION SHALL NOT CONSTITUTE AN OFFER TO SELL, NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION, OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. This is the initial prospectus for the Funds, so it contains no performance data. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense. * Patent Pending. Contents - ------------------------------------------------------------------------------- Investing in Vanguard Managed 1 Investing With Vanguard 79 Payout Funds - ------------------------------------------------------------------------------- Vanguard Fund Profiles Purchasing Shares 79 - ------------------------------------------------------------------------------- Managed Payout Growth Focus 4 Redeeming Shares 82 Fund - ------------------------------------------------------------------------------- Managed Payout Growth and 18 Exchanging Shares 85 Distribution Fund - ------------------------------------------------------------------------------- Managed Payout Distribution 32 Frequent-Trading Limits 85 Focus Fund - ------------------------------------------------------------------------------- More on the Funds 46 Other Rules You Should Know 87 - ------------------------------------------------------------------------------- The Funds and Vanguard 71 Fund and Account Updates 88 - ------------------------------------------------------------------------------- Investment Advisor 72 Contacting Vanguard 93 - ------------------------------------------------------------------------------- Dividends, Capital Gains, and 73 Glossary of Investment Terms 95 Taxes - ------------------------------------------------------------------------------- Share Price 77 - ------------------------------------------------------------------------------- Why Reading This Prospectus Is Important This prospectus explains the investment objective, policies, strategies, and risks associated with each Fund. To highlight terms and concepts important to mutual fund investors, we have provided Plain Talk/(R)/ explanations along the way. Reading the prospectus will help you decide whether a Fund is the right investment for you. We suggest that you keep this prospectus for future reference. Investing in Vanguard Managed Payout Funds This prospectus provides information about the three Vanguard Managed Payout Funds: Vanguard Managed Payout Growth Focus Fund, Vanguard Managed Payout Growth and Distribution Fund, and Vanguard Managed Payout Distribution Focus Fund. Each Fund combines a managed distribution policy with an endowment-like investment strategy to generate regular monthly payments to investors while seeking to preserve their capital over the long term. The Funds' managed distribution policies are designed to provide level monthly payments throughout each year, with payments adjusted each January based on a Fund's performance over the previous three years. Like many university endowments, each Fund may invest across a wide spectrum of asset classes and investments--such as stocks (including stocks issued by REITs), bonds, cash, inflation-linked investments, and selected other investments--that are expected to add diversification and result in a more consistent return pattern than a traditional balanced portfolio of stocks, bonds, and cash. - -------------------------------------------------------------------------------- Plain Talk About "Managed Payout Funds" "Managed payout funds" are funds specifically designed to provide investors with regular cash flows from their investments. For example, many closed-end funds have adopted "managed distribution policies" to pay periodic, level distributions to shareholders on a monthly or quarterly basis. Another example is a mutual fund that self-liquidates gradually over several years through periodic distributions, resulting in a market value close to zero by a scheduled termination date. A recent innovation in managed payout funds is a mutual fund--such as the Vanguard Managed Payout Funds--designed to function like an endowment by investing over the long-term to preserve and grow invested capital, while providing a regular stream of cash distributions. Managed payout funds may be an appropriate way for an investor to generate cash flow to help meet retirement expenses. - -------------------------------------------------------------------------------- It is possible for a Fund's monthly distributions to increase or decrease from one year to the next because the scheduled monthly distributions during any calendar year are based on the Fund's performance over the previous three years. There can be no assurance, and there is no guarantee, that the Funds will provide a fixed or stable level of cash distributions at any time or over any period of time. An investment in a Fund could lose money over short, intermediate, or even long periods of time. The Funds' twelve scheduled distributions in each year are made monthly, at mid-month. A thirteenth distribution may be made in December, and other additional distributions may be made with respect to a particular fiscal year in order to comply with applicable law. The Funds are designed with the expectation that the twelve scheduled monthly distributions will be paid in cash but that any thirteenth distribution or other additional distribution will be automatically reinvested in additional Fund shares. Accordingly, to allow the Funds to achieve their design objectives, the Funds will generally automatically reinvest any thirteenth or other additional distribution in additional Fund shares. These additional shares can be redeemed under the same terms and conditions as any other shares of the Funds. 1 Retirement Investing Many investors arrive at retirement with substantial assets accumulated over years of disciplined saving and prudent investing. Often, these investors are concerned about how to best use their assets to meet monthly retirement expenses, while at the same time preserving their assets for heirs, philanthropy, or other purposes. Traditionally, these investors have had three basic options for generating retirement income: .. A "planned withdrawal program," in which the investor gradually spends a limited portion of assets over a set period, with the remaining assets invested for long-term retirement goals. .. A "guaranteed income option," in which the investor turns over assets to an insurance company and purchases an annuity that provides guaranteed income for life. .. A "spend-only-the-income strategy," in which an investor spends only the dividend and interest income generated by his or her retirement portfolio, leaving the principal intact. The Managed Payout Funds combine elements of a planned withdrawal program and a spend-only-the-income strategy. The Funds aim to satisfy two basic needs shared by many retirees: first, to generate regular monthly payments to help meet retirement expenses; and second, to preserve retirement savings for future use. If investing through a tax-deferred retirement account, please note that the Funds are not designed to comply with any required minimum distribution rules applicable to such accounts. Shareholders receiving cash distributions from the Funds within such accounts will need to include such distributions as appropriate in the computation of their annual required minimum distribution. The Funds in This Prospectus The Vanguard Managed Payout Funds offered by this prospectus have the following investment objectives. Fund Investment Objective Growth Focus Fund The Fund seeks to make monthly distributions of cash while providing inflation protection and capital appreciation over the long term. Growth and The Fund seeks to make monthly distributions of cash while Distribution providing inflation protection and capital preservation over Fund the long term. Distribution Focus The Fund seeks to make monthly distributions of cash while Fund providing capital preservation over the long term. Funds Suited for Investors with Specific Goals Each Managed Payout Fund is expected to suit investors with specific goals, although some overlap is possible. 2 Fund Likely Investors Growth Focus Fund This Fund is expected to have the greatest appeal to investors who seek only a modest current payout from their assets, but who wish to see their capital and payouts increase over time. This Fund has adopted a managed distribution policy with a 3% annual distribution rate that is applied to a hypothetical account value based on the Fund's average performance over the previous three years.* Compared with the other Managed Payout Funds, this Fund has a higher probability of generating growth in both capital and payouts that exceeds inflation, resulting in long-term capital appreciation. Growth and This Fund is likely to appeal to investors who want to Distribution balance a need for a current payout from their assets with Fund the desire to maintain the purchasing power of their payouts and capital over the long term. This Fund has adopted a managed distribution policy with a 5% annual distribution rate that is applied to a hypothetical account value based on the Fund's average performance over the previous three years.* The Fund is also expected to provide inflation protection and capital preservation over the long term. Distribution This Fund is likely to appeal to investors who require a Focus Fund greater payout level to satisfy current spending needs. This Fund has adopted a managed distribution policy with a 7% annual distribution rate that is applied to a hypothetical account value based on the Fund's average performance over the previous three years.* Although the Fund's payouts and capital are not expected to grow at a rate that keeps pace with inflation, the Fund does seek to preserve the "nominal" (or original) value of invested capital over the long term. * For information about the Funds' managed distribution policies, see Dividends, Capital Gains, and Taxes. Each Fund generally expects to distribute to shareholders substantially all of its net income (for example, interest and dividends) as well as substantially all its net capital gains (for example, from the sale of its holdings or distributions from other funds it holds). In addition, each Fund's distributions may be treated in part as a return of capital. Each Fund is a "fund of funds" that invests in other Vanguard funds as well as in non-fund investments. - -------------------------------------------------------------------------------- Plain Talk About "Fund-of-Funds" The term "fund-of-funds" is used to describe a mutual fund that pursues its objective by investing primarily in other mutual funds, rather than primarily in individual stocks or bonds. A fund-of-funds may charge for its own direct expenses, in addition to bearing a proportionate share of the expenses charged by the underlying funds in which it invests. - -------------------------------------------------------------------------------- On the following pages, you'll find profiles that summarize the key features of each Fund. Following the profiles, there is important additional information about the Funds. 3 Fund Profile-- Vanguard Managed Payout Growth Focus Fund Investment Objective The Fund seeks to make monthly distributions of cash while providing inflation protection and capital appreciation over the long term. Primary Investment Strategies The Fund invests in Vanguard mutual funds and other investments according to an asset allocation strategy designed to provide shareholders with regular cash flow from their investments in the Fund. The Fund may allocate its assets across a broadly diversified selection of opportunities--such as stocks (including stocks issued by REITs), bonds, cash, inflation-linked investments, and selected other investments--in proportions that reflect the advisor's evaluation of their expected returns and risks as an integrated whole. The advisor uses quantitative analysis and professional judgment in an attempt to combine complementary asset classes and investments across the risk/reward spectrum. The Fund does not maintain a fixed asset allocation policy, and the exact proportion of each asset class or investment may be changed to reflect shifts in the advisor's risk and return expectations. While the Fund has flexibility to invest substantially in a single asset class or investment, the Fund is generally expected to allocate its assets across multiple asset classes and investments, including the following: .. Stocks. The Fund may invest in Vanguard Total Stock Market Index Fund, Vanguard European Stock Index Fund, Vanguard Pacific Stock Index Fund, and Vanguard Emerging Markets Stock Index Fund (or other Vanguard stock index funds) to capture the investment returns of the overall equity markets. The Fund may also invest in Vanguard REIT Index Fund in order to capture the returns of stocks issued by equity real estate investment trusts (known as REITs). The Fund will, through its investments in Vanguard stock index funds, indirectly hold large-, mid-, and small-capitalization stocks diversified across growth and value styles in the United States, as well as stocks of companies located in developed and emerging markets around the world. .. Bonds and Cash. The Fund may invest in Vanguard Total Bond Market Index Fund (or one or more other Vanguard bond index funds) to capture the investment returns of the overall fixed income market in the United States. Through its investments in one or more Vanguard bond index funds, the Fund will indirectly hold a wide spectrum of public, investment-grade, taxable, fixed income securities in the United States--including government, corporate, and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities--with maturities of more than 1 year. The Fund may allocate a portion of its assets to a Vanguard money market fund investing in high-quality, short-term money market instruments. 4 .. Inflation-Linked Investments. The Fund may invest in Vanguard Inflation-Protected Securities Fund, which invests primarily in inflation-indexed securities issued by the U.S. government, its agencies and instrumentalities, and corporations. .. Other Investments. The Fund may invest in selected other investments ("other investments") that have historically generated capital appreciation over the long-term while exhibiting low correlation with the returns of the U.S. stock market. The advisor believes that the expected return characteristics of these other investments offer potential diversification to a balanced portfolio of stocks, bonds, and cash. The Fund's potential other investments are described below. o Commodity-Linked Investments. The Fund may allocate a portion of its assets to investments that create exposure to the total return of a diversified basket of exchange-traded futures contracts on physical commodities. Commodities include real assets such as agricultural products, livestock, precious and industrial metals, and energy products. Commodity futures prices have a historically low correlation with the returns of the stock and bond markets. The Fund's commodity-linked investments may not be structured to conform to the composition, weighting, roll dates, reset dates, or contract months of any particular commodity futures market index. The Fund's commodity-linked investments may consist of any combination of commodity futures contracts, options on commodity futures contracts, commodity-linked total return swaps, commodity-linked structured notes, and other commodity-linked instruments. o Market Neutral Investments. The Fund may invest in Vanguard Market Neutral Fund, which seeks to provide long-term capital appreciation while limiting exposure to general stock market risk. The fund uses two investment advisors, each of which independently selects and maintains a diversified portfolio of securities for the fund. Each advisor buys securities it considers to be undervalued and sells short an approximately equal dollar amount of securities the advisor considers to be overvalued. By taking long and short positions of approximately equal value in different securities, the Market Neutral Fund attempts to limit the effect of market movements on portfolio performance. Each advisor uses an independent security selection process and may emphasize specific industries, styles (growth/value), capitalization ranges, or other factors. The returns of the Market Neutral Fund depend on the net performance of its long and short positions, and it is possible for the fund to experience a net loss across all positions. If the Market Neutral Fund's investment strategy is successful, however, the net performance of its long and short positions will produce long-term capital appreciation that reflects the quality of the advisors' security selections, with limited exposure to general stock market risk. 5 o Investments in a Prospective Absolute Return Fund. The Fund may invest in a private investment fund that Vanguard may establish and manage (the "absolute return fund"). Vanguard expects that the absolute return fund will seek to generate capital appreciation over the long-term while exhibiting low correlation with the returns of the U.S. stock market. If the absolute return fund commences operations, it is expected to employ multiple strategies, each of which will seek to produce investment returns that have two key characteristics: (1) volatility that is similar in magnitude to the historic volatility of the U.S. stock market; and (2) performance over the long term comparable to, but independent of the direction and timing of, U.S. stock returns. Some of the absolute return fund's strategies may be designed to capture risk premia through investment opportunities arising from the structure, pricing, liquidity, volatility, or other features of the financial markets. Other strategies employed by the absolute return fund may be designed to take advantage of relative value differences perceived among securities or across the financial markets. To the extent that a strategy contemplated for use in the absolute return fund would be expected to exhibit lower volatility than the historic volatility of the U.S. stock market, the absolute return fund may use substantial leverage to amplify the volatility and expected returns of the strategy to targeted levels. The absolute return fund's strategies may be implemented through direct or indirect investments in stocks, bonds, hybrid securities, commodities, currencies, and other asset classes or investments. The absolute return fund may employ derivatives, short sales, and other complex investment techniques or transactions as part of its investment program. Vanguard has not made a decision to establish the absolute return fund and the Fund has not made a decision to invest in the absolute return fund in the future. Vanguard expects that the absolute return fund will not be organized as a mutual fund and will not be registered under any federal or state securities laws, including the Investment Company Act of 1940. Managed Distribution Policy The Fund has adopted a managed distribution policy under which it seeks to distribute a targeted amount of cash to shareholders on or about the 15th calendar day of each month. The monthly distribution per share for a given calendar year will be calculated as of January 1 of that year and is generally expected to be fixed during the year. This monthly distribution per share, however, will vary from year to year based on the Fund's performance over the previous three years. The monthly distribution per share for the Fund is based on the account value of a hypothetical account assumed to hold shares of the Fund purchased at inception. It is further assumed that this hypothetical account experiences the same distributions as the accounts of actual shareholders of the Fund and that no further purchases, redemptions or reinvestments are made for 6 the hypothetical account except the automatic reinvestment of certain required taxable distributions in additional shares of the Fund. The shareholders of the Fund are expected to receive a monthly cash distribution that is equal to the monthly distribution per share (as calculated below) times the number of shares they own on the record date. The formula to calculate the monthly distribution per share in a calendar year is as follows: Average daily Monthly distribution = 3% x value of hypothetical account over prior 3 calendar years ------------- ---------------------------------- per share 12 Number of shares held by hypothetical account at the end of the prior calendar year Please note that the Fund's managed distribution policy is not designed to generate, and is not expected to result in, distributions that equal a fixed percentage of the Fund's current net asset value per share or a fixed percentage of a shareholder's current account value. Instead, Fund shareholders are expected to receive a monthly distribution that is equal to the monthly distribution per share (as determined under the distribution formula) times the number of shares they own on the record date. The hypothetical account value is averaged over the prior three years in order to increase the relative predictability and relative stability of distributions to shareholders from year to year. A modified version of the formula will be used until the Fund has established three calendar years of history. In the first calendar year of the Fund, the monthly per-share distribution will be based on the initial per share value of the hypothetical account. In the second calendar year, the average daily balance of the hypothetical account over the prior calendar year (or the portion of the prior calendar year for which the Fund was in existence) will be used to determine the monthly distribution per share. In the third calendar year, the average daily balance of the hypothetical account over the prior two calendar years will be used to determine the monthly distribution per share. The Fund generally expects to distribute to shareholders substantially all of its net income (for example, interest and dividends) as well as substantially all of its net capital gains (for example, from the sale of its holdings or distributions from other funds it holds). In addition, given its managed distribution policy, the Fund's distributions may be treated in part as a return of capital. For additional information on the Fund's managed distribution policy, see Dividends, Capital Gains, and Taxes. Primary Risks The Fund's investment strategies are intended to create a moderate level of risk for the Fund. An investment in the Fund, however, could lose money over short, intermediate, or even long periods of time because the Fund allocates its assets 7 worldwide across different asset classes and investments with specific risk and return characteristics. Results may vary substantially over time, and there is no guarantee that the Fund will achieve its investment objective or that its investment strategies will succeed. The Fund is expected to continue to make monthly cash distributions under its managed distribution policy irrespective of the Fund's investment performance. Because these distributions will be made from Fund assets and shareholders are not expected to reinvest such distributions in additional Fund shares, the Fund's monthly cash distributions will reduce the amount of assets available for investment by the Fund. It is possible for the Fund to suffer substantial investment losses and simultaneously experience additional asset reductions as a result of its distributions to shareholders under the managed distribution policy. Moreover, even if the Fund's capital grows over short, intermediate, or long periods of time, it is possible that such growth will be insufficient to enable the Fund to maintain the amount of its scheduled cash distributions without returning capital to shareholders. The Fund's managed distribution policy is designed to distribute a consistent amount of cash once per month throughout each calendar year, excluding any additional distributions required to comply with applicable law. Under the managed distribution policy, the dollar amount of the Fund's scheduled monthly distributions for a particular calendar year will increase or decrease each January based on the Fund's performance over the previous three years. Accordingly, the dollar amount of the Fund's monthly cash distributions could go up or down substantially from one year to the next and over time depending on, among other things, the performance of the financial markets in which the Fund invests, the allocation of Fund assets across different asset classes and investments, the performance of the Fund's investment strategies, and the amount and timing of prior distributions by the Fund. It is also possible for your distributions from the Fund to go down substantially from one year to the next and over time depending on the timing of your investments in the Fund. Any redemptions you make from your Fund account will proportionately reduce the amount of future cash distributions you will receive from the Fund. In addition to being subject to the risks described above, the Fund is also subject to manager risk and, depending on the allocation of Fund assets among eligible asset classes and investments, one or more of the additional risks described below. Each of these risks, alone or in combination with other risks, has the potential to hurt Fund performance and reduce Fund distributions. .. Manager risk is the chance that poor investment selections and/or poor asset allocation decisions by the advisor will cause the Fund either to fail to achieve its objective or to generate lower returns than were possible from different investment selections and/or asset allocation decisions. The advisor uses quantitative analysis and professional judgment to select the asset classes and investments that make up the 8 Fund's investment portfolio. In making such decisions, the advisor must, among other tasks, monitor and evaluate the expected risks, returns, and correlations of eligible assets classes and investments, as well as the likelihood that the selected combination will achieve the Fund's investment objective. These decisions are based in part upon the advisor's forecasts and estimates and analysis of historical events, as well as other aspects of quantitative analysis and professional judgment. The advisor's decisions may, for a variety of reasons, fail to accurately predict the actual risk, returns, and correlations of the asset classes and investments held by the Fund. Among the reasons predictions could be inaccurate are scarcity of historical data in respect of certain asset classes or investments, the fact that future events may not follow historical norms, and the potential for human error. It is possible that the advisor's allocation of Fund assets across specific asset classes and investments will cause the Fund to incur losses or underperform other funds with a similar investment objective. There is no guarantee that the advisor will succeed in combining multiple asset classes and investments in a manner that either achieves the Fund's investment objective or maintains a moderate level of risk. There can be no assurance that any asset classes or investments with relatively low historical correlations will in fact exhibit low correlations in the future. It is possible that the returns and direction of the Fund's asset classes and investments may suddenly converge, thereby magnifying the risks of the Fund's portfolio as a whole, with the potential for significant losses and significant reductions in the dollar amount of monthly distributions by the Fund. Diversification does not necessarily ensure a profit or protect against a loss in a declining market. The Fund could lose money at any time and may underperform the markets, asset classes, and investments in which it invests during any given period that such markets, asset classes, or investments rise or fall. The Fund's asset allocation strategy is complex and may involve more risk than other funds that invest only in stocks, bonds, and cash. .. Stock risk includes risks associated with investments in underlying funds that invest in U.S. or foreign stocks, and consists of stock market risk, currency risk, country/ regional risk, emerging markets risk, and REIT stock risk. Stock market risk is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Investments in foreign stocks are associated with the following risks: currency risk, which is the chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates; country/regional risk, which is the chance that events-such as political upheaval, financial troubles, or natural disasters-will weaken the securities of a particular country or an entire region; and emerging markets risk, which is the chance that the emerging markets will be substantially more volatile, and substantially less liquid, than the more developed foreign markets. REIT stock risk includes risks associated with investments in an underlying fund that invests primarily in REITs, and includes real estate industry risk and investment style risk, as well as stock 9 market risk (described above) and interest rate risk (described below). Real estate industry risk is the chance that the stocks of REITs will decline because of adverse developments affecting the real estate industry and real property values. Investment style risk is the chance that the returns from REIT stocks-which typically are small- or mid-capitalization stocks will trail returns from the overall stock market. Historically, these stocks have performed quite differently from the overall market. .. Bond risk includes risks associated with investments in underlying funds that invest in bonds or money market instruments, and consists of the following risks: interest rate risk, which is the chance that bond prices overall will decline because of rising interest rates; income risk, which is the chance that an underlying fund's income will decline because of falling interest rates; credit risk, which is the chance that the issuer of a security will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer's ability to make such payments will cause the price of that security to decline, thus reducing an underlying fund's return; and call risk, which is the chance that during periods of falling interest rates, issuers of callable bonds may call (repay) securities with higher coupons or interest rates before their maturity dates. If an underlying fund holds a bond that is called, the fund would then lose potential price appreciation and would be forced to reinvest the unanticipated proceeds at lower interest rates, resulting in a decline in the fund's income. For mortgage-backed securities, this risk is known as prepayment risk. .. Inflation-linked investment risk includes risks associated with investments in an underlying fund that invests primarily in inflation-indexed securities, and consists of the risk of considerable income fluctuations associated with changes in inflation, as well as bond risks. .. Commodity-linked investment risk includes risks associated with investments that create exposure to the total return of exchange-traded futures contracts on physical commodities. These risks consist of commodity futures trading risk, structured note risks, and derivatives risks. Commodity futures trading risk relates to the fact that commodity futures trading is volatile, and even a small movement in market prices could cause large losses. Consequently, the Fund could lose all or substantially all of its investment in instruments linked to the returns of commodity futures. The prices of commodity futures are subject to change based on various factors, including, but not limited to, the following: the lack of liquidity; global supply and demand for commodities; disorderly markets; limitations on deliverable supplies; the participation of hedgers and speculators; domestic and foreign interest rates and investors' expectations concerning interest rates; domestic and foreign inflation rates and investors' expectations concerning inflation rates; investment and trading activities of institutional investors; global or regional political, economic, or financial events and situations; government regulation and intervention; technical and operational or system failures; nuclear accident; terrorism; and acts of God. Structured note risks are 10 the risks associated with investments in commodity-linked structured notes, which include commodity futures trading risk and bond risk (described above). Derivatives risks include risks associated with the use of futures contracts, options on futures contracts, options on securities, swap agreements, warrants, forward contracts, and other derivatives. Derivatives may involve risks different from, and possibly greater than, investments in the underlying securities, assets, rates, or indexes. Losses involving certain derivatives can sometimes be substantial or even greater than the principal amount invested-in part because a relatively small price movement in such derivatives may result in an immediate and substantial loss to the investor. Derivatives also involve the risk of mispricing or improper valuation and the risk that changes in the value of the derivative may not correlate perfectly with the underlying securities, assets, rates, or indexes. The market for many derivatives is, or suddenly can become, illiquid, which may result in significant, rapid, and unpredictable changes in the prices for derivatives. The use of a derivative subjects the investor to the risk of non-performance by the counterparty, potentially resulting in delayed, partial, or even non-payment of amounts due under the derivative contract. .. Market neutral investment risk includes risks associated with an investment in the Vanguard Market Neutral Fund, and consists of strategy risk, short-selling risk, manager risk, capitalization risk, and style risk. Strategy risk is the chance that the long/short market neutral investment strategy used by the Market Neutral Fund will not succeed. This strategy could cause the Market Neutral Fund to lose money at any time. Short-selling risk is the chance that a fund will lose money in connection with short sales of securities or other investments. Short selling allows a fund an opportunity to profit from declines in the price of securities or other investments. A fund's use of short sales in combination with long positions in an attempt to improve performance or to reduce overall portfolio risk may not be successful and may result in greater losses or lower positive returns than if the fund held only long positions. It is possible that the securities or other investments a fund holds long will decline in value at the same time that the securities or other investments it holds short increase in value, thereby increasing potential losses. A fund may not always be able (or find it economically attractive) to sell short a security or other investment an advisor believes to be particularly overvalued. In that case, the fund may establish a short position in a different security or investment, and that short position may be less profitable for the fund than if the fund had shorted the security or investment the advisor believed was more overvalued. Also, a fund may be unable to close out a short position at an acceptable price, and may have to sell related long positions at disadvantageous times to produce cash to unwind a short position. A fund's loss on a short sale is potentially unlimited because there is no upward limit on the price a borrowed security or other investment could attain. Short selling involves higher transaction costs than typical long-only investing. 11 Manager risk is the chance that poor security selection will cause the Market Neutral Fund to underperform relevant benchmarks or other funds with a similar investment objective. Capitalization risk is the chance that returns from small-, mid-, and/or large-capitalization stocks (to the extent that the Market Neutral Fund's assets are invested in such stocks) will trail returns from the overall stock market. Specific types of stocks tend to go through cycles of doing better or worse than the stock market in general. These periods have, in the past, lasted for as long as several years. Style risk is the chance that returns from value stocks will trail returns from the overall stock market. The security selection processes used by the Market Neutral Fund's advisors are likely to cause the fund's investment portfolio to exhibit sensitivity to the value-growth cycle within the U.S. equity markets, meaning that the fund's performance will be more likely to decline during periods when growth stocks outperform value stocks than during periods when value stocks outperform growth stocks. .. Risks of prospective absolute return fund. If Vanguard establishes the absolute return fund, the risks associated with the absolute return fund are expected to include leverage risk, manager risk, currency trading risk, liquidity risk, leverage financing risk, and unregistered investment risk, which are described below, as well as stock risk, bond risk, short selling risk, and derivatives risk, which are described above. It is possible for the Fund to experience a total loss of the entire amount it may in the future invest in the absolute return fund. o Leverage risk includes the fact that the returns from a leveraged investment will be more volatile than returns from the underlying investment and the chance that leveraged losses will exceed the principal amount invested. Leverage exists when an investor achieves the right to a return on a total investment amount that exceeds the cash amount the investor contributed to the entity or instrument achieving the return. Leverage magnifies the effect of gains and losses. Vanguard expects that the absolute return fund, if established, may employ substantial leverage in connection with its investments. The absolute return fund's losses from its leveraged investments could result in a total loss of all amounts the Fund invests in the absolute return fund. Vanguard expects that the absolute return fund, if established, will issue shares of capital stock or other equity interests that limit the personal liability of shareholders to the amount invested in the absolute return fund. In that case, the Fund, as a shareholder of the absolute return fund, would be legally protected from losing more than the cash amount the Fund invested. o Manager risk is the chance that poor investment selections will cause the absolute return fund either to fail to achieve its investment objective or to generate lower returns than were possible from different investment selections. The absolute return fund does not exist as of the date of this prospectus and, if established, its future success will depend upon the expertise of Vanguard, which has only limited 12 experience in managing absolute return investment strategies. If the absolute return fund commences operations, it will be subject to the risk that Vanguard will not be successful in executing one or more absolute return strategies. The absolute return fund's investment program may be considered speculative and is expected to involve substantial risks. There is no guarantee that the absolute return fund will achieve its investment objective or that its strategies will succeed. The absolute return fund could lose money at any time and may underperform the markets in which it invests during any given period, regardless of whether such markets rise or fall. Absolute return investing is complex and may involve greater risk than investing in a balanced portfolio of stocks, bonds, and cash. There is no guarantee that the performance of the absolute return fund will have low correlation with the returns of the U.S. stock market. It is possible that the investment returns of the absolute return fund may suddenly converge with the investment returns of the U.S. stock market during a period of declining stock prices, thereby eliminating the diversification benefit the advisor would expect from including the absolute return fund within the Fund's investment portfolio. Although the advisor believes an appropriate level of investment in the absolute return fund could have the potential to reduce the volatility of the Fund's investment portfolio as a whole, an investment in the absolute return fund could experience high volatility and increase the Fund's overall volatility. o Currency trading risk is the chance that the absolute return fund could suffer losses from currency-related investments. Currency prices can be highly volatile and trading currencies for non-hedging purposes is generally considered speculative and involves a high risk of a substantial or total loss of invested capital. Currency rates in foreign countries may fluctuate significantly over short periods of time for a number of reasons, including, but not limited to, changes in interest rates, the imposition of currency controls, the devaluation of a currency by a country's government or banking authority, or other political developments in the United States or abroad. o Liquidity risk is the chance that the absolute return fund will invest in markets, assets, and instruments that are, or may become, illiquid. Vanguard expects that the absolute return fund will generally seek to invest in liquid markets, assets, and instruments, although the absolute return fund may have the ability to invest some or all of its assets in markets, assets, or instruments that are or may become illiquid. In addition, Vanguard expects that the shares issued by the absolute return fund will be designed with redemption rights that are substantially similar to the redemption rights associated with mutual fund shares. If the absolute return fund's shares have such redemption rights, the Fund is likely to treat its investment in the absolute return fund as liquid. There is no assurance, however, that the absolute return fund's investments will not suddenly become illiquid for an indefinite period of time. Illiquidity could cause 13 the absolute return fund to experience difficulties in valuing its portfolio holdings and may cause that fund to delay redemptions and/or honor redemption requests by the Fund with distributions of illiquid underlying portfolio holdings on an in-kind basis. o Leverage financing risk is the chance that the absolute return fund will be unable to access and maintain financing sufficient to leverage its investments to targeted levels. Vanguard expects that the absolute return fund will require the use of substantial leverage in order for its absolute return strategies to exhibit volatility and generate expected returns similar to the historic volatility and returns of the U.S. stock market. It is possible that the derivative or other counterparties that finance the leverage employed by the absolute return fund may not be able or willing to provide the level of financing that Vanguard believes is required to achieve its volatility and return targets. o Unregistered investment risk is the chance that the absolute return fund could lose money on investments that would not have been permitted or made had the absolute return fund been organized as a registered investment company. Because the absolute return fund will not register under any federal or state securities laws, including the Investment Company Act of 1940, potential investors in the absolute return fund, such as the Fund, will not have the regulatory protections provided to investors in registered and regulated investment companies. For additional information on investment risks, see More on the Funds. Performance/Risk Information The Fund began operations on ., 2007, so performance information is not yet available. Fees and Expenses The following table describes the fees and expenses you may pay if you buy and hold shares of the Fund. As is the case with all mutual funds, transaction costs incurred by the Fund, and by the Fund's underlying funds, for buying and selling securities are not reflected in the table. However, these costs will be reflected in investment performance figures. The expenses shown under Acquired Fund Fees and Expenses represent a weighted average of the expense ratios of, and the fees charged by, the underlying funds in which the Fund invests, and are based on estimated amounts for the current fiscal year. The Fund has no operating history, and actual operating expenses could differ from the following estimates. 14 Shareholder Fees (Fees paid directly from your investment) - ------------------------------------------------------------------------- Sales Charge (Load) Imposed on Purchases None - ------------------------------------------------------------------------- Purchase Fee None - ------------------------------------------------------------------------- Sales Charge (Load) Imposed on Reinvested Dividends None - ------------------------------------------------------------------------- Redemption Fee None - ------------------------------------------------------------------------- Annual Fund Operating Expenses (Expenses deducted from the Fund's assets) - ------------------------------------------------------------------------- Management Expenses None - ------------------------------------------------------------------------- 12b-1 Distribution Fee None - ------------------------------------------------------------------------- Other Expenses None - ------------------------------------------------------------------------- Acquired Fund Fees and Expenses/1/ 0.58%/2/ Total Annual Fund Operating Expenses 0.58%/3/ - ------------------------------------------------------------------------- 1 In addition to incurring Management Expenses and Other Expenses, the Fund's shareholders indirectly bear the annual net operating expenses of the underlying Vanguard funds (the Acquired Funds) in which the Fund invests. Acquired Fund Fees and Expenses include transaction costs (i.e., purchase and redemption fees), if any, imposed on the Fund by the Acquired Funds. See The Funds and Vanguard. 2 Over 50% of the Fund's Acquired Fund Fees and Expenses is attributable to the short sale dividend expenses reported by Vanguard Market Neutral Fund. Specifically, the Fund's Acquired Fund Fees and Expenses of 0.58% includes 0.30% of "Acquired Fund Short Sale Dividend Expenses," which represent a weighted average of the short sale dividend expenses reported by Vanguard Market Neutral Fund (estimated for the current fiscal year). See Plain Talk About Acquired Fund Short Sale Dividend Expenses. 3 Total Annual Fund Operating Expenses would be 0.28% if Acquired Fund Short Sale Dividend Expenses were excluded. Vanguard Market Neutral Fund's short sale dividend expenses are expected to be offset by amounts the fund earns through short sale-related interest earnings and other investment returns. 15 - -------------------------------------------------------------------------------- Plain Talk About Acquired Fund Short Sale Dividend Expenses The Managed Payout Funds are "funds of funds" that invest in underlying Vanguard funds (the Acquired Funds) as well as non-fund investments. Each Managed Payout Fund may invest in an Acquired Fund that engages in short sales of stock. A short sale occurs when the Acquired Fund sells a stock it does not own and then borrows the stock from a lending stockholder in order to settle the transaction. Until the borrowed stock is returned to the lending stockholder, the Acquired Fund is required to pay the lending stockholder the amount of any dividends paid on the borrowed stock. The Acquired Fund does not itself collect the dividends, thus the payment to the lending stockholder creates a net expense, which is recorded as a "short sale dividend expense" on the financial statements of the Acquired Fund and is reported as part of the Acquired Fund's expense ratio. It is important to note that when the Acquired Fund sells a stock short, the proceeds are typically held in cash which earns interest at a negotiated rate. This interest, when combined with the Acquired Fund's other investment returns, is expected to be greater than the short sale dividend expense the Acquired Fund incurs through its payments to the lending stockholder. These combined amounts offset the Acquired Fund's short sale dividend expenses and thereby reduce total expenses the Managed Payout Funds bear through their investment in the Acquired Fund. - -------------------------------------------------------------------------------- The following example is intended to help you compare the cost of investing in the Fund (based on the fees and expenses of the acquired funds) with the cost of investing in other mutual funds. It illustrates the hypothetical expenses that you would incur over various periods if you invest $10,000 in the Fund's shares. This example assumes that the Fund provides a return of 5% a year and that operating expenses of the Fund and its underlying funds match our estimates. The results apply whether or not you redeem your investment at the end of the given period. 1 Year 3 Years - -------------------------------- $59 $186 - -------------------------------- This example should not be considered to represent actual expenses or performance for the future. 16 Additional Information As of ., 2007 - -------------------------------------------------------------------------------- Net Assets - -------------------------------------------------------------------------------- Investment Advisor The Vanguard Group, Inc., Valley Forge, Pa., since inception - -------------------------------------------------------------------------------- Distributions The Fund's twelve scheduled distributions in each year are made monthly, at mid-month. A thirteenth distribution may be made in December, and other additional distributions may be made with respect to a particular fiscal year, in order to comply with applicable law. Generally speaking, distributions will be paid to you in cash, unless you elect to reinvest in more shares of the Fund. The Fund generally automatically reinvests the thirteenth distribution, and any other additional distributions required to comply with applicable law, in more shares of the Fund. These additional shares can be redeemed under the same terms and conditions as any other shares of the Fund. - -------------------------------------------------------------------------------- Suitable for IRAs Yes - -------------------------------------------------------------------------------- Inception Date ., 2007 - -------------------------------------------------------------------------------- Minimum Initial Investment $25,000 - -------------------------------------------------------------------------------- Newspaper Abbreviation - -------------------------------------------------------------------------------- Vanguard Fund Number 1497 - -------------------------------------------------------------------------------- CUSIP Number 92205M101 - -------------------------------------------------------------------------------- Ticker Symbol VPRGX - -------------------------------------------------------------------------------- 17 Fund Profile-- Vanguard Managed Payout Growth and Distribution Fund Investment Objective The Fund seeks to make monthly distributions of cash while providing inflation protection and capital preservation over the long term. Primary Investment Strategies The Fund invests in Vanguard mutual funds and other investments according to an asset allocation strategy designed to provide shareholders with regular cash flow from their investments in the Fund. The Fund may allocate its assets across a broadly diversified selection of opportunities--such as stocks (including stocks issued by REITs), bonds, cash, inflation-linked investments, and selected other investments--in proportions that reflect the advisor's evaluation of their expected returns and risks as an integrated whole. The advisor uses quantitative analysis and professional judgment in an attempt to combine complementary asset classes and investments across the risk/reward spectrum. The Fund does not maintain a fixed asset allocation policy, and the exact proportion of each asset class or investment may be changed to reflect shifts in the advisor's risk and return expectations. While the Fund has flexibility to invest substantially in a single asset class or investment, the Fund is generally expected to allocate its assets across multiple asset classes and investments, including the following: .. Stocks. The Fund may invest in Vanguard Total Stock Market Index Fund, Vanguard European Stock Index Fund, Vanguard Pacific Stock Index Fund, and Vanguard Emerging Markets Stock Index Fund (or other Vanguard stock index funds) to capture the investment returns of the overall equity markets. The Fund may also invest in Vanguard REIT Index Fund in order to capture the returns of stocks issued by equity real estate investment trusts (known as REITs). The Fund will, through its investments in Vanguard stock index funds, indirectly hold large-, mid-, and small-capitalization stocks diversified across growth and value styles in the United States, as well as stocks of companies located in developed and emerging markets around the world. .. Bonds and Cash. The Fund may invest in Vanguard Total Bond Market Index Fund (or one or more other Vanguard bond index funds) to capture the investment returns of the overall fixed income market in the United States. Through its investments in one or more Vanguard bond index funds, the Fund will indirectly hold a wide spectrum of public, investment-grade, taxable, fixed income securities in the United States--including government, corporate, and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities--with maturities of more than 1 year. The Fund may allocate a portion of its assets to a Vanguard money market fund investing in high-quality, short-term money market instruments. 18 .. Inflation-Linked Investments. The Fund may invest in Vanguard Inflation-Protected Securities Fund, which invests primarily in inflation-indexed securities issued by the U.S. government, its agencies and instrumentalities, and corporations. .. Other Investments. The Fund may invest in selected other investments ("other investments") that have historically generated capital appreciation over the long-term while exhibiting low correlation with the returns of the U.S. stock market. The advisor believes that the expected return characteristics of these other investments offer potential diversification to a balanced portfolio of stocks, bonds, and cash. The Fund's potential other investments are described below. o Commodity-Linked Investments. The Fund may allocate a portion of its assets to investments that create exposure to the total return of a diversified basket of exchange-traded futures contracts on physical commodities. Commodities include real assets such as agricultural products, livestock, precious and industrial metals, and energy products. Commodity futures prices have a historically low correlation with the returns of the stock and bond markets. The Fund's commodity-linked investments may not be structured to conform to the composition, weighting, roll dates, reset dates, or contract months of any particular commodity futures market index. The Fund's commodity-linked investments may consist of any combination of commodity futures contracts, options on commodity futures contracts, commodity-linked total return swaps, commodity-linked structured notes, and other commodity-linked instruments. o Market Neutral Investments. The Fund may invest in Vanguard Market Neutral Fund, which seeks to provide long-term capital appreciation while limiting exposure to general stock market risk. The fund uses two investment advisors, each of which independently selects and maintains a diversified portfolio of securities for the fund. Each advisor buys securities it considers to be undervalued and sells short an approximately equal dollar amount of securities the advisor considers to be overvalued. By taking long and short positions of approximately equal value in different securities, the Market Neutral Fund attempts to limit the effect of market movements on portfolio performance. Each advisor uses an independent security selection process and may emphasize specific industries, styles (growth/value), capitalization ranges, or other factors. The returns of the Market Neutral Fund depend on the net performance of its long and short positions, and it is possible for the fund to experience a net loss across all positions. If the Market Neutral Fund's investment strategy is successful, however, the net performance of its long and short positions will produce long-term capital appreciation that reflects the quality of the advisors' security selections, with limited exposure to general stock market risk. 19 o Investments in a Prospective Absolute Return Fund. The Fund may invest in a private investment fund that Vanguard may establish and manage (the "absolute return fund"). Vanguard expects that the absolute return fund will seek to generate capital appreciation over the long-term while exhibiting low correlation with the returns of the U.S. stock market. If the absolute return fund commences operations, it is expected to employ multiple strategies, each of which will seek to produce investment returns that have two key characteristics: (1) volatility that is similar in magnitude to the historic volatility of the U.S. stock market; and (2) performance over the long term comparable to, but independent of the direction and timing of, U.S. stock returns. Some of the absolute return fund's strategies may be designed to capture risk premia through investment opportunities arising from the structure, pricing, liquidity, volatility, or other features of the financial markets. Other strategies employed by the absolute return fund may be designed to take advantage of relative value differences perceived among securities or across the financial markets. To the extent that a strategy contemplated for use in the absolute return fund would be expected to exhibit lower volatility than the historic volatility of the U.S. stock market, the absolute return fund may use substantial leverage to amplify the volatility and expected returns of the strategy to targeted levels. The absolute return fund's strategies may be implemented through direct or indirect investments in stocks, bonds, hybrid securities, commodities, currencies, and other asset classes or investments. The absolute return fund may employ derivatives, short sales, and other complex investment techniques or transactions as part of its investment program. Vanguard has not made a decision to establish the absolute return fund and the Fund has not made a decision to invest in the absolute return fund in the future. Vanguard expects that the absolute return fund will not be organized as a mutual fund and will not be registered under any federal or state securities laws, including the Investment Company Act of 1940. Managed Distribution Policy The Fund has adopted a managed distribution policy under which it seeks to distribute a targeted amount of cash to shareholders on or about the 15th calendar day of each month. The monthly distribution per share for a given calendar year will be calculated as of January 1 of that year and is generally expected to be fixed during the year. This monthly distribution per share, however, will vary from year to year based on the Fund's performance over the previous three years. The monthly distribution per share for the Fund is based on the account value of a hypothetical account assumed to hold shares of the Fund purchased at inception. It is further assumed that this hypothetical account experiences the same distributions as the accounts of actual shareholders of the Fund and that no further purchases, redemptions or reinvestments are made for 20 the hypothetical account except the automatic reinvestment of certain required taxable distributions in additional shares of the Fund. The shareholders of the Fund are expected to receive a monthly cash distribution that is equal to the monthly distribution per share (as calculated below) times the number of shares they own on the record date. The formula to calculate the monthly distribution per share in a calendar year is as follows: Average daily Monthly distribution = 5% x value of hypothetical account over prior 3 calendar years ------------- ---------------------------------- per share 12 Number of shares held by hypothetical account at the end of the prior calendar year Please note that the Fund's managed distribution policy is not designed to generate, and is not expected to result in, distributions that equal a fixed percentage of the Fund's current net asset value per share or a fixed percentage of a shareholder's current account value. Instead, Fund shareholders are expected to receive a monthly distribution that is equal to the monthly distribution per share (as determined under the distribution formula) times the number of shares they own on the record date. The hypothetical account value is averaged over the prior three years in order to increase the relative predictability and relative stability of distributions to shareholders from year to year. A modified version of the formula will be used until the Fund has established three calendar years of history. In the first calendar year of the Fund, the monthly per-share distribution will be based on the initial per share value of the hypothetical account. In the second calendar year, the average daily balance of the hypothetical account over the prior calendar year (or the portion of the prior calendar year for which the Fund was in existence) will be used to determine the monthly distribution per share. In the third calendar year, the average daily balance of the hypothetical account over the prior two calendar years will be used to determine the monthly distribution per share. The Fund generally expects to distribute to shareholders substantially all of its net income (for example, interest and dividends) as well as substantially all of its net capital gains (for example, from the sale of its holdings or as distributions from other funds it holds). In addition, given its managed distribution policy, the Fund's distributions may be treated in part as a return of capital. For additional information on the Fund's managed distribution policy, see Dividends, Capital Gains, and Taxes. Primary Risks The Fund's investment strategies are intended to create a moderate level of risk for the Fund. An investment in the Fund, however, could lose money over short, intermediate, or even long periods of time because the Fund allocates its assets 21 worldwide across different asset classes and investments with specific risk and return characteristics. Results may vary substantially over time, and there is no guarantee that the Fund will achieve its investment objective or that its investment strategies will succeed. The Fund is expected to continue to make monthly cash distributions under its managed distribution policy irrespective of the Fund's investment performance. Because these distributions will be made from Fund assets and shareholders are not expected to reinvest such distributions in additional Fund shares, the Fund's monthly cash distributions will reduce the amount of assets available for investment by the Fund. It is possible for the Fund to suffer substantial investment losses and simultaneously experience additional asset reductions as a result of its distributions to shareholders under the managed distribution policy. Moreover, even if the Fund's capital grows over short, intermediate, or long periods of time, it is possible that such growth will be insufficient to enable the Fund to maintain the amount of its scheduled cash distributions without returning capital to shareholders. The Fund's managed distribution policy is designed to distribute a consistent amount of cash once per month throughout each calendar year, excluding any additional distributions required to comply with applicable law. Under the managed distribution policy, the dollar amount of the Fund's scheduled monthly distributions for a particular calendar year will increase or decrease each January based on the Fund's performance over the previous three years. Accordingly, the dollar amount of the Fund's monthly cash distributions could go up or down substantially from one year to the next and over time depending on, among other things, the performance of the financial markets in which the Fund invests, the allocation of Fund assets across different asset classes and investments, the performance of the Fund's investment strategies, and the amount and timing of prior distributions by the Fund. It is also possible for your distributions from the Fund to go down substantially from one year to the next and over time depending on the timing of your investments in the Fund. Any redemptions you make from your Fund account will proportionately reduce the amount of future cash distributions you will receive from the Fund. In addition to being subject to the risks described above, the Fund is also subject to manager risk and, depending on the allocation of Fund assets among eligible asset classes and investments, one or more of the additional risks described below. Each of these risks, alone or in combination with other risks, has the potential to hurt Fund performance and reduce Fund distributions. .. Manager risk is the chance that poor investment selections and/or poor asset allocation decisions by the advisor will cause the Fund either to fail to achieve its objective or to generate lower returns than were possible from different investment selections and/or asset allocation decisions. The advisor uses quantitative analysis and professional judgment to select the asset classes and investments that make up the 22 Fund's investment portfolio. In making such decisions, the advisor must, among other tasks, monitor and evaluate the expected risks, returns, and correlations of eligible assets classes and investments, as well as the likelihood that the selected combination will achieve the Fund's investment objective. These decisions are based in part upon the advisor's forecasts and estimates and analysis of historical events, as well as other aspects of quantitative analysis and professional judgment. The advisor's decisions may, for a variety of reasons, fail to accurately predict the actual risk, returns, and correlations of the asset classes and investments held by the Fund. Among the reasons predictions could be inaccurate are scarcity of historical data in respect of certain asset classes or investments, the fact that future events may not follow historical norms, and the potential for human error. It is possible that the advisor's allocation of Fund assets across specific asset classes and investments will cause the Fund to incur losses or underperform other funds with a similar investment objective. There is no guarantee that the advisor will succeed in combining multiple asset classes and investments in a manner that either achieves the Fund's investment objective or maintains a moderate level of risk. There can be no assurance that any asset classes or investments with relatively low historical correlations will in fact exhibit low correlations in the future. It is possible that the returns and direction of the Fund's asset classes and investments may suddenly converge, thereby magnifying the risks of the Fund's portfolio as a whole, with the potential for significant losses and significant reductions in the dollar amount of monthly distributions by the Fund. Diversification does not necessarily ensure a profit or protect against a loss in a declining market. The Fund could lose money at any time and may underperform the markets, asset classes, and investments in which it invests during any given period that such markets, asset classes, or investments rise or fall. The Fund's asset allocation strategy is complex and may involve more risk than other funds that invest only in stocks, bonds, and cash. .. Stock risk includes risks associated with investments in underlying funds that invest in U.S. or foreign stocks, and consists of stock market risk, currency risk, country/ regional risk, emerging markets risk, and REIT stock risk. Stock market risk is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Investments in foreign stocks are associated with the following risks: currency risk, which is the chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates; country/regional risk, which is the chance that events-such as political upheaval, financial troubles, or natural disasters-will weaken the securities of a particular country or an entire region; and emerging markets risk, which is the chance that the emerging markets will be substantially more volatile, and substantially less liquid, than the more developed foreign markets. REIT stock risk includes risks associated with investments in an underlying fund that invests primarily in REITs, and includes real estate industry risk and investment style risk, as well as stock 23 market risk (described above) and interest rate risk (described below). Real estate industry risk is the chance that the stocks of REITs will decline because of adverse developments affecting the real estate industry and real property values. Investment style risk is the chance that the returns from REIT stocks-which typically are small- or mid-capitalization stocks will trail returns from the overall stock market. Historically, these stocks have performed quite differently from the overall market. .. Bond risk includes risks associated with investments in underlying funds that invest in bonds or money market instruments, and consists of the following risks: interest rate risk, which is the chance that bond prices overall will decline because of rising interest rates; income risk, which is the chance that an underlying fund's income will decline because of falling interest rates; credit risk, which is the chance that the issuer of a security will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer's ability to make such payments will cause the price of that security to decline, thus reducing an underlying fund's return; and call risk, which is the chance that during periods of falling interest rates, issuers of callable bonds may call (repay) securities with higher coupons or interest rates before their maturity dates. If an underlying fund holds a bond that is called, the fund would then lose potential price appreciation and would be forced to reinvest the unanticipated proceeds at lower interest rates, resulting in a decline in the fund's income. For mortgage-backed securities, this risk is known as prepayment risk. .. Inflation-linked investment risk includes risks associated with investments in an underlying fund that invests primarily in inflation-indexed securities, and consists of the risk of considerable income fluctuations associated with changes in inflation, as well as bond risks. .. Commodity-linked investment risk includes risks associated with investments that create exposure to the total return of exchange-traded futures contracts on physical commodities. These risks consist of commodity futures trading risk, structured note risks, and derivatives risks. Commodity futures trading risk relates to the fact that commodity futures trading is volatile, and even a small movement in market prices could cause large losses. Consequently, the Fund could lose all or substantially all of its investment in instruments linked to the returns of commodity futures. The prices of commodity futures are subject to change based on various factors, including, but not limited to, the following: the lack of liquidity; global supply and demand for commodities; disorderly markets; limitations on deliverable supplies; the participation of hedgers and speculators; domestic and foreign interest rates and investors' expectations concerning interest rates; domestic and foreign inflation rates and investors' expectations concerning inflation rates; investment and trading activities of institutional investors; global or regional political, economic, or financial events and situations; government regulation and intervention; technical and operational or system failures; nuclear accident; terrorism; and acts of God. Structured note risks are 24 the risks associated with investments in commodity-linked structured notes, which include commodity futures trading risk and bond risk (described above). Derivatives risks include risks associated with the use of futures contracts, options on futures contracts, options on securities, swap agreements, warrants, forward contracts, and other derivatives. Derivatives may involve risks different from, and possibly greater than, investments in the underlying securities, assets, rates, or indexes. Losses involving certain derivatives can sometimes be substantial or even greater than the principal amount invested-in part because a relatively small price movement in such derivatives may result in an immediate and substantial loss to the investor. Derivatives also involve the risk of mispricing or improper valuation and the risk that changes in the value of the derivative may not correlate perfectly with the underlying securities, assets, rates, or indexes. The market for many derivatives is, or suddenly can become, illiquid, which may result in significant, rapid, and unpredictable changes in the prices for derivatives. The use of a derivative subjects the investor to the risk of non-performance by the counterparty, potentially resulting in delayed, partial, or even non-payment of amounts due under the derivative contract. .. Market neutral investment risk includes risks associated with an investment in the Vanguard Market Neutral Fund, and consists of strategy risk, short-selling risk, manager risk, capitalization risk, and style risk. Strategy risk is the chance that the long/short market neutral investment strategy used by the Market Neutral Fund will not succeed. This strategy could cause the Market Neutral Fund to lose money at any time. Short-selling risk is the chance that a fund will lose money in connection with short sales of securities or other investments. Short selling allows a fund an opportunity to profit from declines in the price of securities or other investments. A fund's use of short sales in combination with long positions in an attempt to improve performance or to reduce overall portfolio risk may not be successful and may result in greater losses or lower positive returns than if the fund held only long positions. It is possible that the securities or other investments a fund holds long will decline in value at the same time that the securities or other investments it holds short increase in value, thereby increasing potential losses. A fund may not always be able (or find it economically attractive) to sell short a security or other investment an advisor believes to be particularly overvalued. In that case, the fund may establish a short position in a different security or investment, and that short position may be less profitable for the fund than if the fund had shorted the security or investment the advisor believed was more overvalued. Also, a fund may be unable to close out a short position at an acceptable price, and may have to sell related long positions at disadvantageous times to produce cash to unwind a short position. A fund's loss on a short sale is potentially unlimited because there is no upward limit on the price a borrowed security or other investment could attain. Short selling involves higher transaction costs than typical long-only investing. 25 Manager risk is the chance that poor security selection will cause the Market Neutral Fund to underperform relevant benchmarks or other funds with a similar investment objective. Capitalization risk is the chance that returns from small-, mid-, and/or large-capitalization stocks (to the extent that the Market Neutral Fund's assets are invested in such stocks) will trail returns from the overall stock market. Specific types of stocks tend to go through cycles of doing better or worse than the stock market in general. These periods have, in the past, lasted for as long as several years. Style risk is the chance that returns from value stocks will trail returns from the overall stock market. The security selection processes used by the Market Neutral Fund's advisors are likely to cause the fund's investment portfolio to exhibit sensitivity to the value-growth cycle within the U.S. equity markets, meaning that the fund's performance will be more likely to decline during periods when growth stocks outperform value stocks than during periods when value stocks outperform growth stocks. .. Risks of prospective absolute return fund. If Vanguard establishes the absolute return fund, the risks associated with the absolute return fund are expected to include leverage risk, manager risk, currency trading risk, liquidity risk, leverage financing risk, and unregistered investment risk, which are described below, as well as stock risk, bond risk, short selling risk, and derivatives risk, which are described above. It is possible for the Fund to experience a total loss of the entire amount it may in the future invest in the absolute return fund. o Leverage risk includes the fact that the returns from a leveraged investment will be more volatile than returns from the underlying investment and the chance that leveraged losses will exceed the principal amount invested. Leverage exists when an investor achieves the right to a return on a total investment amount that exceeds the cash amount the investor contributed to the entity or instrument achieving the return. Leverage magnifies the effect of gains and losses. Vanguard expects that the absolute return fund, if established, may employ substantial leverage in connection with its investments. The absolute return fund's losses from its leveraged investments could result in a total loss of all amounts the Fund invests in the absolute return fund. Vanguard expects that the absolute return fund, if established, will issue shares of capital stock or other equity interests that limit the personal liability of shareholders to the amount invested in the absolute return fund. In that case, the Fund, as a shareholder of the absolute return fund, would be legally protected from losing more than the cash amount the Fund invested. o Manager risk is the chance that poor investment selections will cause the absolute return fund either to fail to achieve its investment objective or to generate lower returns than were possible from different investment selections. The absolute return fund does not exist as of the date of this prospectus and, if established, its future success will depend upon the expertise of Vanguard, which has only limited experience in managing absolute return investment 26 strategies. If the absolute return fund commences operations, it will be subject to the risk that Vanguard will not be successful in executing one or more absolute return strategies. The absolute return fund's investment program may be considered speculative and is expected to involve substantial risks. There is no guarantee that the absolute return fund will achieve its investment objective or that its strategies will succeed. The absolute return fund could lose money at any time and may underperform the markets in which it invests during any given period, regardless of whether such markets rise or fall. Absolute return investing is complex and may involve greater risk than investing in a balanced portfolio of stocks, bonds, and cash. There is no guarantee that the performance of the absolute return fund will have low correlation with the returns of the U.S. stock market. It is possible that the investment returns of the absolute return fund may suddenly converge with the investment returns of the U.S. stock market during a period of declining stock prices, thereby eliminating the diversification benefit the advisor would expect from including the absolute return fund within the Fund's investment portfolio. Although the advisor believes an appropriate level of investment in the absolute return fund could have the potential to reduce the volatility of the Fund's investment portfolio as a whole, an investment in the absolute return fund could experience high volatility and increase the Fund's overall volatility. o Currency trading risk is the chance that the absolute return fund could suffer losses from currency-related investments. Currency prices can be highly volatile and trading currencies for non-hedging purposes is generally considered speculative and involves a high risk of a substantial or total loss of invested capital. Currency rates in foreign countries may fluctuate significantly over short periods of time for a number of reasons, including, but not limited to, changes in interest rates, the imposition of currency controls, the devaluation of a currency by a country's government or banking authority, or other political developments in the United States or abroad. o Liquidity risk is the chance that the absolute return fund will invest in markets, assets, and instruments that are, or may become, illiquid. Vanguard expects that the absolute return fund will generally seek to invest in liquid markets, assets, and instruments, although the absolute return fund may have the ability to invest some or all of its assets in markets, assets, or instruments that are or may become illiquid. In addition, Vanguard expects that the shares issued by the absolute return fund will be designed with redemption rights that are substantially similar to the redemption rights associated with mutual fund shares. If the absolute return fund's shares have such redemption rights, the Fund is likely to treat its investment in the absolute return fund as liquid. There is no assurance, however, that the absolute return fund's investments will not suddenly become illiquid for an indefinite period of time. Illiquidity could cause 27 the absolute return fund to experience difficulties in valuing its portfolio holdings and may cause that fund to delay redemptions and/or honor redemption requests by the Fund with distributions of illiquid underlying portfolio holdings on an in-kind basis. o Leverage financing risk is the chance that the absolute return fund will be unable to access and maintain financing sufficient to leverage its investments to targeted levels. Vanguard expects that the absolute return fund will require the use of substantial leverage in order for its absolute return strategies to exhibit volatility and generate expected returns similar to the historic volatility and returns of the U.S. stock market. It is possible that the derivative or other counterparties that finance the leverage employed by the absolute return fund may not be able or willing to provide the level of financing that Vanguard believes is required to achieve its volatility and return targets. o Unregistered investment risk is the chance that the absolute return fund could lose money on investments that would not have been permitted or made had the absolute return fund been organized as a registered investment company. Because the absolute return fund will not register under any federal or state securities laws, including the Investment Company Act of 1940, potential investors in the absolute return fund, such as the Fund, will not have the regulatory protections provided to investors in registered and regulated investment companies. For additional information on investment risks, see More on the Funds. Performance/Risk Information The Fund began operations on ., 2007, so performance information is not yet available. Fees and Expenses The following table describes the fees and expenses you may pay if you buy and hold shares of the Fund. As is the case with all mutual funds, transaction costs incurred by the Fund, and by the Fund's underlying funds, for buying and selling securities are not reflected in the table. However, these costs will be reflected in investment performance figures. The expenses shown under Acquired Fund Fees and Expenses represent a weighted average of the expense ratios of, and the fees charged by, the underlying funds in which the Fund invests, and are based on estimated amounts for the current fiscal year. The Fund has no operating history, and actual operating expenses could differ from the following estimates. 28 Shareholder Fees (Fees paid directly from your investment) - ------------------------------------------------------------------------- Sales Charge (Load) Imposed on Purchases None - ------------------------------------------------------------------------- Purchase Fee None - ------------------------------------------------------------------------- Sales Charge (Load) Imposed on Reinvested Dividends None - ------------------------------------------------------------------------- Redemption Fee None - ------------------------------------------------------------------------- Annual Fund Operating Expenses (Expenses deducted from the Fund's assets) - ------------------------------------------------------------------------- Management Expenses None - ------------------------------------------------------------------------- 12b-1 Distribution Fee None - ------------------------------------------------------------------------- Other Expenses None - ------------------------------------------------------------------------- Acquired Fund Fees and Expenses/1/ 0.58%/2/ Total Annual Fund Operating Expenses 0.58%/3/ - ------------------------------------------------------------------------- 1 In addition to incurring Management Expenses and Other Expenses, the Fund's shareholders indirectly bear the annual net operating expenses of the underlying Vanguard funds (the Acquired Funds) in which the Fund invests. Acquired Fund Fees and Expenses include transaction costs (i.e., purchase and redemption fees), if any, imposed on the Fund by the Acquired Funds. See The Funds and Vanguard. 2 Over 50% of the Fund's Acquired Fund Fees and Expenses is attributable to the short sale dividend expenses reported by Vanguard Market Neutral Fund. Specifically, the Fund's Acquired Fund Fees and Expenses of 0.58% includes 0.30% of "Acquired Fund Short Sale Dividend Expenses," which represent a weighted average of the short sale dividend expenses reported by Vanguard Market Neutral Fund (estimated for the current fiscal year). See Plain Talk About Acquired Fund Short Sale Dividend Expenses. 3 Total Annual Fund Operating Expenses would be 0.28% if Acquired Fund Short Sale Dividend Expenses were excluded. Vanguard Market Neutral Fund's short sale dividend expenses are expected to be offset by amounts the fund earns through short sale-related interest earnings and other investment returns. See Plain Talk About Acquired Fund Short Sale Dividend Expenses. 29 - -------------------------------------------------------------------------------- Plain Talk About Acquired Fund Short Sale Dividend Expenses The Managed Payout Funds are "funds of funds" that invest in underlying Vanguard funds (the Acquired Funds) as well as non-fund investments. Each Managed Payout Fund may invest in an Acquired Fund that engages in short sales of stock. A short sale occurs when the Acquired Fund sells a stock it does not own and then borrows the stock from a lending stockholder in order to settle the transaction. Until the borrowed stock is returned to the lending stockholder, the Acquired Fund is required to pay the lending stockholder the amount of any dividends paid on the borrowed stock. The Acquired Fund does not itself collect the dividends, thus the payment to the lending stockholder creates a net expense, which is recorded as a "short sale dividend expense" on the financial statements of the Acquired Fund and is reported as part of the Acquired Fund's expense ratio. It is important to note that when the Acquired Fund sells a stock short, the proceeds are typically held in cash which earns interest at a negotiated rate. This interest, when combined with the Acquired Fund's other investment returns, is expected to be greater than the short sale dividend expense the Acquired Fund incurs through its payments to the lending stockholder. These combined amounts offset the Acquired Fund's short sale dividend expenses and thereby reduce total expenses the Managed Payout Funds bear through their investment in the Acquired Fund. - -------------------------------------------------------------------------------- The following example is intended to help you compare the cost of investing in the Fund (based on the fees and expenses of the acquired funds) with the cost of investing in other mutual funds. It illustrates the hypothetical expenses that you would incur over various periods if you invest $10,000 in the Fund's shares. This example assumes that the Fund provides a return of 5% a year and that operating expenses of the Fund and its underlying funds match our estimates. The results apply whether or not you redeem your investment at the end of the given period. 1 Year 3 Years - -------------------- $59 $186 - -------------------- This example should not be considered to represent actual expenses or performance for the future. 30 Additional Information As of ., 2007 - -------------------------------------------------------------------------------- Net Assets (all share classes) - -------------------------------------------------------------------------------- Investment Advisor The Vanguard Group, Inc., Valley Forge, Pa., since inception - -------------------------------------------------------------------------------- Distributions The Fund's twelve scheduled distributions in each year are made monthly, at mid-month. A thirteenth distribution may be made in December, and other additional distributions may be made with respect to a particular fiscal year, in order to comply with applicable law. Generally speaking, distributions will be paid to you in cash, unless you elect to reinvest in more shares of the Fund. The Fund generally automatically reinvests the thirteenth distribution, and any other additional distributions required to comply with applicable law, in more shares of the Fund. These additional shares can be redeemed under the same terms and conditions as any other shares of the Fund. - -------------------------------------------------------------------------------- Suitable for IRAs Yes - -------------------------------------------------------------------------------- Inception Date ., 2007 - -------------------------------------------------------------------------------- Minimum Initial Investment $25,000 - -------------------------------------------------------------------------------- Newspaper Abbreviation - -------------------------------------------------------------------------------- Vanguard Fund Number 1498 - -------------------------------------------------------------------------------- CUSIP Number 92205M200 - -------------------------------------------------------------------------------- Ticker Symbol VPMGX - -------------------------------------------------------------------------------- 31 Fund Profile-- Vanguard Managed Payout Distribution Focus Fund Investment Objective The Fund seeks to make monthly distributions of cash while providing capital preservation over the long term. Primary Investment Strategies The Fund invests in Vanguard mutual funds and other investments according to an asset allocation strategy designed to provide shareholders with regular cash flow from their investments in the Fund. The Fund may allocate its assets across a broadly diversified selection of opportunities--such as stocks (including stocks issued by REITs), bonds, cash, inflation-linked investments, and selected other investments--in proportions that reflect the advisor's evaluation of their expected returns and risks as an integrated whole. The advisor uses quantitative analysis and professional judgment in an attempt to combine complementary asset classes and investments across the risk/reward spectrum. The Fund does not maintain a fixed asset allocation policy, and the exact proportion of each asset class or investment may be changed to reflect shifts in the advisor's risk and return expectations. While the Fund has flexibility to invest substantially in a single asset class or investment, the Fund is generally expected to allocate its assets across multiple asset classes and investments, including the following: .. Stocks. The Fund may invest in Vanguard Total Stock Market Index Fund, Vanguard European Stock Index Fund, Vanguard Pacific Stock Index Fund, and Vanguard Emerging Markets Stock Index Fund (or other Vanguard stock index funds) to capture the investment returns of the overall equity markets. The Fund may also invest in Vanguard REIT Index Fund in order to capture the returns of stocks issued by equity real estate investment trusts (known as REITs). The Fund will, through its investments in Vanguard stock index funds, indirectly hold large-, mid-, and small-capitalization stocks diversified across growth and value styles in the United States, as well as stocks of companies located in developed and emerging markets around the world. .. Bonds and Cash. The Fund may invest in Vanguard Total Bond Market Index Fund (or one or more other Vanguard bond index funds) to capture the investment returns of the overall fixed income market in the United States. Through its investments in one or more Vanguard bond index funds, the Fund will indirectly hold a wide spectrum of public, investment-grade, taxable, fixed income securities in the United States--including government, corporate, and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities--with maturities of more than 1 year. The Fund may allocate a portion of its assets to a Vanguard money market fund investing in high-quality, short-term money market instruments. 32 .. Inflation-Linked Investments. The Fund may invest in Vanguard Inflation-Protected Securities Fund, which invests primarily in inflation-indexed securities issued by the U.S. government, its agencies and instrumentalities, and corporations. .. Other Investments. The Fund may invest in selected other investments ("other investments") that have historically generated capital appreciation over the long-term while exhibiting low correlation with the returns of the U.S. stock market. The advisor believes that the expected return characteristics of these other investments offer potential diversification to a balanced portfolio of stocks, bonds, and cash. The Fund's potential other investments are described below. o Commodity-Linked Investments. The Fund may allocate a portion of its assets to investments that create exposure to the total return of a diversified basket of exchange-traded futures contracts on physical commodities. Commodities include real assets such as agricultural products, livestock, precious and industrial metals, and energy products. Commodity futures prices have a historically low correlation with the returns of the stock and bond markets. The Fund's commodity-linked investments may not be structured to conform to the composition, weighting, roll dates, reset dates, or contract months of any particular commodity futures market index. The Fund's commodity-linked investments may consist of any combination of commodity futures contracts, options on commodity futures contracts, commodity-linked total return swaps, commodity-linked structured notes, and other commodity-linked instruments. o Market Neutral Investments. The Fund may invest in Vanguard Market Neutral Fund, which seeks to provide long-term capital appreciation while limiting exposure to general stock market risk. The fund uses two investment advisors, each of which independently selects and maintains a diversified portfolio of securities for the fund. Each advisor buys securities it considers to be undervalued and sells short an approximately equal dollar amount of securities the advisor considers to be overvalued. By taking long and short positions of approximately equal value in different securities, the Market Neutral Fund attempts to limit the effect of market movements on portfolio performance. Each advisor uses an independent security selection process and may emphasize specific industries, styles (growth/value), capitalization ranges, or other factors. The returns of the Market Neutral Fund depend on the net performance of its long and short positions, and it is possible for the fund to experience a net loss across all positions. If the Market Neutral Fund's investment strategy is successful, however, the net performance of its long and short positions will produce long-term capital appreciation that reflects the quality of the advisors' security selections, with limited exposure to general stock market risk. 33 o Investments in a Prospective Absolute Return Fund. The Fund may invest in a private investment fund that Vanguard may establish and manage (the "absolute return fund"). Vanguard expects that the absolute return fund will seek to generate capital appreciation over the long-term while exhibiting low correlation with the returns of the U.S. stock market. If the absolute return fund commences operations, it is expected to employ multiple strategies, each of which will seek to produce investment returns that have two key characteristics: (1) volatility that is similar in magnitude to the historic volatility of the U.S. stock market; and (2) performance over the long term comparable to, but independent of the direction and timing of, U.S. stock returns. Some of the absolute return fund's strategies may be designed to capture risk premia through investment opportunities arising from the structure, pricing, liquidity, volatility, or other features of the financial markets. Other strategies employed by the absolute return fund may be designed to take advantage of relative value differences perceived among securities or across the financial markets. To the extent that a strategy contemplated for use in the absolute return fund would be expected to exhibit lower volatility than the historic volatility of the U.S. stock market, the absolute return fund may use substantial leverage to amplify the volatility and expected returns of the strategy to targeted levels. The absolute return fund's strategies may be implemented through direct or indirect investments in stocks, bonds, hybrid securities, commodities, currencies, and other asset classes or investments. The absolute return fund may employ derivatives, short sales, and other complex investment techniques or transactions as part of its investment program. Vanguard has not made a decision to establish the absolute return fund and the Fund has not made a decision to invest in the absolute return fund in the future. Vanguard expects that the absolute return fund will not be organized as a mutual fund and will not be registered under any federal or state securities laws, including the Investment Company Act of 1940. Managed Distribution Policy The Fund has adopted a managed distribution policy under which it seeks to distribute a targeted amount of cash to shareholders on or about the 15th calendar day of each month. The monthly distribution per share for a given calendar year will be calculated as of January 1 of that year and is generally expected to be fixed during the year. This monthly distribution per share, however, will vary from year to year based on the Fund's performance over the previous three years. The monthly distribution per share for the Fund is based on the account value of a hypothetical account assumed to hold shares of the Fund purchased at inception. It is further assumed that this hypothetical account experiences the same distributions as the accounts of actual shareholders of the Fund and that no further purchases, redemptions or reinvestments are made for 34 the hypothetical account except the automatic reinvestment of certain required taxable distributions in additional shares of the Fund. The shareholders of the Fund are expected to receive a monthly cash distribution that is equal to the monthly distribution per share (as calculated below) times the number of shares they own on the record date. The formula to calculate the monthly distribution per share in a calendar year is as follows: Average daily Monthly distribution = 7% x value of hypothetical account over prior 3 calendar years ------------- ---------------------------------- per share 12 Number of shares held by hypothetical account at the end of the prior calendar year Please note that the Fund's managed distribution policy is not designed to generate, and is not expected to result in, distributions that equal a fixed percentage of the Fund's current net asset value per share or a fixed percentage of a shareholder's current account value. Instead, Fund shareholders are expected to receive a monthly distribution that is equal to the monthly distribution per share (as determined under the distribution formula) times the number of shares they own on the record date. The hypothetical account value is averaged over the prior three years in order to increase the relative predictability and relative stability of distributions to shareholders from year to year. A modified version of the formula will be used until the Fund has established three calendar years of history. In the first calendar year of the Fund, the monthly per-share distribution will be based on the initial per share value of the hypothetical account. In the second calendar year, the average daily balance of the hypothetical account over the prior calendar year (or the portion of the prior calendar year for which the Fund was in existence) will be used to determine the monthly distribution per share. In the third calendar year, the average daily balance of the hypothetical account over the prior two calendar years will be used to determine the monthly distribution per share. The Fund generally expects to distribute to shareholders substantially all of its net income (for example, interest and dividends) as well as substantially all of its net capital gains (for example, from the sale of its holdings or as distributions from other funds it holds). In addition, given its managed distribution policy, the Fund's distributions may be treated in part as a return of capital. For additional information on the Fund's managed distribution policy, see Dividends, Capital Gains, and Taxes. Primary Risks The Fund's investment strategies are intended to create a moderate level of risk for the Fund. An investment in the Fund, however, could lose money over short, intermediate, or even long periods of time because the Fund allocates its assets 35 worldwide across different asset classes and investments with specific risk and return characteristics. Results may vary substantially over time, and there is no guarantee that the Fund will achieve its investment objective or that its investment strategies will succeed. The Fund is expected to continue to make monthly cash distributions under its managed distribution policy irrespective of the Fund's investment performance. Because these distributions will be made from Fund assets and shareholders are not expected to reinvest such distributions in additional Fund shares, the Fund's monthly cash distributions will reduce the amount of assets available for investment by the Fund. It is possible for the Fund to suffer substantial investment losses and simultaneously experience additional asset reductions as a result of its distributions to shareholders under the managed distribution policy. Moreover, even if the Fund's capital grows over short, intermediate, or long periods of time, it is possible that such growth will be insufficient to enable the Fund to maintain the amount of its scheduled cash distributions without returning capital to shareholders. The Fund's managed distribution policy is designed to distribute a consistent amount of cash once per month throughout each calendar year, excluding any additional distributions required to comply with applicable law. Under the managed distribution policy, the dollar amount of the Fund's scheduled monthly distributions for a particular calendar year will increase or decrease each January based on the Fund's performance over the previous three years. Accordingly, the dollar amount of the Fund's monthly cash distributions could go up or down substantially from one year to the next and over time depending on, among other things, the performance of the financial markets in which the Fund invests, the allocation of Fund assets across different asset classes and investments, the performance of the Fund's investment strategies, and the amount and timing of prior distributions by the Fund. It is also possible for your distributions from the Fund to go down substantially from one year to the next and over time depending on the timing of your investments in the Fund. Any redemptions you make from your Fund account will proportionately reduce the amount of future cash distributions you will receive from the Fund. In addition to being subject to the risks described above, the Fund is also subject to manager risk and, depending on the allocation of Fund assets among eligible asset classes and investments, one or more of the additional risks described below. Each of these risks, alone or in combination with other risks, has the potential to hurt Fund performance and reduce Fund distributions. .. Manager risk is the chance that poor investment selections and/or poor asset allocation decisions by the advisor will cause the Fund either to fail to achieve its objective or to generate lower returns than were possible from different investment selections and/or asset allocation decisions. The advisor uses quantitative analysis and professional judgment to select the asset classes and investments that make up the 36 Fund's investment portfolio. In making such decisions, the advisor must, among other tasks, monitor and evaluate the expected risks, returns, and correlations of eligible assets classes and investments, as well as the likelihood that the selected combination will achieve the Fund's investment objective. These decisions are based in part upon the advisor's forecasts and estimates and analysis of historical events, as well as other aspects of quantitative analysis and professional judgment. The advisor's decisions may, for a variety of reasons, fail to accurately predict the actual risk, returns, and correlations of the asset classes and investments held by the Fund. Among the reasons predictions could be inaccurate are scarcity of historical data in respect of certain asset classes or investments, the fact that future events may not follow historical norms, and the potential for human error. It is possible that the advisor's allocation of Fund assets across specific asset classes and investments will cause the Fund to incur losses or underperform other funds with a similar investment objective. There is no guarantee that the advisor will succeed in combining multiple asset classes and investments in a manner that either achieves the Fund's investment objective or maintains a moderate level of risk. There can be no assurance that any asset classes or investments with relatively low historical correlations will in fact exhibit low correlations in the future. It is possible that the returns and direction of the Fund's asset classes and investments may suddenly converge, thereby magnifying the risks of the Fund's portfolio as a whole, with the potential for significant losses and significant reductions in the dollar amount of monthly distributions by the Fund. Diversification does not necessarily ensure a profit or protect against a loss in a declining market. The Fund could lose money at any time and may underperform the markets, asset classes, and investments in which it invests during any given period that such markets, asset classes, or investments rise or fall. The Fund's asset allocation strategy is complex and may involve more risk than other funds that invest only in stocks, bonds, and cash. .. Stock risk includes risks associated with investments in underlying funds that invest in U.S. or foreign stocks, and consists of stock market risk, currency risk, country/ regional risk, emerging markets risk, and REIT stock risk. Stock market risk is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Investments in foreign stocks are associated with the following risks: currency risk, which is the chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates; country/regional risk, which is the chance that events-such as political upheaval, financial troubles, or natural disasters-will weaken the securities of a particular country or an entire region; and emerging markets risk, which is the chance that the emerging markets will be substantially more volatile, and substantially less liquid, than the more developed foreign markets. REIT stock risk includes risks associated with investments in an underlying fund that invests primarily in REITs, and includes real estate industry risk and investment style risk, as well as stock 37 market risk (described above) and interest rate risk (described below). Real estate industry risk is the chance that the stocks of REITs will decline because of adverse developments affecting the real estate industry and real property values. Investment style risk is the chance that the returns from REIT stocks-which typically are small- or mid-capitalization stocks will trail returns from the overall stock market. Historically, these stocks have performed quite differently from the overall market. .. Bond risk includes risks associated with investments in underlying funds that invest in bonds or money market instruments, and consists of the following risks: interest rate risk, which is the chance that bond prices overall will decline because of rising interest rates; income risk, which is the chance that an underlying fund's income will decline because of falling interest rates; credit risk, which is the chance that the issuer of a security will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer's ability to make such payments will cause the price of that security to decline, thus reducing an underlying fund's return; and call risk, which is the chance that during periods of falling interest rates, issuers of callable bonds may call (repay) securities with higher coupons or interest rates before their maturity dates. If an underlying fund holds a bond that is called, the fund would then lose potential price appreciation and would be forced to reinvest the unanticipated proceeds at lower interest rates, resulting in a decline in the fund's income. For mortgage-backed securities, this risk is known as prepayment risk. .. Inflation-linked investment risk includes risks associated with investments in an underlying fund that invests primarily in inflation-indexed securities, and consists of the risk of considerable income fluctuations associated with changes in inflation, as well as bond risks. .. Commodity-linked investment risk includes risks associated with investments that create exposure to the total return of exchange-traded futures contracts on physical commodities. These risks consist of commodity futures trading risk, structured note risks, and derivatives risks. Commodity futures trading risk relates to the fact that commodity futures trading is volatile, and even a small movement in market prices could cause large losses. Consequently, the Fund could lose all or substantially all of its investment in instruments linked to the returns of commodity futures. The prices of commodity futures are subject to change based on various factors, including, but not limited to, the following: the lack of liquidity; global supply and demand for commodities; disorderly markets; limitations on deliverable supplies; the participation of hedgers and speculators; domestic and foreign interest rates and investors' expectations concerning interest rates; domestic and foreign inflation rates and investors' expectations concerning inflation rates; investment and trading activities of institutional investors; global or regional political, economic, or financial events and situations; government regulation and intervention; technical and operational or system failures; nuclear accident; terrorism; and acts of God. Structured note risks are 38 the risks associated with investments in commodity-linked structured notes, which include commodity futures trading risk and bond risk (described above). Derivatives risks include risks associated with the use of futures contracts, options on futures contracts, options on securities, swap agreements, warrants, forward contracts, and other derivatives. Derivatives may involve risks different from, and possibly greater than, investments in the underlying securities, assets, rates, or indexes. Losses involving certain derivatives can sometimes be substantial or even greater than the principal amount invested-in part because a relatively small price movement in such derivatives may result in an immediate and substantial loss to the investor. Derivatives also involve the risk of mispricing or improper valuation and the risk that changes in the value of the derivative may not correlate perfectly with the underlying securities, assets, rates, or indexes. The market for many derivatives is, or suddenly can become, illiquid, which may result in significant, rapid, and unpredictable changes in the prices for derivatives. The use of a derivative subjects the investor to the risk of non-performance by the counterparty, potentially resulting in delayed, partial, or even non-payment of amounts due under the derivative contract. .. Market neutral investment risk includes risks associated with an investment in the Vanguard Market Neutral Fund, and consists of strategy risk, short-selling risk, manager risk, capitalization risk, and style risk. Strategy risk is the chance that the long/short market neutral investment strategy used by the Market Neutral Fund will not succeed. This strategy could cause the Market Neutral Fund to lose money at any time. Short-selling risk is the chance that a fund will lose money in connection with short sales of securities or other investments. Short selling allows a fund an opportunity to profit from declines in the price of securities or other investments. A fund's use of short sales in combination with long positions in an attempt to improve performance or to reduce overall portfolio risk may not be successful and may result in greater losses or lower positive returns than if the fund held only long positions. It is possible that the securities or other investments a fund holds long will decline in value at the same time that the securities or other investments it holds short increase in value, thereby increasing potential losses. A fund may not always be able (or find it economically attractive) to sell short a security or other investment an advisor believes to be particularly overvalued. In that case, the fund may establish a short position in a different security or investment, and that short position may be less profitable for the fund than if the fund had shorted the security or investment the advisor believed was more overvalued. Also, a fund may be unable to close out a short position at an acceptable price, and may have to sell related long positions at disadvantageous times to produce cash to unwind a short position. A fund's loss on a short sale is potentially unlimited because there is no upward limit on the price a borrowed security or other investment could attain. Short selling involves higher transaction costs than typical long-only investing. 39 Manager risk is the chance that poor security selection will cause the Market Neutral Fund to underperform relevant benchmarks or other funds with a similar investment objective. Capitalization risk is the chance that returns from small-, mid-, and/or large-capitalization stocks (to the extent that the Market Neutral Fund's assets are invested in such stocks) will trail returns from the overall stock market. Specific types of stocks tend to go through cycles of doing better or worse than the stock market in general. These periods have, in the past, lasted for as long as several years. Style risk is the chance that returns from value stocks will trail returns from the overall stock market. The security selection processes used by the Market Neutral Fund's advisors are likely to cause the fund's investment portfolio to exhibit sensitivity to the value-growth cycle within the U.S. equity markets, meaning that the fund's performance will be more likely to decline during periods when growth stocks outperform value stocks than during periods when value stocks outperform growth stocks. .. Risks of prospective absolute return fund. If Vanguard establishes the absolute return fund, the risks associated with the absolute return fund are expected to include leverage risk, manager risk, currency trading risk, liquidity risk, leverage financing risk, and unregistered investment risk, which are described below, as well as stock risk, bond risk, short selling risk, and derivatives risk, which are described above. It is possible for the Fund to experience a total loss of the entire amount it may in the future invest in the absolute return fund. o Leverage risk includes the fact that the returns from a leveraged investment will be more volatile than returns from the underlying investment and the chance that leveraged losses will exceed the principal amount invested. Leverage exists when an investor achieves the right to a return on a total investment amount that exceeds the cash amount the investor contributed to the entity or instrument achieving the return. Leverage magnifies the effect of gains and losses. Vanguard expects that the absolute return fund, if established, may employ substantial leverage in connection with its investments. The absolute return fund's losses from its leveraged investments could result in a total loss of all amounts the Fund invests in the absolute return fund. Vanguard expects that the absolute return fund, if established, will issue shares of capital stock or other equity interests that limit the personal liability of shareholders to the amount invested in the absolute return fund. In that case, the Fund, as a shareholder of the absolute return fund, would be legally protected from losing more than the cash amount the Fund invested. o Manager risk is the chance that poor investment selections will cause the absolute return fund either to fail to achieve its investment objective or to generate lower returns than were possible from different investment selections. The absolute return fund does not exist as of the date of this prospectus and, if established, its future success will depend upon the expertise of Vanguard, which has only limited experience in managing absolute return investment 40 strategies. If the absolute return fund commences operations, it will be subject to the risk that Vanguard will not be successful in executing one or more absolute return strategies. The absolute return fund's investment program may be considered speculative and is expected to involve substantial risks. There is no guarantee that the absolute return fund will achieve its investment objective or that its strategies will succeed. The absolute return fund could lose money at any time and may underperform the markets in which it invests during any given period, regardless of whether such markets rise or fall. Absolute return investing is complex and may involve greater risk than investing in a balanced portfolio of stocks, bonds, and cash. There is no guarantee that the performance of the absolute return fund will have low correlation with the returns of the U.S. stock market. It is possible that the investment returns of the absolute return fund may suddenly converge with the investment returns of the U.S. stock market during a period of declining stock prices, thereby eliminating the diversification benefit the advisor would expect from including the absolute return fund within the Fund's investment portfolio. Although the advisor believes an appropriate level of investment in the absolute return fund could have the potential to reduce the volatility of the Fund's investment portfolio as a whole, an investment in the absolute return fund could experience high volatility and increase the Fund's overall volatility. o Currency trading risk is the chance that the absolute return fund could suffer losses from currency-related investments. Currency prices can be highly volatile and trading currencies for non-hedging purposes is generally considered speculative and involves a high risk of a substantial or total loss of invested capital. Currency rates in foreign countries may fluctuate significantly over short periods of time for a number of reasons, including, but not limited to, changes in interest rates, the imposition of currency controls, the devaluation of a currency by a country's government or banking authority, or other political developments in the United States or abroad. o Liquidity risk is the chance that the absolute return fund will invest in markets, assets, and instruments that are, or may become, illiquid. Vanguard expects that the absolute return fund will generally seek to invest in liquid markets, assets, and instruments, although the absolute return fund may have the ability to invest some or all of its assets in markets, assets, or instruments that are or may become illiquid. In addition, Vanguard expects that the shares issued by the absolute return fund will be designed with redemption rights that are substantially similar to the redemption rights associated with mutual fund shares. If the absolute return fund's shares have such redemption rights, the Fund is likely to treat its investment in the absolute return fund as liquid. There is no assurance, however, that the absolute return fund's investments will not suddenly become illiquid for an indefinite period of time. Illiquidity could cause 41 the absolute return fund to experience difficulties in valuing its portfolio holdings and may cause that fund to delay redemptions and/or honor redemption requests by the Fund with distributions of illiquid underlying portfolio holdings on an in-kind basis. o Leverage financing risk is the chance that the absolute return fund will be unable to access and maintain financing sufficient to leverage its investments to targeted levels. Vanguard expects that the absolute return fund will require the use of substantial leverage in order for its absolute return strategies to exhibit volatility and generate expected returns similar to the historic volatility and returns of the U.S. stock market. It is possible that the derivative or other counterparties that finance the leverage employed by the absolute return fund may not be able or willing to provide the level of financing that Vanguard believes is required to achieve its volatility and return targets. o Unregistered investment risk is the chance that the absolute return fund could lose money on investments that would not have been permitted or made had the absolute return fund been organized as a registered investment company. Because the absolute return fund will not register under any federal or state securities laws, including the Investment Company Act of 1940, potential investors in the absolute return fund, such as the Fund, will not have the regulatory protections provided to investors in registered and regulated investment companies. For additional information on investment risks, see More on the Funds. Performance/Risk Information The Fund began operations on ., 2007, so performance information is not yet available. Fees and Expenses The following table describes the fees and expenses you may pay if you buy and hold shares of the Fund. As is the case with all mutual funds, transaction costs incurred by the Fund, and by the Fund's underlying funds, for buying and selling securities are not reflected in the table. However, these costs will be reflected in investment performance figures. The expenses shown under Acquired Fund Fees and Expenses represent a weighted average of the expense ratios of, and the fees charged by, the underlying funds in which the Fund invests, and are based on estimated amounts for the current fiscal year. The Fund has no operating history, and actual operating expenses could differ from the following estimates. 42 Shareholder Fees (Fees paid directly from your investment) - -------------------------------------------------------------------------------- Sales Charge (Load) Imposed on Purchases None - -------------------------------------------------------------------------------- Purchase Fee None - -------------------------------------------------------------------------------- Sales Charge (Load) Imposed on Reinvested Dividends None - -------------------------------------------------------------------------------- Redemption Fee None - -------------------------------------------------------------------------------- Annual Fund Operating Expenses (Expenses deducted from the Fund's assets) - -------------------------------------------------------------------------------- Management Expenses None - -------------------------------------------------------------------------------- 12b-1 Distribution Fee None - -------------------------------------------------------------------------------- Other Expenses None - -------------------------------------------------------------------------------- Acquired Fund Fees and Expenses/1/ 0.57%/2/ Total Annual Fund Operating Expenses 0.57% /3/ - -------------------------------------------------------------------------------- 1 In addition to incurring Management Expenses and Other Expenses, the Fund's shareholders indirectly bear the annual net operating expenses of the underlying Vanguard funds (the Acquired Funds) in which the Fund invests. Acquired Fund Fees and Expenses include transaction costs (i.e., purchase and redemption fees), if any, imposed on the Fund by the Acquired Funds. See The Funds and Vanguard. 2 Over 50% of the Fund's Acquired Fund Fees and Expenses is attributable to the short sale dividend expenses reported by Vanguard Market Neutral Fund. Specifically, the Fund's Acquired Fund Fees and Expenses of 0.57% includes 0.30% of "Acquired Fund Short Sale Dividend Expenses," which represent a weighted average of the short sale dividend expenses reported by Vanguard Market Neutral Fund (estimated for the current fiscal year). See Plain Talk About Acquired Fund Short Sale Dividend Expenses. 3 Total Annual Fund Operating Expenses would be 0.27% if Acquired Fund Short Sale Dividend Expenses were excluded. Vanguard Market Neutral Fund's short sale dividend expenses are expected to be offset by amounts the fund earns through short sale-related interest earnings and other investment returns. See Plain Talk About Acquired Fund Short Sale Dividend Expenses. 43 - -------------------------------------------------------------------------------- Plain Talk About Acquired Fund Short Sale Dividend Expenses The Managed Payout Funds are "funds of funds" that invest in underlying Vanguard funds (the Acquired Funds) as well as non-fund investments. Each Managed Payout Fund may invest in an Acquired Fund that engages in short sales of stock. A short sale occurs when the Acquired Fund sells a stock it does not own and then borrows the stock from a lending stockholder in order to settle the transaction. Until the borrowed stock is returned to the lending stockholder, the Acquired Fund is required to pay the lending stockholder the amount of any dividends paid on the borrowed stock. The Acquired Fund does not itself collect the dividends, thus the payment to the lending stockholder creates a net expense, which is recorded as a "short sale dividend expense" on the financial statements of the Acquired Fund and is reported as part of the Acquired Fund's expense ratio. It is important to note that when the Acquired Fund sells a stock short, the proceeds are typically held in cash which earns interest at a negotiated rate. This interest, when combined with the Acquired Fund's other investment returns, is expected to be greater than the short sale dividend expense the Acquired Fund incurs through its payments to the lending stockholder. These combined amounts offset the Acquired Fund's short sale dividend expenses and thereby reduce total expenses the Managed Payout Funds bear through their investment in the Acquired Fund. - -------------------------------------------------------------------------------- The following example is intended to help you compare the cost of investing in the Fund (based on the fees and expenses of the acquired funds) with the cost of investing in other mutual funds. It illustrates the hypothetical expenses that you would incur over various periods if you invest $10,000 in the Fund's shares. This example assumes that the Fund provides a return of 5% a year and that operating expenses of the Fund and its underlying funds match our estimates. The results apply whether or not you redeem your investment at the end of the given period. 1 Year 3 Years - ------------------- $58 $183 - ------------------- This example should not be considered to represent actual expenses or performance for the future. 44 Additional Information As of ., 2007 - -------------------------------------------------------------------------------- Net Assets - -------------------------------------------------------------------------------- Investment Advisor The Vanguard Group, Inc., Valley Forge, Pa., since inception - -------------------------------------------------------------------------------- Distributions The Fund's twelve scheduled distributions in each year are made monthly, at mid-month. A thirteenth distribution may be made in December, and other additional distributions may be made with respect to a particular fiscal year, in order to comply with applicable law. Generally speaking, distributions will be paid to you in cash, unless you elect to reinvest in more shares of the Fund. The Fund generally requires the thirteenth distribution, and any other additional distributions automatically reinvests to comply with applicable law, in more shares of the Fund. These additional shares can be redeemed under the same terms and conditions as any other shares of the Fund. - -------------------------------------------------------------------------------- Suitable for IRAs Yes - -------------------------------------------------------------------------------- Inception Date ., 2007 - -------------------------------------------------------------------------------- Minimum Initial Investment $25,000 - -------------------------------------------------------------------------------- Newspaper Abbreviation - -------------------------------------------------------------------------------- Vanguard Fund Number 1499 - -------------------------------------------------------------------------------- CUSIP Number 92205M309 - -------------------------------------------------------------------------------- Ticker Symbol VPCPX - -------------------------------------------------------------------------------- 45 More on the Funds This prospectus describes the primary risks you would face as a Fund shareholder. It is important to keep in mind one of the main axioms of investing: The higher the risk of losing money, the higher the potential reward. The reverse, also, is generally true: The lower the risk, the lower the potential reward. As you consider an investment in any mutual fund, you should take into account your personal tolerance for fluctuations in the securities markets. Look for this [FLAG] symbol throughout the prospectus. It is used to mark detailed information about the more significant risks that you would confront as a Fund shareholder. The following sections explain the primary investment strategies and policies that each Fund uses in pursuit of its objective. The Fund's board of trustees, which oversees the Fund's management, may change investment strategies or policies in the interest of shareholders without a shareholder vote, unless those strategies or policies are designated as fundamental. Note that the Funds' investment objectives are not fundamental and may be changed without a shareholder vote. As "funds-of-funds," the Managed Payout Funds achieve their investment objectives by investing primarily in other Vanguard mutual funds but also in other potential investments. Because each Managed Payout Fund holds only a limited number of underlying funds, each Fund is classified as nondiversified. However, through its investments in these underlying funds, and through direct investments, each of the Managed Payout Funds is generally expected to maintain a broadly diversified portfolio. Asset Allocation Framework Asset allocation--that is, dividing your investment among stocks, bonds, cash, and other asset classes or investments--is one of the most critical decisions you can make as an investor. Each Managed Payout Fund invests in Vanguard mutual funds and other investments according to an asset allocation strategy designed to provide shareholders with regular cash flow from their investments in the Fund. The advisor uses quantitative analysis and professional judgment in an attempt to combine complementary asset classes and investments across the risk/reward spectrum. The advisor's goal for each Fund is to construct a broadly diversified portfolio that achieves the Fund's investment objective. The advisor has appointed an investment committee for the Funds. The investment committee makes three key asset allocation decisions for the Funds. First, the committee identifies eligible asset classes and investments for each Fund. Second, the committee establishes strategic asset allocation ranges specifying the Funds' minimum and maximum long-term allocations to eligible asset classes and investments. Third, the committee establishes a short-to intermediate-term asset allocation target for each Fund. The committee's asset allocation targets govern the portfolio manager's day-to-day investment decisions for each Fund. The investment committee's decisions are based, in part, on a consideration of a wide range of strategic inputs, which may include some combination of the following factors (or others): the Funds' prior performance; value at risk and expected shortfall; volatility; macroeconomic factors; current and expected market conditions; cash 46 flows; estimates of changes in the spreads between the expected returns of eligible asset classes and investments; historical and expected correlations between and among asset classes and investments; quantitative modeling of the likelihood that a proposed combination of asset classes and investments will achieve a Fund's investment objective; and the results of stress tests. The investment committee's decisions are also based on the collective professional judgment of its members. The Funds are managed in accordance with a variety of statistical and compliance-based risk management controls and procedures. The Funds do not have fixed asset allocations and have flexibility, subject to applicable law, to invest substantially in a single asset class or investment, although the Funds are generally expected to invest their assets across multiple asset classes or investments. The assets of each Fund are independently allocated based on the Fund's investment objective. The exact proportion of each asset class or investment held by a Fund may change to reflect shifts in the advisor's risk-and-return expectations. Funds Suited for Investors with Specific Goals Each Managed Payout Fund is expected to suit investors with specific goals, although some overlap is possible.
Growth Focus Fund This Fund is expected to have the greatest appeal to investors who seek only a modest current payout from their assets, but who wish to see their capital and payouts increase over time. This Fund has adopted a managed distribution policy with a 3% annual distribution rate that is applied to a hypothetical account value based on the Fund's average performance over the previous three years.* Compared to the other Managed Payout Funds, this Fund has a higher probability of generating growth in both capital and payouts that exceeds inflation, resulting in long-term capital appreciation. Growth and Distribution This Fund is likely to appeal to investors who want to Fund balance a need for a current payout from their assets with the desire to maintain the purchasing power of their payouts and capital over the long term. This Fund has adopted a managed distribution policy with a 5% annual distribution rate that is applied to a hypothetical account value based on the Fund's average performance over the previous three years.* The Fund is expected to provide inflation protection and capital preservation over the long term. Distribution Focus Fund This Fund is likely to appeal to investors who require a greater payout level to satisfy current spending needs. This Fund has adopted a managed distribution policy with a 7% annual distribution rate that is applied to a hypothetical account value based on the Fund's average performance over the previous three years.* Although the Fund's payouts and capital are not expected to grow at a rate that keeps pace with inflation, the Fund does seek to preserve the "nominal" (or original) value of invested capital over the long term. * For information about the Funds' managed distribution policies, see Dividends, Capital Gains, and Taxes.
47 In deciding whether any Managed Payout Fund is right for you, it is important to consider how each Fund is expected to perform over time, among other key considerations. Because each Fund has a different investment objective, investment portfolio, and managed distribution policy, each Fund is expected to perform differently. Choosing among the three Funds generally involves a trade-off between shorter-term spending needs and longer-term goals. All things being equal, selecting a Fund with a lower annual distribution rate is expected to result in the investor, over the long term, receiving higher monthly payments and having a higher account balance than if the investor had instead selected a Fund with a higher annual distribution rate. This somewhat counter-intuitive result is best explained by an example. The following hypothetical example assumes that a single "buy-and-hold" investment is made in each Fund on a single day, and that no purchases (other than mandatory reinvestments in additional Fund shares) or redemptions are made in the future. The example also assumes that each Fund achieves its investment objective over the long term, and that annual inflation is greater than zero over that period. Based on these assumptions, the Funds are expected to perform as follows: .. The Growth Focus Fund is expected to have the lowest short-term payout and the highest long-term payout and growth of capital. Because the Growth Focus Fund has the lowest annual distribution rate, initially this Fund will generate the lowest dollar amount of monthly distributions to shareholders, as compared with the other two Funds. Eventually, however, the Growth Focus Fund is expected to generate long-term capital appreciation, which is expected to result in the Growth Focus Fund making a higher dollar amount of monthly distributions than the Growth and Distribution Fund and the Distribution Focus Fund. That is because the Growth Focus Fund, by virtue of its modest annual distribution rate, puts comparatively more of its assets to work from the beginning; also, this Fund invests more aggressively than the other Funds by allocating comparatively more of its assets to higher-return/higher-risk investments. These two factors should allow the Growth Focus Fund more opportunity to seek capital appreciation than the other Funds. .. The performance of the Growth and Distribution Fund is expected to fall somewhere between the performance of the Growth Focus Fund and the Distribution Focus Fund. Because the Growth and Distribution Fund has, compared with the other two Funds, an intermediate annual distribution rate, the dollar amount of its initial monthly distributions will fall somewhere between the dollar amount of the initial monthly distributions of the Growth Focus Fund and those of the Distribution Focus Fund. Over time, however, the higher annual distribution rate of the Growth and Distribution Fund, along with its comparatively less aggressive investment program, is expected to cause its long-term performance to lag the performance of the Growth Focus Fund. By contrast, the Growth and Distribution Fund is expected, over the long term, to generate a higher dollar amount of monthly distributions, and have better 48 performance, than the Distribution Focus Fund, which has a higher annual distribution rate and a comparatively conservative investment program. .. The Distribution Focus Fund is expected to have the highest short-term payout and the lowest long-term payout and capital growth. Initially, the Distribution Focus Fund will generate monthly distributions that exceed the monthly distributions generated by the other two Funds. Eventually, however, the Distribution Focus Fund's higher annual distribution rate, comparatively conservative investment program, and lack of inflation protection are expected to cause its monthly distributions, as well as its performance, to lag the monthly distributions and net asset value of the Growth Focus Fund and the Growth and Distribution Fund. THESE HYPOTHETICAL EXAMPLES SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL PERFORMANCE, DISTRIBUTIONS, OR INFLATION FOR THE FUTURE. EXPECTATIONS ABOUT FUTURE INFLATION OR ABOUT THE FUNDS' FUTURE RELATIVE PERFORMANCE OR DISTRIBUTIONS ARE NOT A GUARANTEE OF FUTURE INFLATION OR OF THE FUNDS' ACTUAL FUTURE RELATIVE PERFORMANCE OR DISTRIBUTIONS. IT IS POSSIBLE THAT AN INVESTMENT IN A FUND COULD LOSE MONEY OVER SHORT, INTERMEDIATE, OR EVEN LONG PERIODS OF TIME. RESULTS MAY VARY SUBSTANTIALLY OVER TIME. THERE IS NO GUARANTEE THAT ANY FUND WILL ACHIEVE ITS INVESTMENT OBJECTIVE OR THAT ITS INVESTMENT STRATEGIES WILL SUCCEED. IT IS POSSIBLE FOR A FUND'S MONTHLY DISTRIBUTIONS TO INCREASE OR DECREASE FROM ONE YEAR TO THE NEXT OVER SEVERAL YEARS BECAUSE MONTHLY DISTRIBUTIONS DURING ANY CALENDAR YEAR ARE BASED ON THE FUND'S PERFORMANCE OVER THE PREVIOUS THREE YEARS. THE FUNDS ARE NOT GUARANTEED TO PROVIDE A FIXED OR STABLE LEVEL OF CASH DISTRIBUTIONS AT ANY TIME OR OVER ANY PERIOD OF TIME. 49 - -------------------------------------------------------------------------------- Plain Talk About Retirement Investing: 'Real' Returns versus 'Nominal' Returns In retirement, the primary purpose of your investment portfolio is to meet current and future spending needs. If you have accumulated adequate retirement savings, it should be relatively easy to generate sufficient cash to satisfy a reasonable level of spending in the near term. It is important, however, to consider the destructive effects that inflation can have on the purchasing power of your retirement portfolio over time. Inflation--the increase in the price of goods and services--can wreak havoc on a long-term investor's money. Unless the returns of your retirement portfolio keep place with inflation, your money's purchasing power will erode over time, with the risk that you may run out of money. Because inflation's erosion of value increases over time, the longer you expect to live, the more concerned you should be about your retirement portfolio's future purchasing power. Based on the average inflation rate of about 3% (annualized Consumer Price Index (CPI), 1926-2005), half of your retirement portfolio's purchasing power would be lost in less than 25 years. A retirement investment, then, should be evaluated not only for its expected gross total return (the "nominal" return) but also for its expected total return as reduced to take into account the effects of inflation (the "real" return). (Because every retiree has his or her own personal spending pattern, or "personal inflation rate," it may not be appropriate to base investment decisions on a broad inflation average, such as CPI. For example, some services, such as health care, may make up a larger portion of personal spending in retirement, and have been increasing in cost at rates exceeding CPI.) Ideally, a retiree should seek real returns that match his or her expected retirement spending rate plus a reserve for unplanned medical or other expenses. - -------------------------------------------------------------------------------- [FLAG] An investment in a Fund could lose money over short, intermediate, or even long periods of time because each Fund allocates its assets worldwide across different asset classes and investments with specific risk and return characteristics. Results may vary substantially over time, and there is no guarantee that a Fund will achieve its investment objective or that its investment strategies will succeed. 50 Each Fund is expected to continue to make monthly cash distributions under its managed distribution policy irrespective of the Fund's investment performance. Because these distributions will be made from Fund assets and shareholders are not expected to reinvest such distributions in additional Fund shares, a Fund's monthly cash distributions will reduce the amount of assets available for investment by the Fund. It is possible for a Fund to suffer substantial investment losses and simultaneously experience additional asset reductions as a result of its distributions to shareholders under the managed distribution policy. Moreover, even if a Fund's capital grows over short, intermediate, or long periods of time, it is possible that such growth will be insufficient to enable the Fund to maintain the amount of its scheduled cash distributions without returning capital to shareholders. Each Fund's managed distribution policy is designed to distribute a consistent amount of cash once per month throughout each calendar year, excluding any additional distributions required to comply with applicable law. Under the managed distribution policy, the dollar amount of a Fund's scheduled monthly distributions for a particular calendar year will increase or decrease each January based on the Fund's performance over the previous three years. Accordingly, the dollar amount of a Fund's monthly cash distributions could go up or down substantially from one year to the next and over time depending on, among other things, the performance of the capital markets in which the Fund invests, the allocation of Fund assets across different asset classes and investments, the performance of the Fund's investment strategies, and the amount and timing of prior distributions by the Fund. It is also possible for your distributions from a Fund to go down substantially from one year to the next and over time depending on the timing of your investments in the Fund. Any redemptions you make from your Fund account will proportionately reduce the amount of future cash distributions you will receive from the Fund. Security Selection Each Fund invests in Vanguard mutual funds and other investments according to an asset allocation strategy designed to provide shareholders with regular cash flow from their investments in the Fund. 51 [FLAG] Each Fund is subject to manager risk, which is the chance that poor investment selections and/or poor asset allocation decisions by the advisor will cause the Fund either to fail to achieve its investment objective or to generate lower returns than were possible from different investment selections and/or asset allocations. The advisor uses quantitative analysis and professional judgment to select the asset classes and investments that make up the Fund's investment portfolio. In making such decisions, the advisor must, among other tasks, monitor and evaluate the expected risks, returns, and correlations of eligible assets classes and investments, as well as the likelihood that the selected combination will achieve the Fund's investment objective. These decisions are based in part upon the advisor's forecasts and estimates and analysis of historical events, as well as other aspects of quantitative analysis and professional judgment. The advisor's decisions may, for a variety of reasons, fail to accurately predict the actual risk, returns, and correlations of the asset classes and investments held by the Fund. Among the reasons predictions could be inaccurate are scarcity of historical data in respect of certain asset classes or investments, the fact that future events may not follow historical norms, and the potential for human error. It is possible that the advisor's allocation of Fund assets across specific asset classes and investments will cause the Fund to incur losses or underperform other funds with a similar investment objective. There is no guarantee that the advisor will succeed in combining multiple asset classes and investments in a manner that either achieves the Fund's investment objective or maintains a moderate level of risk. There can be no assurance that any asset classes or investments with relatively low historical correlations will in fact exhibit low correlations in the future. It is possible that the returns and direction of the Fund's asset classes and investments may suddenly converge, thereby magnifying the risks of the Fund's portfolio as a whole, with the potential for significant losses and significant reductions in the dollar amount of monthly distributions by the Fund. Diversification does not necessarily ensure a profit or protect against a loss in a declining market. The Fund could lose money at any time and may underperform the markets, asset classes, and investments in which it invests during any given period that such markets, asset classes, or investments rise or fall. The Fund's asset allocation strategy is complex and may involve more risk than other funds that invest only in stocks, bonds, and cash. 52 The investment portfolio of each Fund will be managed to ensure that the Fund qualifies as a regulated investment company for federal income tax purposes. Stocks By owning shares of Vanguard stock index funds, each of the Managed Payout Funds indirectly invests, to varying degrees, in a diversified selection of U.S. stocks, including large-, mid-, and small-capitalization stocks diversified across growth and value styles. Each of the Managed Payout Funds also indirectly invests in a diversified selection of stocks of companies located in developed and emerging markets around the world. [FLAG] Each Fund is subject to risks associated with investments in stocks. Stock prices overall may decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. In addition, investments in foreign stock markets can be riskier than U.S. stock investments. The prices of foreign stocks and the prices of U.S. stocks have, at times, moved in opposite directions. Historically, mid- and small-cap stocks have been more volatile than--and at times have performed quite differently from--large-cap stocks. This volatility is due to several factors, including the fact that smaller companies often have fewer customers and financial resources than larger firms. These characteristics can make medium-size and small companies more sensitive to economic conditions, leading to less certain growth and dividend prospects. To illustrate the volatility of stock prices, the following table shows the best, worst, and average annual total returns for the U.S. stock market over various periods as measured by the Standard & Poor's 500 Index, a widely used barometer of market activity. (Total returns consist of dividend income plus change in market price.) Note that the returns shown do not include the costs of buying and selling stocks or other expenses that a real-world investment portfolio would incur. U.S. Stock Market Returns (1926-2006) 1 Year 5 Years 10 Years 20 Years - ------------------------------------------------------------------ Best 54.2% 28.6% 19.9% 17.8% - ------------------------------------------------------------------ Worst -43.1 -12.4 -0.8 3.1 - ------------------------------------------------------------------ Average 12.3 10.4 11.1 11.4 - ------------------------------------------------------------------ 53 The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926 through 2006. You can see, for example, that while the average return on common stocks for all of the 5-year periods was 10.4%, average returns for individual 5-year periods ranged from -12.4% (from 1928 through 1932) to 28.6% (from 1995 through 1999). These average returns reflect past performance of common stocks; you should not regard them as an indication of future performance of either the stock market as a whole or the Funds in particular. [FLAG] Each Fund is subject to risks associated with investments in foreign stocks. Stocks of foreign companies located in established and emerging markets around the world are subject to country/regional risk and currency risk. Country/regional risk is the chance that domestic events--such as political upheaval, financial troubles, or natural disasters--will weaken the securities of a particular country or an entire region. Currency risk is the chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates. In addition, investments in foreign stock markets can be riskier than U.S. stock investments. The prices of foreign stocks and the prices of U.S. stocks have, at times, moved in opposite directions. Stocks of companies located in emerging markets are subject to the risk that emerging markets may be substantially more volatile, and substantially less liquid, than the more developed foreign markets. Each of the Managed Payout Funds may allocate a portion of its assets to Vanguard REIT Index Fund, which invests primarily in stocks issued by equity REITs. [FLAG] Depending on the amount of Fund assets allocated to Vanguard REIT Index Fund, each Fund could be hurt by risks associated with an investment in REITs, which include real estate industry risk and investment style risk, as well as stock market risk and interest rate risk (described above). Real estate industry risk is the chance that the stocks of REITs will decline because of adverse developments affecting the real estate industry and real property values. Investment style risk is the chance that the returns from REIT stocks--which typically are small- or mid-capitalization stocks--will trail returns from the overall stock market. Historically, these stocks have performed quite differently from the overall market. Bonds By owning shares of Vanguard bond index funds, each of the Managed Payout Funds indirectly invests, to varying degrees, in government and corporate bonds, as well as in mortgage-backed securities. The credit quality of bonds held by the underlying funds is expected to be very high. 54 Although bonds are often thought to be less risky than stocks, there have been periods when bond prices have fallen significantly because of rising interest rates. For instance, prices of long-term bonds fell by almost 48% between December 1976 and September 1981. To illustrate the relationship between bond prices and interest rates, the following table shows the effect of a 1% and a 2% change (both up and down) in interest rates on the values of three noncallable bonds of different maturities, each with a face value of $1,000. How Interest Rate Changes Affect the Value of a $1,000 Bond/1/ After a 1% After a 1% After a 2% After a 2% Type of Bond (Maturity) Increase Decrease Increase Decrease - ------------------------------------------------------------------------------ Short-Term (2.5 years) $977 $1,024 $955 $1,048 - ------------------------------------------------------------------------------ Intermediate-Term (10 years) 926 1,082 858 1,172 - ------------------------------------------------------------------------------ Long-Term (20 years) 884 1,137 786 1,299 - ------------------------------------------------------------------------------ 1 Assuming a 5% yield. These figures are for illustration only; you should not regard them as an indication of future performance of the bond market as a whole or the Funds in particular. - -------------------------------------------------------------------------------- Plain Talk About Bonds and Interest Rates As a rule, when interest rates rise, bond prices fall. The opposite is also true: Bond prices go up when interest rates fall. Why do bond prices and interest rates move in opposite directions? Let's assume that you hold a bond offering a 5% yield. A year later, interest rates are on the rise and bonds of comparable quality and maturity are offered with a 6% yield. With higher-yielding bonds available, you would have trouble selling your 5% bond for the price you paid--you would probably have to lower your asking price. On the other hand, if interest rates were falling and 4% bonds were being offered, you should be able to sell your 5% bond for more than you paid. How mortgage-backed securities are different: In general, declining interest rates will not lift the prices of mortgage-backed securities--such as GNMAs--as much as the prices of comparable bonds. Why? Because when interest rates fall, the bond market tends to discount the prices of mortgage-backed securities for prepayment risk--the possibility that homeowners will refinance their mortgages at lower rates and cause the bonds to be paid off prior to maturity. In part to compensate for this prepayment possibility, mortgage-backed securities tend to offer higher yields than other bonds of comparable credit quality and maturity. - -------------------------------------------------------------------------------- 55 [FLAG] Depending on the amount of Fund assets allocated to bond funds, a Fund could be hurt by risks associated with investments in bonds. Generally speaking, bond investments are subject, in varying degrees, to interest rate risk, income risk, call risk, credit risk, and, to a limited extent, event risk. Interest rate risk is the chance that bond prices overall will decline because of rising interest rates. Interest rate risk should be low for short-term bonds, moderate for intermediate-term bonds, and high for long-term bonds. Changes in interest rates will affect bond income as well as bond prices. Income risk is the chance that an investor's income will decline because of falling interest rates. An investor holding bonds will experience a decline in income when interest rates fall because the investor over time must invest in lower-yielding bonds. Income risk is generally higher for investments in short-term bonds and lower for funds holding long-term bonds. Call risk is the chance that during periods of falling interest rates, issuers of callable bonds may call (repay) securities with higher coupons or interest rates before their maturity dates. If an underlying fund holds a bond that is called, the fund would lose potential price appreciation and would be forced to reinvest the unanticipated proceeds at lower interest rates, resulting in a decline in the investor's income. For mortgage-backed securities, this risk is known as prepayment risk. Credit risk is the chance that the issuer of a security will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer's ability to make such payments will cause the price of that security to decline, thus reducing an investor's return. Event risk is the chance that corporate fixed income securities will suffer a substantial decline in credit quality and market value because of a corporate restructuring. - -------------------------------------------------------------------------------- Plain Talk About Bond Maturities A bond is issued with a specific maturity date--the date when the issuer must pay back the bond's principal (face value). Bond maturities range from less than 1 year to more than 30 years. Typically, the longer a bond's maturity, the more price risk you, as a bond investor, face as interest rates rise--but also the higher yield you could receive. Longer-term bonds are more suitable for investors willing to take a greater risk of price fluctuations to get higher and more stable interest income. Shorter-term bond investors should be willing to accept lower yields and greater income variability in return for less fluctuation in the value of their investment. - -------------------------------------------------------------------------------- 56 Short-Term Investments Each of the Managed Payout Funds may invest a portion of its assets in a Vanguard money market fund. [FLAG] While designed as low risk investments, money market instruments, like most bonds, are subject to income risk and credit risk. Inflation-Linked Investments Each of the Managed Payout Funds may allocate a portion of its assets to Vanguard Inflation-Protected Securities Fund, which invests primarily in inflation-indexed securities issued by the U.S. government, its agencies and instrumentalities, and corporations. - -------------------------------------------------------------------------------- Plain Talk About Inflation-Indexed Securities Unlike a conventional bond, whose issuer makes regular fixed interest payments and repays the face value of the bond at maturity, an inflation-indexed security (IIS) provides principal and interest payments that are adjusted over time to reflect a rise (inflation) or a drop (deflation) in the general price level. This adjustment is a key feature, given that the Consumer Price Index (CPI) has risen in each of the past 50 years. (Source: Bureau of Labor Statistics.) It is important to note that, in the event of deflation, the U.S. Treasury has guaranteed that it will repay at least the face value of an IIS issued by the U.S. government. Inflation measurement and adjustment for an IIS have two important features. There is a two-month lag between the time that inflation occurs in the economy and when it is factored into IIS valuations. This is due to the time required to measure and calculate the CPI and for the Treasury to adjust the inflation accrual schedules for an IIS. For example, inflation that occurs in January is calculated and announced during February and affects IIS valuations throughout the month of March. In addition, the inflation index used is the non-seasonally adjusted index. It differs from the CPI that is reported by most news organizations, which is statistically smoothed to overcome highs and lows observed at different points each year. The use of the non-seasonally adjusted index can cause the Fund's income level to fluctuate. - -------------------------------------------------------------------------------- [FLAG] Depending on the amount of assets allocated to Vanguard Inflation-Protected Securities Fund, a Fund could be hurt by risks associated with an investment in inflation-indexed securities, which include the risk of considerable income fluctuations associated with changes in inflation, as well as bond risks (described above). 57 - -------------------------------------------------------------------------------- Plain Talk About Inflation-Indexed Securities and Interest Rates Interest rates on conventional bonds have two primary components: a "real" yield and an increment that reflects investor expectations of future inflation. By contrast, interest rates on an IIS are adjusted for inflation and, therefore, are not affected meaningfully by inflation expectations. This leaves only real rates to influence the price of an IIS. A rise in real rates will cause the price of an IIS to fall, while a decline in real rates will boost the price of an IIS. In the past, interest rates on conventional bonds have varied considerably more than real rates because of wide fluctuations in actual and expected inflation (annual changes in the CPI since 1925 have ranged from -10% to +18% and have averaged +3.1%). (Source: Bureau of Labor Statistics.) Because real interest yields have been relatively stable, the prices of IISs have generally fluctuated less than those of conventional bonds with comparable maturity and credit-quality characteristics. - -------------------------------------------------------------------------------- Other Investments Each of the Managed Payout Funds may invest in selected other investments ("other investments") that have historically generated capital appreciation over the long-term while exhibiting low correlation with the returns of the U.S. stock market. The advisor believes that the expected return characteristics of these other investments offer potential diversification to a balanced portfolio of stocks, bonds, and cash. The Fund's potential other investments include commodity-linked investments, investments in Vanguard Market Neutral Fund, and investments in a prospective absolute return fund. These investments are described below. Commodity-Linked Investments A Fund may allocate a portion of its assets to investments that create exposure to the total return of a diversified basket of exchange-traded futures contracts on physical commodities. Commodities include real assets such as agricultural products, livestock, precious and industrial metals, and energy products. Commodity futures prices have a historically low correlation with the returns of the stock and bond markets. The Fund's commodity-linked investments may not be structured to conform to the composition, weighting, roll dates, reset dates, or contract months of any particular commodity futures market index. The Fund's commodity-linked investments may consist of any combination of commodity futures contracts, options on commodity futures contracts, commodity-linked total or return swaps, commodity-linked structured notes, and other commodity-linked instruments. To illustrate the volatility of commodity futures prices, the following table shows the best, worst, and average annual total returns for the U.S. commodities futures market over various periods as measured by the S&P GSCI/TM/ Total Return Index, a widely 58 used barometer of commodity futures activity. (This index measures a fully collateralized commodity futures investment that is rolled forward from the 5th to the 9th business day of each month.) Note that the returns shown do not include the costs of buying and selling these investments or other expenses that a real-world investment portfolio would incur, and the return on this index is significantly different from the return on buying physical commodities. U.S. Commodity Futures Returns* (1983-2006) 1 Year 5 Years 10 Years 20 Years - -------------------------------------------------------------------------------- Best 49.74% 23.60% 15.21% 10.84% - -------------------------------------------------------------------------------- Worst -35.75 -4.53 2.11 9.08 - -------------------------------------------------------------------------------- Average 11.81 10.08 8.33 9.83 - -------------------------------------------------------------------------------- * Returns represent average cumulative average returns over all one-year periods, and all 5-, 10-, and 20- year consecutive periods from 1983 to 2006. The table covers all of the 1-, 5-, 10-, and 20-year periods from 1983 through 2006. You can see, for example, that while the average return on commodity futures for all of the 5-year periods was 10.08%, average returns for individual 5-year periods ranged from -4.53% to 23.60%. These average returns reflect past performance of commodity futures; you should not regard them as an indication of future performance of either the commodities futures market as a whole or the Funds in particular. Also note that the returns of the index only measure the returns of the specific commodity futures contracts tracked by the index over the relatively short period covered by the index. The returns of the index may not necessarily illustrate the volatility of commodity futures contracts not included within the index and may not necessarily illustrate the historic volatility of the commodity futures market as a whole. Because the history of the S&P GSCI Total Return Index is relatively short, we also illustrate the volatility of commodity futures prices as reflected by the prices of physical commodities that are bought for immediate delivery ("on the spot".) The following table shows the best, worst, and average annual total returns for the U.S. commodity market as measured by the CRB Spot Index/TM/ over various periods from 1948 through 2006. (This index is a measure of price movements of 22 basic physical commodities whose markets are presumed to be among the first to be influenced by changes in economic conditions.) The spot return for a physical commodity represents the return from changes in the price of the commodity. While the CRB Spot Index only captures the spot return of physical commodities and does not capture the total return of commodity futures, it does serve as a reasonable proxy for the volatility of commodity futures prices in general because the change in the spot prices of physical commodities has been the largest source of volatility in the commodities futures market over time. Note 59 that the returns shown do not include the costs of buying, storing, and selling physical commodities or other expenses that a real-world commodity portfolio would incur. U.S. Commodity Futures Returns* (1948-2006) 1 Year 5 Years 10 Years 20 Years - -------------------------------------------------------------------------------- Best 58.25% 15.37% 10.32% 5.57% - -------------------------------------------------------------------------------- Worst -19.02 -6.94 -4.49 -1.80 - -------------------------------------------------------------------------------- Average 2.51 1.69 1.71 2.28 - -------------------------------------------------------------------------------- * Returns represent average cumulative average returns over all one-year periods, and all 5-, 10-, and 20- year consecutive periods from 1948 to 2006. The table covers all of the 1-, 5-, 10-, and 20-year periods from 1948 through 2006. You can see, for example, that while the average return on commodities for all of the 5-year periods was 1.69%, average returns for individual 5-year periods ranged from -6.94% to 15.37%. These average returns reflect past performance of the index; you should not regard them as an indication of future performance of either the commodities market as a whole or the Funds in particular. - -------------------------------------------------------------------------------- Plain Talk About Commodities Commodities are raw materials used to create the goods that consumers buy. They include a wide range of physical assets, such as agricultural products, livestock, precious metals, energy products, and industrial metals. Commodities can be purchased for immediate delivery ("on the spot") or delivery within a specific time period in the future under the terms of a futures contract. An exchange-traded commodity futures contract provides for the purchase and sale of a specified type and quantity of a commodity during a stated delivery month. A futures contract on an index of commodities provides for the payment and receipt of cash, based on the level of the index at settlement or liquidation of the contract. Unlike equity securities, futures contracts, by their terms, have stated expirations and, at a specified time prior to expiration, trading in a futures contract for the current delivery month will cease. As a result, an investor wishing to maintain exposure to a futures contract on a particular commodity with the nearest expiration must close out a position in the expiring contract and establish a new position in the contract for the next delivery month, a process referred to as "rolling." An investor will profit from rolling a futures contract if the cost for the new contract is lower than the cost of the expiring contract. Conversely, an investor will lose money by rolling a futures contract if the cost for the new contract is higher than the cost of the expiring contract. - -------------------------------------------------------------------------------- 60 [FLAG] Depending on the amount of Fund assets allocated to investments that create exposure to the total return of exchange-traded futures contracts on physical commodities, each Fund could be hurt by risks associated with an investment in commodity-linked investments, which include commodity futures trading risk, structured note risks, and derivatives risks. Commodity futures trading risk relates to the fact that commodity futures trading is volatile, and even a small movement in market prices could cause large losses. Consequently, the Fund could lose all or substantially all of its investment in instruments linked to the returns of commodity futures. The prices of commodity futures are subject to change based on various factors, including, but not limited to, the following: the lack of liquidity; global supply and demand for commodities; disorderly markets; limitations on deliverable supplies; the participation of hedgers and speculators; domestic and foreign interest rates and investors' expectations concerning interest rates; domestic and foreign inflation rates and investors' expectations concerning inflation rates; investment and trading activities of institutional investors; global or regional political, economic, or financial events and situations; government regulation and intervention; technical and operational or system failures; nuclear accident; terrorism; and acts of God. Structured note risks are the risks associated with investments in commodity-linked structured notes, which include commodity futures trading risk and bond risk (described above). Derivatives risks include risks associated with the use of futures contracts, options on futures contracts, options on securities, swap agreements, warrants, forward contracts, and other derivatives. Derivatives may involve risks different from, and possibly greater than, investments in the underlying securities, assets, rates, or indexes. Losses involving certain derivatives can sometimes be substantial or even greater than the principal amount invested-in part because a relatively small price movement in such derivatives may result in an immediate and substantial loss to the investor. Derivatives also involve the risk of mispricing or improper valuation and the risk that changes in the value of the derivative may not correlate perfectly with the underlying securities, assets, rates, or indexes. The market for many derivatives is, or suddenly can become, illiquid, which may result in significant, rapid, and unpredictable changes in the prices for derivatives. The use of a derivative subjects the investor to the risk of non-performance by the counterparty, potentially resulting in delayed, partial, or even non-payment of amounts due under the derivative contract. 61 - -------------------------------------------------------------------------------- Plain Talk About Derivatives Generally speaking, a derivative is a financial contract whose value is based on the value of a financial asset (such as a stock, bond, or currency), a physical asset (such as gold), or a market index (such as the S&P 500 Index). Derivatives can take many forms. Some forms of derivatives, such as exchange- traded futures and options on securities, commodities, or indexes, have been trading on regulated exchanges for decades. These types of derivatives are standardized contracts that can easily be bought and sold, and whose market values are determined and published daily. Nonstandardized derivatives (such as swap agreements), on the other hand, tend to be more specialized or complex, and may be harder to value. - -------------------------------------------------------------------------------- Market Neutral Investments Each of the Managed Payout Funds may invest in Vanguard Market Neutral Fund, which seeks to provide long-term capital appreciation while limiting exposure to general stock market risk. The fund uses two investment advisors, each of which independently selects and maintains a diversified portfolio of securities for the fund. Each advisor buys securities it considers to be undervalued and sells short an approximately equal dollar amount of securities the advisor considers to be overvalued. By taking long and short positions of approximately equal value in different securities, the Market Neutral Fund attempts to limit the effect of market movements on portfolio performance to the extent consistent with the advisors' individual investment decisions to create exposure to specific risk factors. Each advisor uses an independent security selection process and may emphasize specific industries, styles (growth/value), capitalization ranges, or other factors. The returns of the Market Neutral Fund depend on the net performance of its long and short positions, and it is possible for the fund to experience a net loss across all positions. If the Market Neutral Fund's investment strategy is successful, however, the net performance of its long and short positions will produce long-term capital appreciation that reflects the quality of the advisors' security selections, with limited exposure to general stock market risk. 62 - -------------------------------------------------------------------------------- Plain Talk About Market Neutral Investing The goal of market neutral investing is to generate returns that are independent of the returns and direction of the stock market (called "beta") and driven by the value added by the advisor's skill in selecting stocks (called "alpha"). Market neutral investing is often implemented through a long/short portfolio of investments in publicly traded U.S. stocks. The advisor buys what it believes are attractive (or undervalued) stocks for the long portion of the portfolio, and sells an approximately equal dollar amount of what it believes are unattractive (or overvalued) stocks for the short portion of the portfolio. The long portion of the portfolio is expected to deliver the overall returns of the stock market, plus additional performance unique to the specific stocks purchased by the advisor. The short portion of the portfolio is expected to deliver the overall returns of the stock market, plus additional performance unique to the specific stocks the advisor sold short. The long and short positions can have risk exposures significantly different from those of the overall market. The larger these risk differences, the more the performance of the portfolio will differ from the overall market. The market exposure of the combined long and short positions is expected to cancel out, producing a net stock market return of zero, plus or minus the alpha added by the advisor's stock-selection process. Market neutral investing is sometimes called an "absolute return" strategy because it seeks positive returns whether the stock market goes up or down. - -------------------------------------------------------------------------------- [FLAG] Depending on the amount of assets allocated to Vanguard Market Neutral Fund, a Fund could be hurt by risks associated with an investment in the Vanguard Market Neutral Fund, including strategy risk, short-selling risk, manager risk, capitalization risk, and style risk. Strategy risk is the chance that the long/short market neutral investment strategy used by the Market Neutral Fund will not succeed. This strategy could cause the Market Neutral Fund to lose money at any time. Short-selling risk is the chance that a fund will lose money in connection with short sales of securities or other investments. Short selling allows a fund an opportunity to profit from declines in the price of securities or other investments. A fund's use of short sales in combination with long positions in an attempt to improve performance or to reduce overall portfolio risk may not be successful and may result in greater losses or lower positive returns than if the fund held only long positions. It is possible that the securities or other investments a fund holds long will decline in value at the same time that the securities or other investments it holds short increase in value, thereby increasing potential losses. A fund may not always be able (or find it economically attractive) to sell short a security or other investment an advisor believes to be particularly overvalued. In that case, the fund may establish a short position in a different security or investment, and that short position may be less profitable for the fund than if the fund had shorted the security or investment the advisor believed was more 63 overvalued. Also, a fund may be unable to close out a short position at an acceptable price, and may have to sell related long positions at disadvantageous times to produce cash to unwind a short position. A fund's loss on a short sale is potentially unlimited because there is no upward limit on the price a borrowed security or other investment could attain. Short selling involves higher transaction costs than typical long-only investing. Manager risk is the chance that poor security selection will cause the Market Neutral Fund to underperform relevant benchmarks or other funds with a similar investment objective. Capitalization risk is the chance that returns from small-, mid-, and/or large-capitalization stocks (to the extent that the Market Neutral Fund's assets are invested in such stocks) will trail returns from the overall stock market. Specific types of stocks tend to go through cycles of doing better or worse than the stock market in general. These periods have, in the past, lasted for as long as several years. Style risk is the chance that returns from value stocks will trail returns from the overall stock market. The security selection processes used by the Market Neutral Fund's advisors are likely to cause the fund's investment portfolio to exhibit sensitivity to the value-growth cycle within the U.S. equity markets, meaning that the fund's performance will be more likely to decline during periods when growth stocks outperform value stocks than during periods when value stocks outperform growth stocks. - -------------------------------------------------------------------------------- Plain Talk About Short Sales A short sale is the sale of a security that the seller does not own. In order to deliver the security to the purchaser, the short seller borrows the security, typically from a broker-dealer or an institutional investor. The short seller later closes out the position by returning the security to the lender, typically by purchasing the same security on the open market. - -------------------------------------------------------------------------------- Prospective Absolute Return Fund Each of the Managed Payout Funds may invest in a private investment fund that Vanguard may establish and manage (the "Vanguard absolute return fund"). Vanguard expects that the absolute return fund will seek to generate capital appreciation over the long-term while exhibiting low correlation with the returns of the U.S. stock market. If the absolute return fund commences operations, it is expected to employ multiple strategies, each of which will seek to produce investment returns that have two key characteristics: (1) volatility that is similar in magnitude to the historic volatility of the U.S. stock market; and (2) performance over the long term comparable to, but independent of the direction and timing of, U.S. stock returns. Some of the absolute return fund's strategies may be designed to capture risk premia through investment opportunities arising from the structure, pricing, liquidity, volatility, or other features of the financial markets. Other strategies employed by the absolute return fund may be 64 designed to take advantage of relative value differences perceived among securities or across the financial markets. To the extent that a strategy contemplated for use in the absolute return fund would be expected to exhibit lower volatility than the historic volatility of the U.S. stock market, the absolute return fund may use substantial leverage to amplify the volatility and expected returns of these investments to targeted levels. The absolute return fund's strategies may be implemented through direct or indirect investments in stocks, bonds, hybrid securities, commodities, currencies, and other asset classes or investments. The absolute return fund may employ derivatives, short sales, and other complex investment techniques or transactions as part of its investment program. Vanguard has not made a decision to establish the absolute return fund and the Managed Payout Funds have not made a decision to invest in the absolute return fund in the future. Vanguard expects that the absolute return fund will not be established as a mutual fund and will not be registered under any federal or state securities laws, including the Investment Company Act of 1940. If the absolute return fund is established and approved for investment by the Managed Payout Funds, each Fund expects to adhere to a policy (which can be changed only by the board of trustees) that it will not invest more than 40% of its assets in the absolute return fund under any circumstances. - -------------------------------------------------------------------------------- Plain Talk About Absolute Return Investing Conventional approaches to investing money seek either to duplicate or exceed the performance of a specific asset class. An absolute return approach to investing, however, seeks capital appreciation over the long-term while exhibiting low correlation with the returns of the U.S. stock market. During periods of falling or rising stock prices, an absolute return investment may generate returns that are markedly different from the returns of the stock market, for better or worse. Some absolute return strategies are designed to take advantage of disparities or inefficiencies in different markets or benefit from cyclical relationships or special situations. Certain absolute return strategies may be designed to systematically capture risk premia across the financial markets by offering risk transfer opportunities to market participants. Other absolute return strategies are designed to track the performance of an asset class that has historically positive long-term returns while exhibiting low correlation with stock market returns. Generally speaking, an absolute return approach to investing places a premium on manager insight, effective execution, and disciplined risk controls. Absolute return strategies often use a high degree of implicit or explicit leverage, which introduces the potential for a substantial or total loss of invested capital over short periods of time. - -------------------------------------------------------------------------------- 65 [FLAG] Depending on the amount of Fund assets that may in the future be allocated to the absolute return fund (if that fund is established), each Fund could be hurt by risks associated with an investment in the absolute return fund. If the absolute return fund is established, its risks are expected to include leverage risk, manager risk, currency trading risk, liquidity risk, leverage financing risk, and unregistered investment risk, which are described below, as well as stock risk, bond risk, short selling risk, and derivatives risk, which are described above. It is possible for a Fund to experience a total loss of the entire amount it may in the future invest in the absolute return fund. Leverage risk includes the fact that the returns from a leveraged investment will be more volatile than returns from the underlying investment and the chance that leveraged losses will exceed the principal amount invested. Leverage exists when an investor achieves the right to a return on a total investment amount that exceeds the cash amount the investor contributed to the entity or instrument achieving the return. Leverage magnifies the effect of gains and losses. Vanguard expects that the absolute return fund, if established, will employ substantial leverage in connection with its investments. The absolute return fund's losses from its leveraged investments could result in a total loss of all amounts a Fund invests in the absolute return fund. Vanguard expects that the absolute return fund, if established, will issue shares of capital stock or other equity interests that limit the personal liability of shareholders to the amount invested in the absolute return fund. In that case, a Fund, as a shareholder of the absolute return fund, would be legally protected from losing more than the cash amount the Fund invested. Manager risk is the chance that poor investment selections will cause the absolute return fund either to fail to achieve its investment objective or to generate lower returns than were possible from different investment selections. The absolute return fund does not exist as of the date of this prospectus and, if established, its future success will depend upon the expertise of Vanguard, which has only limited experience in managing absolute return investment strategies. If the absolute return fund commences operations, it will be subject to the risk that Vanguard will not be successful in executing one or more absolute return strategies. The absolute return fund's investment program may be considered speculative and is expected to involve substantial risks. There is no guarantee that the absolute return fund will achieve its investment objective or that its strategies will succeed. The absolute return fund could lose money at any time and may underperform the markets in which it invests during any given period, regardless of whether such markets rise or fall. Absolute return investing is complex and may involve greater risk than investing in a balanced portfolio of stocks, bonds, 66 and cash. There is no guarantee that the performance of the absolute return fund will have low correlation with the returns of the U.S. stock market. It is possible that the investment returns of the absolute return fund may suddenly converge with the investment returns of the U.S. stock market during a period of declining stock prices, thereby eliminating the diversification benefit the advisor would expect from including the absolute return fund within the Fund's investment portfolio. Although the advisor believes an appropriate level of investment in the absolute return fund could have the potential to reduce the volatility of the Fund's investment portfolio as a whole, an investment in the absolute return fund could experience high volatility and increase the Fund's overall volatility. Currency trading risk is the chance that the absolute return fund could suffer losses from currency-related investments. Currency prices can be highly volatile and trading currencies for non-hedging purposes is generally considered speculative and involves a high risk of a substantial or total loss of invested capital. Currency rates in foreign countries may fluctuate significantly over short periods of time for a number of reasons, including, but not limited to, changes in interest rates, the imposition of currency controls, the devaluation of a currency by a country's government or banking authority, or other political developments in the United States or abroad. Liquidity risk is the chance that the absolute return fund will invest in markets, assets, and instruments that are, or may become, illiquid. Vanguard expects that the absolute return fund will generally seek to invest in liquid markets, assets, and instruments, although the absolute return fund may have the ability to invest some or all of its assets in markets, assets, or instruments that are or may become illiquid. In addition, Vanguard expects that the shares issued by the absolute return fund will be designed with redemption rights that are substantially similar to the redemption rights associated with mutual fund shares. If the absolute return fund's shares have such redemption rights, the Fund is likely to treat its investment in the absolute return fund as liquid. There is no assurance, however, that the absolute return fund's investments will not suddenly become illiquid for an indefinite period of time. Illiquidity could cause in the absolute return fund to experience difficulties in valuing its portfolio holdings and may cause that fund to delay redemptions and/or honor redemption requests by an investing Fund with distributions of illiquid underlying portfolio holdings on an in-kind basis. Leverage financing risk is the chance that the absolute return fund will be unable to access and maintain financing sufficient to leverage its investments 67 to targeted levels. Vanguard expects that the absolute return fund will require the use of substantial leverage in order for its absolute return strategies to exhibit volatility and generate expected returns similar to the historic volatility and returns of the U.S. stock market. It is possible that the derivative or other counterparties that finance the leverage employed by the absolute return fund may not be able or willing to provide the level of financing that Vanguard believes is required to achieve its volatility and return targets. Unregistered investment risk is the chance that the absolute return fund could lose money on investments that would not have been permitted or made had the Vanguard absolute return fund been organized as a registered investment company. Because the Vanguard absolute return fund will not register under any federal or state securities laws, including the Investment Company Act of 1940, potential investors in the Vanguard absolute return fund, such as the Fund, will not have the regulatory protections provided to investors in registered and regulated investment companies. Other Investment Policies and Risks Although the Funds actively allocate their assets principally among some combination of stocks (including stocks issued by REITs), bonds, cash, inflation-linked investments, and selected other investments, each Fund may invest in other types of instruments. The other types of instruments are described below. Each Fund may invest up to 15% of its net assets in illiquid securities. Illiquid securities are securities that a Fund may not be able to sell in the ordinary course of business. Restricted securities are a special type of illiquid security; these securities have not been publicly issued and legally can be resold only to qualified buyers. From time to time, the board of trustees may determine that particular restricted securities are not illiquid, and those securities may then be purchased by a Fund without limit. Each Fund may invest in derivatives only if the expected risks and rewards of the derivatives are consistent with the investment objective, policies, strategies, and risks of the Fund as disclosed in this prospectus. The advisor will not use derivatives to change the risks of a Fund as a whole as such risks are disclosed in this prospectus. In particular, derivatives will be used only where they may help the advisor: .. Invest in eligible asset classes or investments with greater efficiency and lower cost than is possible through direct investment; .. Add value when these instruments are attractively priced; .. Hedge specific risk factors associated with eligible asset classes or investments or the investment portfolio as a whole; .. Reduce the potential volatility of the investment portfolio as a whole; or 68 .. Minimize the risk of loss. The Funds' derivative investments may include futures contracts, options on futures contracts, options on securities or securities indexes, credit default swaps, interest rate swaps, total or return swaps, forward foreign currency agreements, or other derivatives. Each Fund may invest a portion of its assets in direct holdings of investment-grade fixed income securities, high-quality money market instruments, and cash. The primary purpose of these investments is to enable the Fund to satisfy margin deposit, collateralization, and/or segregation obligations associated with its use of derivatives. Vanguard may invest a small portion of a Fund's assets in shares of stock or bond exchange-traded funds (ETFs). ETFs provide returns similar to those of the bonds listed in the index or a subset of the index. Vanguard may purchase ETFs when doing so will facilitate cash management or potentially add value because the instruments are favorable priced. Vanguard receives no additional revenue from investing Fund assets in ETF Shares of other Vanguard funds, because Fund assets invested in ETF Shares are excluded when allocating to the Fund its share of the costs of Vanguard operations. The Funds are generally managed without regard to tax ramifications. Cash Management Each Fund's daily cash balance may be invested in one or more Vanguard CMT Funds, which are very low-cost money market funds. When investing in a Vanguard CMT Fund, each Fund bears its proportionate share of the at-cost expenses of the CMT Fund in which it invests. Temporary Investment Measures Each Fund may temporarily depart from its normal investment policies and strategies when doing so is believed to be in the Fund's best interest, so long as the alternative is consistent with the Fund's investment objective. For instance, the Fund may invest beyond the normal limits in derivatives or ETFs that are consistent with the Fund's objective when those instruments are more favorably priced or provide needed liquidity, as might be the case when the Fund is transitioning assets from one advisor to another or receives large cash flows that it cannot prudently invest immediately. In addition, each Fund may take temporary defensive positions that are inconsistent with its normal investment policies and strategies--for instance, by allocating substantial assets to cash, commercial paper, or other less volatile instruments--in response to adverse or unusual market, economic, political, or other conditions. In 69 doing so, the Fund may succeed in avoiding losses but may otherwise fail to achieve its investment objective. - -------------------------------------------------------------------------------- Plain Talk About Costs of Investing Costs are an important consideration in choosing a mutual fund. That's because you, as a shareholder, pay the costs of operating a fund, plus any transaction costs incurred when the fund buys or sells securities. These costs can erode a substantial portion of the gross income or the capital appreciation a fund achieves. Even seemingly small differences in expenses can, over time, have a dramatic effect on a fund's performance. - -------------------------------------------------------------------------------- Frequent Trading or Market-Timing Background. Some investors try to profit from strategies involving frequent trading of mutual fund shares, such as market-timing. For funds holding foreign securities, investors may try to take advantage of an anticipated difference between the price of the fund's shares and price movements in overseas markets, a practice also known as time-zone arbitrage. Investors also may try to engage in frequent trading of funds holding investments such as small-cap stocks and high-yield bonds. As money is shifted into and out of a fund by a shareholder engaging in frequent trading, a fund incurs costs for buying and selling securities, resulting in increased brokerage and administrative costs. These costs are borne by all fund shareholders, including the long-term investors who do not generate the costs. In addition, frequent trading may interfere with an advisor's ability to efficiently manage the fund. Policies to Address Frequent Trading. The Vanguard funds (other than money market funds, short-term bond funds, and Vanguard ETF(TM) Shares) do not knowingly accommodate frequent trading. The board of trustees of each Vanguard fund has adopted policies and procedures reasonably designed to detect and discourage frequent trading and, in some cases, to compensate the fund for the costs associated with it. Although there is no assurance that Vanguard will be able to detect or prevent frequent trading or market-timing in all circumstances, the following policies have been adopted to address these issues: .. Each Vanguard fund reserves the right to reject any purchase request--including exchanges from other Vanguard funds--without notice and regardless of size. For example, a purchase request could be rejected if Vanguard determines that such purchase may negatively affect a fund's operation or performance or because of a history of frequent trading by the investor. .. Each Vanguard fund (other than money market funds, short-term bond funds, and ETF Shares) generally prohibits, except as otherwise noted in the Investing With 70 Vanguard section, an investor's purchases or exchanges into a fund account for 60 calendar days after the investor has redeemed or exchanged out of that fund account. .. Certain Vanguard funds charge shareholders purchase and/or redemption fees on transactions. See the Investing With Vanguard section of this prospectus for further details on Vanguard's transaction policies. Each fund (other than money market funds), in determining its net asset value, will use fair-value pricing as described in the Share Price section. Fair-value pricing may reduce or eliminate the profitability of certain frequent-trading strategies. Do not invest with Vanguard if you are a market-timer. Turnover Rate Although each Fund normally seeks to invest for the long term, each Fund may sell shares of the underlying funds regardless of how long they have been held. A turnover rate of 100%, for example, would mean that a Fund had sold and replaced shares of underlying funds valued at 100% of its net assets within a one-year period. - -------------------------------------------------------------------------------- Plain Talk About Turnover Rate Turnover rates give an indication of how transaction costs, which are not included in the fund's expense ratio, could affect the fund's future returns. In general, the greater the volume of buying and selling by the fund, the greater the impact that dealer markups and other transaction costs will have on its return. Also, funds with high turnover rates may be more likely to generate capital gains that must be distributed to shareholders as taxable income. - -------------------------------------------------------------------------------- The Funds and Vanguard Each Fund is a member of The Vanguard Group, a family of 37 investment companies with more than 145 funds holding assets in excess of $1 trillion. All of the funds that are members of The Vanguard Group share in the expenses associated with administrative services and business operations, such as personnel, office space, equipment, and advertising. Vanguard also provides marketing services to the funds. Although shareholders do not pay sales commissions or 12b-1 distribution fees, each fund (or in the case of a fund with multiple share classes, each share class of the fund) pays its allocated share of The Vanguard Group's marketing costs. 71 According to an agreement between the Managed Payout Funds and Vanguard, the Funds' expenses will be offset by a reimbursement from Vanguard for (1) the Funds' contributions to the costs of operating the underlying Vanguard funds in which the Managed Payout Funds invest, and (2) certain savings in administrative and marketing costs that Vanguard expects to derive from the Funds' operation. The Funds' trustees believe that the reimbursements should be sufficient to offset most, if not all, of the expenses incurred by the Funds. As a result, each Fund is expected to operate at a very low or zero expense ratio. - -------------------------------------------------------------------------------- Plain Talk About Vanguard's Unique Corporate Structure The Vanguard Group is truly a mutual mutual fund company. It is owned jointly by the funds it oversees and thus indirectly by the shareholders in those funds. Most other mutual funds are operated by management companies that may be owned by one person, by a group of individuals, or by investors who own the management company's stock. The management fees charged by these companies include a profit component over and above the companies' cost of providing services. By contrast, Vanguard provides services to its member funds on an at-cost basis, with no profit component, which helps to keep the funds' expenses low. - -------------------------------------------------------------------------------- Investment Advisor The Vanguard Group, Inc. (Vanguard), P.O. Box 2600, Valley Forge, PA 19482, which began operations in 1975, serves as advisor to the Funds through an investment committee and a portfolio manager subject to the supervision and oversight of the board of trustees. Vanguard also serves as investment advisor for each of the underlying funds. As of June 30, 2007, Vanguard served as advisor for about $xxx billion in assets. For a discussion of why the board of trustees approved the Fund's investment advisory arrangements, see the Fund's annual report to shareholders covering the Fund's fiscal year ending on December 31, 2007, which will be available 60 days after that date. George U. Sauter is Chief Investment Officer and Managing Director of Vanguard. As Chief Investment Officer, he is responsible for the oversight of Vanguard's Quantitative Equity and Fixed Income Groups. The investments managed by these two groups include active quantitative equity funds, equity index funds, active bond funds, index bond funds, stable value portfolios, and money market funds. Since joining Vanguard in 1987, Mr. Sauter has been a key contributor to the development of Vanguard's stock indexing and active quantitative equity investment strategies. He received his A.B. in Economics from Dartmouth College and an M.B.A. in Finance from the University of Chicago. 72 - -------------------------------------------------------------------------------- Plain Talk About the Funds' Portfolio Manager The manager primarily responsible for the day-to-day management of the Funds, consistent with the asset allocation targets established by the Funds' investment committee, is: Michael H. Buek, CFA, Principal of Vanguard. He has been with Vanguard since 1987; has managed investment portfolios since 1991; and has managed the Funds since their inception. Education: B.S., University of Vermont; M.B.A., Villanova University. - -------------------------------------------------------------------------------- The Statement of Additional Information provides information about the portfolio manager's compensation, other accounts under management, and ownership of securities in the Funds. Dividends, Capital Gains, and Taxes Fund Distributions Each of the Managed Payout Funds has adopted a managed distribution policy under which it seeks to distribute a targeted amount of cash to shareholders on or about the 15th calendar day of each month. The monthly distribution per share for a given calendar year, will be calculated as of January 1 of that year and is expected to be fixed during the year unless there is an additional distribution in December or after the fiscal year-end, as in the description that follows. This monthly distribution per share, however, will vary from year to year based on a Fund's performance over the previous three years. The monthly distribution per share for a Fund is based on the account value of a hypothetical account assumed to have purchased shares of the Fund at inception. It is further assumed that this hypothetical account experiences the same distributions as the accounts of actual shareholders of the Fund and that no further purchases or redemptions are made for the hypothetical account except the automatic reinvestment of certain required taxable distributions in additional shares of the Fund, which is explained in more detail that follows. The shareholders of a Fund are expected to receive a monthly cash distribution that is equal to the monthly distribution per share (as in the calculation that follows) times the number of shares they own on the record date. The formula to calculate the monthly distribution per share in a calendar year is as follows (the annual distribution rate depends on the Fund): Annual distribution Average daily value of rate hypothetical account Monthly distribution = (3%, 5%, or 7%) x over prior 3 calendar years ------------------------ ------------------------ per share 12 Number of shares held by hypothetical account at the end of the prior calendar year 73 Please note that the Funds' managed distribution policies are not designed to generate, and are not expected to result in, distributions that equal a fixed percentage of a Fund's current net asset value per share or a fixed percentage of a shareholder's current account value. Instead, Fund shareholders are expected to receive a monthly distribution that is equal to the monthly distribution per share (as determined under the distribution formula) times the number of shares they own on the record date. The hypothetical account value is averaged over the prior three years in order to increase the relative predictability and relative stability of distributions to shareholders from year to year. A modified version of the formula will be used until the Fund has established three calendar years of history. In the first calendar year of the Fund, the monthly per-share distribution will be based on the initial per-share value of the hypothetical account. In the second calendar year, the average daily balance of the hypothetical account over the prior calendar year (or the portion of the prior calendar year for which the Fund was in existence) will be used to determine the monthly distribution per share. In the third calendar year, the average daily balance of the hypothetical account over the prior two calendar years will be used to determine the monthly distribution per share. Shareholders can choose to receive their twelve scheduled monthly distributions in each year in cash or to automatically reinvest their distributions in additional Fund shares or in shares of other Vanguard funds (subject to any fund-specific requirements or limitations). Because the monthly distribution per share is expected to remain fixed during a calendar year, shareholders are expected to receive twelve fixed monthly payments over the course of the calendar year, unless the number of Fund shares they hold changes because of purchases, including any voluntary reinvestment of Fund distributions in more Fund shares, or redemptions. Each Fund generally expects to distribute to shareholders substantially all of its net income (for example, interest and dividends) as well as substantially all of its net capital gains (for example, from the sale of its holdings or distributions from other funds it holds). In addition, pursuant to its managed distribution policy, each Fund may make distributions that are treated as a return of capital. Each Fund will provide disclosures with each monthly distribution that estimate the percentages of the current and year-to-date distributions that represent net investment income, other income or capital gains, and return of capital (if any). At the end of the year, the Funds may be required under applicable law to recharacterize distributions for the year among ordinary income, capital gains, and return of capital (if any) for purposes of tax reporting to shareholders. 74 A thirteenth distribution may be made in December, and other additional distributions may be made with respect to a particular fiscal year in order to comply with applicable law. The Funds are designed with the expectation that the twelve scheduled monthly distributions will be paid in cash but that any thirteenth distribution or other additional distribution will be automatically reinvested in additional shares. Accordingly, the Funds will generally automatically reinvest any thirteenth or other additional distribution in additional shares. These additional shares can be redeemed under the same terms and conditions as any other shares of the Funds. Shareholders can receive cash in respect of the thirteenth or any other additional distributions by redeeming these additional shares for cash. The Funds also may upon written request distribute cash rather than automatically reinvesting a thirteenth or other additional distribution in additional shares. The hypothetical account will also be required to reinvest the thirteenth distribution and any other additional required distributions in additional shares of the Fund. A Fund's board of trustees may change the managed distribution policy in the interest of shareholders without a shareholder vote. - -------------------------------------------------------------------------------- Plain Talk About Distributions As a shareholder, you are entitled to your portion of a fund's income from interest, dividends, and other sources as well as gains from the sale of investments. Income consists of, among other things, the dividends that the fund earns from any stock holdings and the interest it receives from any money market and bond investments. Capital gains are realized whenever the fund sells investments for higher prices than it paid for them or receives certain distributions or allocations from funds it holds. These capital gains are either short-term or long-term, depending on whether the fund held the investments for one year or less or for more than one year. You receive the fund's earnings as either a dividend or capital gains distribution, even if the distribution is reinvested in more shares of the Fund. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Plain Talk About Return of Capital The Managed Payout Funds may make distributions that are treated as return of capital. "Return of capital" is the portion of a distribution representing the return of your original investment in the Fund. Return of capital reduces your cost basis in the Fund's shares, and is not taxable to you until your cost basis has been reduced to zero. - -------------------------------------------------------------------------------- 75 Basic Tax Points Vanguard will send you a statement each year showing the tax status of all your distributions. In addition, investors in taxable accounts should be aware of the following basic tax points: .. Distributions are taxable to you for federal income tax purposes, whether or not you reinvest these amounts in additional Fund shares. .. Distributions declared in December--if paid to you by the end of January--are taxable for federal income tax purposes as if received in December. .. Any dividend and short-term capital gains distributions that you receive are taxable to you as ordinary income for federal income tax purposes. If you are an individual and meet certain holding-period requirements with respect to your Fund shares, you may be eligible for reduced federal tax rates on "qualified dividend income," if any, distributed by the Fund. .. Any distributions of net long-term capital gains are taxable to you as long-term capital gains for federal income tax purposes, no matter how long you've owned shares in the Fund. .. Capital gains distributions may vary considerably from year to year as a result of the Funds' normal investment activities and cash flows. .. A sale or exchange of Fund shares is a taxable event. This means that you may have a capital gain to report as income, or a capital loss to report as a deduction, when you complete your federal income tax return. .. Dividend and capital gains distributions that you receive, as well as your gains or losses from any sale or exchange of Fund shares, may be subject to state and local income taxes. - -------------------------------------------------------------------------------- Plain Talk About "Buying a Dividend" Unless you are investing through a tax-deferred retirement account (such as an IRA), you should consider avoiding a purchase of fund shares shortly before the fund makes a distribution, because doing so can cost you money in taxes. This is known as "buying a dividend". For example: On December 15, you invest $5,000, buying 250 shares for $20 each. If the fund pays a distribution of $1 per share on December 16, its share price will drop to $19 (not counting market change). You still have only $5,000 (250 shares x $19 = $4,750 in share value, plus 250 shares x $1 = $250 in distributions), but you owe tax on the $250 distribution you received--even if you reinvest it in more shares. To avoid "buying a dividend," check a fund's distribution schedule before you invest. - -------------------------------------------------------------------------------- 76 General Information Backup withholding. By law, Vanguard must withhold 28% of any taxable distributions or redemptions from your account if you do not: .. Provide us with your correct taxpayer identification number; .. Certify that the taxpayer identification number is correct; and .. Confirm that you are not subject to backup withholding. Similarly, Vanguard must withhold taxes from your account if the IRS instructs us to do so. Foreign investors. Vanguard funds generally are not sold outside the United States, except to certain qualified investors. If you reside outside the United States, please consult our website at www.vanguard.com and review "Non-U.S. investors." Foreign investors should be aware that U.S. withholding or other taxes may apply to any investments in Vanguard funds. Invalid addresses. If a dividend or capital gains distribution check mailed to your address of record is returned as undeliverable, Vanguard will automatically reinvest all future distributions until you provide us with a valid mailing address. Tax consequences. This prospectus provides general tax information only. If you are investing through a tax-deferred retirement account, such as an IRA, special tax rules apply. The Funds' distributions are not designed to comply with any required minimum distribution rules applicable to tax-deferred retirement accounts, and shareholders receiving cash distributions from the Funds within such accounts will need to include such distributions as appropriate in the computation of their annual required minimum distribution. Please consult your tax advisor for detailed information about a fund's tax consequences for you. Share Price Each Fund's share price, called its net asset value, or NAV, is calculated each business day as of the close of regular trading on the New York Stock Exchange, generally 4 p.m., Eastern time. NAV per share is computed by dividing the net assets of the Fund by the number of Fund shares outstanding. On holidays or other days when the Exchange is closed, the NAV is not calculated, and the Fund does not transact purchase or redemption requests. Each Fund's NAV is calculated based, in part, upon the NAVs of the underlying mutual funds in which the Fund invests (in the case of conventional share classes) or the market value of the shares (in the case of exchange-traded fund shares, such as ETF Shares). The prospectuses for the underlying funds explain the circumstances under which those funds will use fair-value pricing and the effects of doing so. A Fund's NAV calculation incudes any stocks held by a Fund, which are valued at their market value when reliable market 77 quotations are readily available. Debt securities held by a Fund are valued (and included in the calculation of NAV) based on information furnished by an independent pricing service or market quotations. Certain short-term debt instruments used to manage a fund's cash are valued on the basis of amortized cost. When pricing-service information or reliable market quotations are not readily available, securities are priced at their fair value (the amount that the owner might reasonably expect to receive upon the current sale of a security). A fund also will use fair-value pricing if the value of a security it holds has been materially affected by events occurring before the fund's pricing time but after the close of the primary markets or exchanges on which the security is traded. This most commonly occurs with foreign stocks, which may trade on foreign exchanges that close many hours before the fund's pricing time. Fair-value pricing also may be used for domestic stocks--for example, if (1) trading in a security is halted and does not resume before the fund's pricing time or if a security does not trade in the course of a day, and (2) the fund holds enough of the security that its price could affect the fund's NAV. A fund may use fair-value pricing with respect to its fixed income securities (1) on bond market holidays when the fund is open for business (such as Columbus Day and Veterans Day), or (2) if the value of a security it holds has been materially affected by events occurring before the fund's pricing time but after 3 p.m., Eastern time (per industry standard, pricing services base bond prices on the 3 p.m. yield curve). Fair-value prices are determined by Vanguard according to procedures adopted by the board of trustees. When fair-value pricing is employed, the prices of securities used by a fund to calculate its NAV may differ from quoted or published prices for the same securities. Vanguard fund share prices can be found daily in the mutual fund listings of most major newspapers under various "Vanguard" headings. 78 INVESTING WITH VANGUARD This section of the prospectus explains the basics of doing business with Vanguard. Be sure to carefully read each topic that pertains to your relationship with Vanguard. Vanguard reserves the right to change the following policies, without prior notice to shareholders. Please call or check online for current information. PURCHASING SHARES Vanguard reserves the right, without prior notice, to increase or decrease the minimum amount required to open or maintain a fund account, or to add to an existing fund account. Investment minimums may differ for certain categories of investors. ACCOUNT MINIMUMS TO OPEN AND MAINTAIN AN ACCOUNT. $25,000. TO ADD TO AN EXISTING ACCOUNT. $50 by Automatic Investment Plan; $100 by check, exchange, wire, or electronic bank transfer (other than Automatic Investment Plan). HOW TO PURCHASE SHARES Be sure to check Exchanging Shares, Frequent-Trading Limits, and Other Rules You Should Know before initiating your request. ONLINE TRANSACTIONS. You may open certain types of accounts, request an electronic bank transfer, and make an exchange (the purchase of shares in an open fund with the proceeds of a redemption from another fund) through our website at www.vanguard.com. BY TELEPHONE. You may begin the account registration process or request that the account-opening forms be sent to you. You may also call Vanguard to request a purchase of shares by wire, by electronic bank transfer, or by an exchange. See Contacting Vanguard. BY MAIL. You may send your account registration form and check to open a new fund account at Vanguard. To add to an existing fund account, you may send your check with an Invest-by-Mail form (from your account statement) or with a deposit slip (available online). You may also send a written request to Vanguard to add to a fund account or to make an exchange. The request must be in good order. See How to Make a Purchase Request: By check. For a list of Vanguard addresses, see Contacting Vanguard. 79 HOW TO MAKE A PURCHASE REQUEST BY ELECTRONIC BANK TRANSFER. To establish the electronic bank transfer option on an account, you must designate a bank account online, complete a special form, or fill out the appropriate section of your account registration form. After the option is set up on your account, you can purchase shares by electronic bank transfer on a regular schedule (Automatic Investment Plan) or whenever you wish. Your purchase request can be initiated online, by telephone, or by mail if your request is in good order. BY WIRE. Wiring instructions vary for different types of purchases. Please call Vanguard for instructions and policies on purchasing shares by wire. You may initiate your wire purchase by phone or online. See Contacting Vanguard. BY CHECK. You may send a check to make initial or additional purchases to your fund account. Also see How to Purchase Shares: By mail. Make your check payable to Vanguard and include the appropriate fund number (e.g., Vanguard--xx). " For a list of Fund numbers (for funds in this prospectus), see Contacting Vanguard. TRADE DATES If the New York Stock Exchange (NYSE) is open for regular trading (a business day) at the time a purchase, exchange, or redemption request is received in good order, the trade date will generally be the same day. See Other Rules You Should Know--Good Order for additional information on all transaction requests. You buy shares at a fund's next-determined NAV after Vanguard receives your purchase request in good order. NAVs are determined only on days when the NYSE is open for regular trading. For example, if your request is received by Vanguard before the close of regular trading on the NYSE (generally 4 p.m., Eastern time), your shares are purchased at that day's NAV. This is known as your trade date. For CHECK purchases into all funds other than money market funds, and for exchanges and WIRE purchases into all funds: For a purchase request received by Vanguard before the close of regular trading on the NYSE (generally 4 p.m., Eastern time), the trade date will be the same day the purchase request was received. For a purchase request received after the close of regular trading on the NYSE, the trade date will be the first business day following the day the purchase request was received. For CHECK purchases of money market funds only: For a purchase request received by Vanguard before the close of regular trading on the NYSE (generally 4 p.m., Eastern time), the trade date will be the first business day following the day the purchase request was received. For a purchase request received after the close of regular trading on the NYSE, the trade date will be the second business day following the day the purchase request was received. Because money market instruments must be purchased with federal funds and it takes a money market mutual fund one business day to convert check proceeds into federal funds, the trade date will be one business day later than for other funds. 80 For an electronic bank transfer by AUTOMATIC INVESTMENT PLAN: If you have established the Automatic Investment Option, your trade date generally will be one business day before the date you designated for withdrawal from your bank account. If the trade date would fall in the year preceding the date you designated for withdrawal from your bank account, the trade date will be the first business day of the new year (the year you designated for withdrawal from your bank account. For an ELECTRONIC BANK TRANSFER (other than an Automatic Investment Plan purchase): For a purchase request received by Vanguard on a business day before 10 p.m., Eastern time, the trade date will be the following business day. Your purchase request must be accurate and complete. See Other Rules You Should Know--Good Order. For further information about purchase transactions, consult our website at www.vanguard.com or see Contacting Vanguard. OTHER PURCHASE RULES YOU SHOULD KNOW CHECK PURCHASES. All purchase checks must be written in U.S. dollars and must be on a U.S. bank. Vanguard does not accept cash, traveler's checks, or money orders. In addition, to protect the funds from fraud, Vanguard may refuse "starter checks" and checks that are not made payable to Vanguard. NEW ACCOUNTS. We are required by law to obtain from you certain personal information that we will use to verify your identity. If you do not provide the information, we may not be able to open your account. If we are unable to verify your identity, Vanguard reserves the right, without prior notice, to close your account or take such other steps as we deem reasonable. REFUSED OR REJECTED PURCHASE REQUESTS. Vanguard reserves the right to stop selling fund shares or to reject any purchase request at any time and without prior notice, including, but not limited to, purchases requested by exchange from another Vanguard fund. This also includes the right to reject any purchase request because of a history of frequent trading by the investor or because the purchase may negatively affect a fund's operation or performance. LARGE PURCHASES. Please call Vanguard before attempting to invest a large dollar amount. NO CANCELLATIONS. Place your transaction requests carefully. Vanguard will not accept your request to cancel any transaction request after processing of the request has begun. 81 REDEEMING SHARES HOW TO REDEEM SHARES Be sure to check Exchanging Shares, Frequent-Trading Limits, and Other Rules You Should Know before initiating your request. ONLINE TRANSACTIONS. You may redeem shares, request an electronic bank transfer, and make an exchange (the purchase of shares with the proceeds of a redemption from another fund) through our website at www.vanguard.com. BY TELEPHONE. You may call Vanguard to request a redemption of shares by wire, by electronic bank transfer, by check, or by an exchange. See Contacting Vanguard. BY MAIL. You may send a written request to Vanguard to redeem from a fund account or to make an exchange. The request must be in good order. See Contacting Vanguard. HOW TO RECEIVE REDEMPTION PROCEEDS BY ELECTRONIC BANK TRANSFER. To establish the electronic bank transfer option, you must designate a bank account online, complete a special form, or fill out the appropriate section of your account registration form. You can then redeem shares by electronic bank transfer on a regular schedule (Automatic Withdrawal Plan--$50 minimum) or whenever you wish ($100 minimum). Your transaction can be initiated online, by telephone, or by mail if your request is in good order. BY WIRE. When redeeming from a money market fund or a bond fund, you may instruct Vanguard to wire your redemption proceeds ($1,000 minimum) to a previously designated bank account. Wire redemptions generally are not available for Vanguard's balanced or stock funds. The wire redemption option is not automatic; you must designate a bank account online, complete a special form, or fill out the appropriate section of your account registration form. Vanguard charges a $5 fee for wire redemptions under $5,000. BY CHECK. If you have not chosen another redemption method, Vanguard will mail you a redemption check, normally within two business days of your trade date. TRADE DATES If the NYSE is open for regular trading (a business day) at the time a purchase, exchange, or redemption request is received in good order, the trade date will generally be the same day. See Other Rules You Should Know--Good Order for additional information on all transaction requests. You redeem shares at a fund's next-determined NAV after Vanguard receives your redemption request in good order. NAVs are determined only on days when the NYSE is open for regular trading. For example, if your request is received by Vanguard before the close of regular trading on the NYSE (generally 4 p.m., 82 Eastern time), your shares are redeemed at that day's NAV. This is known as your trade date. For CHECK redemptions and EXCHANGES from all funds: For redemption request received by Vanguard before the close of regular trading on the New York Stock Exchange (generally 4 p.m., Eastern time), the trade date will be the same day the redemption request was received. For a redemption request received after the close of regular trading on the NYSE, the trade date will be the first business day following the day the redemption request was received. For money market fund redemptions by WIRE: For telephone requests received by Vanguard before 10:45 a.m., Eastern time (2 p.m., Eastern time, for Vanguard Prime Money Market Fund), on the day that the NYSE has regular trading hours, the redemption proceeds will leave Vanguard by the close of business the day the redemption request was received. For other money market wire redemption requests received before the close of regular trading on the NYSE (generally 4 p.m., Eastern time), the redemption proceeds will leave Vanguard by the close of business on the business day following the day the redemption request was received. For bond fund redemptions by wire: For a redemption request request received by Vanguard before the close of regular trading on the NYSE (generally 4 p.m., Eastern time, the redemption proceeds will leave Vanguard by the close of business on the first business day following the day the redemption request was received. For an electronic bank transfer by Automatic Withdrawal Plan: Your trade date is the date you designated for withdrawal of funds (redemption of shares) from your Vanguard account. Proceeds of redeemed shares generally will be transferred from Vanguard to your designated bank account two business days after your trade date. If the date you designated for withdrawal falls on a weekend, holiday, or other nonbusiness day, your trade date will be the previous business day; however, if the shares would be transferred from Vanguard, the trade date will actually be the first business day of the new year (the year proceeds of redeemed shares would be transferred from Vanguard to your bank account.) For an electronic bank transfer (other than an Automatic Withdrawal Plan redemption): For a redemption request received by Vanguard before the close of regular trading on the NYSE (generally 4 p.m., Eastern time) the trade date will be the same day the redemption request was received. For a redemption request received after the close of regular trading on the NYSE, the trade date will be the first business day following the day the redemption request was received. Your redemption request must be accurate and complete. See Other Rules You Should Know--Good Order. 83 For further information about redemption transactions, consult our website at www.vanguard.com or see Contacting Vanguard. OTHER REDEMPTION RULES YOU SHOULD KNOW DOCUMENTATION FOR CERTAIN ACCOUNTS. Special documentation may be required to redeem from certain types of accounts, such as trust, corporate, nonprofit, or retirement accounts. Please call us before attempting to redeem from these types of accounts. POTENTIALLY DISRUPTIVE REDEMPTIONS. Vanguard reserves the right to pay all or part of a redemption in kind--that is, in the form of securities--if we reasonably believe that a cash redemption would negatively affect the fund's operation or performance or that the shareholder may be engaged in frequent trading. Under these circumstances, Vanguard also reserves the right to delay payment of the redemption proceeds for up to seven calendar days. By calling us before you attempt to redeem a large dollar amount, you may avoid in-kind or delayed payment of your redemption. Please see Frequent-Trading Limits for information about Vanguard's policies to limit frequent trading. RECENTLY PURCHASED SHARES. Although you can redeem shares at any time, proceeds may not be made available to you until the fund collects payment for your purchase. This may take up to ten calendar days for shares purchased by check or by electronic bank transfer. If you have written a check on a fund with checkwriting privileges, that check may be rejected if your fund account does not have a sufficient available balance. ADDRESS CHANGE. If you change your address online or by telephone, there may be a 15-day restriction on your ability to make online and telephone redemptions. You can request a redemption in writing at any time. Confirmations of address changes are sent to both the old and new addresses. PAYMENT TO A DIFFERENT PERSON OR ADDRESS. At your request, we can make your redemption check payable to a different person or send it to a different address. However, this requires the written consent of all registered account owners and may require a signature guarantee. You can obtain a signature guarantee from most commercial and savings banks, credit unions, trust companies, or member firms of a U.S. stock exchange. A notary public cannot provide a signature guarantee. NO CANCELLATIONS. Place your transaction requests carefully. Vanguard will not accept your request to cancel any transaction request after processing of the request has begun. EMERGENCY CIRCUMSTANCES. Vanguard funds can postpone payment of redemption proceeds for up to seven calendar days. In addition, Vanguard funds can suspend redemptions and/or postpone payments of redemption proceeds beyond seven 84 calendar days at times when the NYSE is closed or during emergency circumstances, as determined by the SEC. EXCHANGING SHARES If the NYSE is open for regular trading (a business day) at the time a purchase, conversion, exchange, or redemption request is received in good order, the trade date will generally be the same day. See Other Rules You Should Know--Good Order for additional information on all transaction requests. An exchange occurs when the assets redeemed from one Vanguard fund are used to purchase shares in an open Vanguard fund. You can make exchange requests online (if you are a registered use of Vanguard.com), by telephone, or by mail. See Purchasing Shares and Redeeming Shares. Please note that Vanguard reserves the right, without prior notice, to revise or terminate the exchange privilege, limit the amount of any exchange, or reject an exchange, at any time, for any reason. FREQUENT-TRADING LIMITS Because excessive transactions can disrupt management of a fund and increase the fund's costs for all shareholders, Vanguard places certain limits on frequent trading in the Vanguard funds. Each Vanguard fund (other than money market funds, short-term bond funds, and ETF Shares) limits an investor's purchases or exchanges into a fund account for 60 calendar days after the investor has redeemed or exchanged out of that fund account. For Vanguard fund accounts (including participants in employer-sponsored defined contribution plans that are served by Vanguard Small Business Services), the policy does not apply to the following: .. Purchases of shares with reinvested dividend or capital gains distributions. .. Transactions through Vanguard's Automatic Investment Plan, Automatic Exchange Service, Direct Deposit Service, Automatic Withdrawal Plan, Required Minimum Distribution Service, and Vanguard Small Business Online/(R)/. .. Redemptions of shares to pay fund or account fees. .. Transaction requests submitted by mail to Vanguard from shareholders who hold their accounts directly with Vanguard. (Wire transactions and transaction requests submitted by fax are not mail transactions and are subject to the policy.) .. Transfers and re-registrations of shares within the same fund. .. Purchases of shares by asset transfer or direct rollover. 85 .. Conversions of shares from one share class to another in the same fund. .. Checkwriting redemptions. .. Section 529 college savings plans. .. Certain approved institutional portfolios and asset allocation programs, as well as trades made by Vanguard funds that invest in other Vanguard funds. (Please note that shareholders of Vanguard's funds of funds are subject to the policy.) For participants in employer-sponsored defined contribution plans that are not served by Vanguard Small Business Services, the frequent-trading policy does not apply to: .. Purchases of shares with participant payroll or employer contributions or loan repayments. .. Purchases of shares with reinvested dividend or capital gains distributions. .. Distributions, loans, and in-service withdrawals from a plan. .. Redemptions of shares as part of a plan termination or at the direction of the plan. .. Automated transactions executed during the first six months of a participant's enrollment in the Vanguard Managed Account Program. .. Redemptions of shares to pay fund or account fees. .. Share or asset transfers or rollovers. .. Re-registrations of shares. .. Conversions of shares from one share class to another in the same fund. ACCOUNTS HELD BY INSTITUTIONS (OTHER THAN DEFINED CONTRIBUTION PLANS) Vanguard will systematically monitor for frequent trading in institutional clients' accounts. If we detect suspicious trading activity, we will investigate and take appropriate action, which may include applying to a client's accounts the 60-day policy previously described, prohibiting a client's purchases of fund shares, and/or eliminating the client's exchange privilege. ACCOUNTS HELD BY INTERMEDIARIES When intermediaries establish accounts in Vanguard funds for their clients, we cannot always monitor the trading activity of the individual clients. However, we review trading activity at the omnibus level, and if we detect suspicious activity, we will investigate and take appropriate action. If necessary, Vanguard may prohibit additional purchases of fund shares by an intermediary or by certain of the intermediary's clients. Intermediaries may also monitor their clients' trading activities in the Vanguard funds. For those Vanguard funds that charge purchase or redemption fees, intermediaries will be asked to assess purchase and redemption fees on shareholder and participant accounts and remit these fees to the funds. The application of 86 purchase and redemption fees and frequent-trading policies may vary among intermediaries. There are no assurances that Vanguard will successfully identify all intermediaries or that intermediaries will properly assess purchase and redemption fees or administer frequent-trading policies. If you invest with Vanguard through an intermediary, please read that firm's materials carefully to learn of any other rules or fees that may apply. OTHER RULES YOU SHOULD KNOW PROSPECTUS AND SHAREHOLDER REPORT MAILINGS Vanguard attempts to eliminate the unnecessary expense of duplicate mailings by sending just one prospectus and/or report when two or more shareholders have the same last name and address. You may request individual prospectuses and reports by contacting our Client Services Department in writing, by telephone, or by e-mail. VANGUARD.COM/(R)/ REGISTRATION. If you are a registered user of Vanguard.com, you can use your personal computer to review your account holdings; to buy, sell, or exchange shares of most Vanguard funds; and to perform most other transactions. You must register for this service online. ELECTRONIC DELIVERY. Vanguard can deliver your account statements, transaction confirmations, and fund financial reports electronically. If you are a registered user of Vanguard.com, you can consent to the electronic delivery of these documents by logging on and changing your mailing preference under "My Profile." You can revoke your electronic consent at any time, and we will begin to send paper copies of these documents within 30 days of receiving your notice. TELEPHONE TRANSACTIONS AUTOMATIC. When we set up your account, we'll automatically enable you to do business with us by telephone, unless you instruct us otherwise in writing. TELE-ACCOUNT/(R)/. To conduct account transactions through Vanguard's automated telephone service, you must first obtain a Personal Identification Number (PIN). Call Tele-Account at 800-662-6273 to obtain a PIN, and allow seven days after requesting the PIN before using this service. PROOF OF A CALLER'S AUTHORITY. We reserve the right to refuse a telephone request if the caller is unable to provide the requested information or if we reasonably believe that the caller is not an individual authorized to act on the account. Before we allow a caller to act on an account, we may request the following information: .. Authorization to act on the account (as the account owner or by legal documentation or other means). 87 .. Account registration and address. .. Fund name and account number, if applicable. .. Other information relating to the caller, the account holder, or the account. SUBJECT TO REVISION. For any and all shareholders, we reserve the right, at any time and without prior notice, to revise, suspend, or terminate the privilege to transact or communicate with Vanguard by telephone. GOOD ORDER We reserve the right to reject any transaction instructions that are not in "good order." Good order generally means that your instructions include: .. The fund name and account number. .. The amount of the transaction (stated in dollars, shares, or percentage). Written instructions also must include: .. Signatures of all registered owners. .. Signature guarantees, if required for the type of transaction.(Call Vanguard for specific signature-guarantee requirements.) .. Any supporting documentation that may be required. The requirements vary among types of accounts and transactions. Vanguard reserves the right, without prior notice, to revise the requirements for good order. FUTURE TRADE-DATE REQUESTS Vanguard does not accept requests to hold a purchase, redemption, or exchange transaction for a future date. All such requests will receive trade dates as previously described in Buying Shares and Redeeming Shares. Vanguard reserves the right to return future-dated purchase checks. ACCOUNTS WITH MORE THAN ONE OWNER If an account has more than one owner or authorized person, Vanguard will accept telephone or online instructions from any one owner or authorized person. RESPONSIBILITY FOR FRAUD Vanguard will not be responsible for any account losses because of fraud if we reasonably believe that the person transacting business on an account is authorized to do so. Please take precautions to protect yourself from fraud. Keep your account information private, and immediately review any account 88 statements that we provide to you. It is important that you contact Vanguard immediately about any transactions you believe to be unauthorized. UNCASHED CHECKS Please cash your distribution or redemption checks promptly. Vanguard will not pay interest on uncashed checks. UNUSUAL CIRCUMSTANCES If you experience difficulty contacting Vanguard online, by telephone, or by Tele-Account, you can send us your transaction request by regular or express mail. See Contacting Vanguard for addresses. INVESTING WITH VANGUARD THROUGH OTHER FIRMS You may purchase or sell shares of most Vanguard funds through a financial intermediary, such as a bank, broker, or investment advisor. Please see Frequent-Trading Limits--Accounts Held by Intermediaries for information about the assessment of redemption fees and monitoring of frequent trading for accounts held by intermediaries. ACCOUNT SERVICE FEE For most shareholders, Vanguard deducts a $20 account service fee from all fund accounts that have a balance below $10,000 for any reason, including market fluctuations. The account service fee applies to both retirement and nonretirement fund accounts. The fee will be assessed on fund accounts in all Vanguard funds, regardless of a fund's minimum investment amount. The account service fee, which will be assessed by redeeming fund shares in the amount of $20, will be deducted from a fund account only once per calendar year. If you register on Vanguard.com and elect to receive electronic delivery of statements, reports, and other materials for all of your fund accounts, the account service fee for balances below $10,000 will not be charged, so long as that election remains in effect. The account service fee also does not apply to the following: .. Money market sweep accounts held through Vanguard Brokerage Services. .. Accounts held through intermediaries. .. Accounts registered to Voyager/TM/, Voyager Select/TM/, and Flagship/TM/ clients. Membership is based on total household assets held at Vanguard, with a minimum of $100,000 to qualify for Vanguard Voyager Services/(R)/, $500,000 for Vanguard Voyager Select Services/TM/, and $1 million for Vanguard Flagship Services/TM/. Vanguard determines membership by aggregating assets of all 89 eligible accounts held by the investor and immediate family members who reside at the same address. Aggregate assets include investments in Vanguard mutual funds, Vanguard ETFs/TM/, annuities through Vanguard, the Vanguard 529 Plan, certain small-business accounts, and employer-sponsored retirement plans for which Vanguard provides recordkeeping services. .. Participant accounts in employer-sponsored defined contribution plans (other than those served by the Vanguard Small Business Services Department, which are subject to various fee structures. Please consult your enrollment materials for the rules that apply to your account). .. Section 529 college savings plans. LOW-BALANCE ACCOUNTS The Funds reserve the right without prior notice, to liquidate any investment-only retirement-plan fund account or any nonretirement fund account whose balance falls below the minimum initial investment for any reason, including market fluctuation. Shares redeemed in accordance with this policy will be subject to applicable redemption fees. RIGHT TO CHANGE POLICIES In addition to the rights expressly stated elsewhere in this prospectus, Vanguard reserves the right to (1) alter, add, or discontinue any conditions of purchase (including eligibility requirements), redemption, exchange, service, or privilege at any time without prior notice; (2) accept initial purchases by telephone; (3) freeze any account and/or suspend account services when Vanguard has received reasonable notice of a dispute regarding the assets in an account, including notice of a dispute between the registered or beneficial account owners or when we reasonably believe a fraudulent transaction may occur or has occurred; (4) temporarily freeze any account and/or suspend account services upon Vanguard's initial notification of the death of the shareholder until Vanguard receives required documentation in good order; (5) alter, impose, discontinue, or waive any redemption fee, account service fee, or other fees charged to a group of shareholders; and (6) redeem an account, without the owner's permission to do so, in cases of threatening conduct or suspicious, fraudulent, or illegal activity. Changes may affect any or all investors. These actions will be taken when, at the sole discretion of Vanguard management, we reasonably believe they are deemed to be in the best interest of a fund. 90 FUND AND ACCOUNT UPDATES CONFIRMATION STATEMENTS We will send (or provide online, whichever you prefer) a confirmation of your trade date and the amount of your transaction when you buy, sell, exchange, or convert shares. However, we will not send confirmations reflecting only checkwriting redemptions or the reinvestment of dividends or capital gains distributions. For any month in which you had a checkwriting redemption, a Checkwriting Activity Statement will be sent to you itemizing the checkwriting redemptions for that month. Promptly review each confirmation statement that we provide to you by mail or online. It is important that you contact Vanguard immediately with any questions you may have about any transaction reflected on a confirmation statement, or Vanguard will consider the transaction properly processed. PORTFOLIO SUMMARIES We will send (or provide online, whichever you prefer) quarterly portfolio summaries to help you keep track of your accounts throughout the year. Each summary shows the market value of your account at the close of the statement period, as well as all distributions, purchases, redemptions, exchanges, transfers, and conversions for the current calendar year. Promptly review each summary that we provide to you by mail or online. It is important that you contact Vanguard immediately with any questions you may have about any transaction reflected on the summary, or Vanguard will consider the transaction properly processed. TAX STATEMENTS For most taxable accounts, we will send annual tax statements to assist you in preparing your income tax returns. These statements, which are generally mailed in January, will report the previous year's dividend and capital gains distributions, proceeds from the sale of shares, and distributions from IRAs and other retirement plans. These statements can be viewed online. AVERAGE-COST REVIEW STATEMENTS For most taxable accounts, average-cost review statements will accompany annual 1099B tax forms. These tax forms show the average cost of shares that you redeemed during the previous calendar year, using the average-cost single-category method, which is one of the methods established by the IRS. 91 ANNUAL AND SEMIANNUAL REPORTS We will send (or provide online, whichever you prefer) financial reports about Vanguard Managed Payout Funds twice a year, in May and November. These comprehensive reports include overviews of the financial markets and provide the following specific Fund information: .. Performance assessments and comparisons with industry benchmarks. .. Financial statements with detailed listings of the Funds' holdings. Vanguard attempts to eliminate the unnecessary expense of duplicate mailings by sending just one report when two or more shareholders have the same last name and address. You may request individual reports by contacting our Client Services Department in writing, by telephone, or by e-mail. PORTFOLIO HOLDINGS We generally post on our website at www.vanguard.com, in the Holdings section of each Fund's Profile page, a detailed list of the securities held by the Fund (under Portfolio Holdings), as of the most recent calendar-quarter-end. This list is generally updated within 30 days after the end of each calendar quarter. Vanguard may exclude any portion of these portfolio holdings from publication when deemed in the best interest of the Fund. We also generally post the ten largest stock portfolio holdings of the Fund, and the percentage of the Fund's total assets that each of these holdings represents, as of the most recent calendar-quarter-end. This list is generally updated within 15 calendar days after the end of each calendar quarter. Please consult the Fund's Statement of Additional Information or our website for a description of the policies and procedures that govern disclosure of the Fund's portfolio holdings. 92
CONTACTING VANGUARD WEB - ---------------------------------------------------------------------------------------- Vanguard.com For the most complete source of Vanguard news 24 hours a day, 7 days For fund, account, and service information a week For most account transactions For literature requests - ---------------------------------------------------------------------------------------- PHONE - ---------------------------------------------------------------------------------------- Vanguard For automated fund and account information Tele-Account/(R)/ For exchange transactions (subject to limitations) 800-662-6273 Toll-free, 24 hours a day, 7 days a week (ON-BOARD) - ---------------------------------------------------------------------------------------- Investor Information For fund and service information 800-662-7447 (SHIP) For literature requests (Text telephone for Business hours only: Monday-Friday, 8 a.m. to 10 p.m., people with hearing Eastern time; Saturday, 9 a.m. to 4 p.m., Eastern time impairment at 800-952-3335) - ---------------------------------------------------------------------------------------- Client Services For account information 800-662-2739 (CREW) For most account transactions (Text telephone for Business hours only: Monday-Friday, 8 a.m. to 10 p.m., people with hearing Eastern time; Saturday, 9 a.m. to 4 p.m., Eastern time impairment at 800-749-7273) - ---------------------------------------------------------------------------------------- Institutional Division For information and services for large institutional investors 888-809-8102 Business hours only : Monday-Friday, 8:30 a.m. to 9 p.m., Eastern time - ---------------------------------------------------------------------------------------- Intermediary Sales For information and services for financial intermediaries Support including broker-dealers, trust institutions, insurance 800-997-2798 companies, and financial advisors Business hours only: Monday-Friday, 8:30 a.m. to 7 p.m., Eastern time - ----------------------------------------------------------------------------------------
93 VANGUARD ADDRESSES Please be sure to use the correct address, depending on your method of delivery. Use of an incorrect address could delay the processing of your transaction. REGULAR MAIL (INDIVIDUALS) The Vanguard Group P.O. Box 1110 Valley Forge, PA 19482-1110 - ---------------------------------------------------------------------- REGULAR MAIL (INSTITUTIONS) The Vanguard Group P.O. Box 2900 Valley Forge, PA 19482-2900 - ---------------------------------------------------------------------- REGISTERED, EXPRESS, OR OVERNIGHT The Vanguard Group 455 Devon Park Drive Wayne, PA 19087-1815 - ---------------------------------------------------------------------- FUND NUMBERS Please use the specific fund number when contacting us: Vanguard Managed Payout Growth Focus Fund 1497 - ----------------------------------------------------------------- Vanguard Managed Payout Growth and Distribution Fund 1498 - ----------------------------------------------------------------- Vanguard Managed Payout Distribution Focus Fund 1499 - ----------------------------------------------------------------- Vanguard, Vanguard.com, Connect with Vanguard, Plain Talk, Vanguard Tele-Account, Tele-Account, Vanguard ETF, Vanguard ETFs, Vanguard Small Business Online, Vanguard Brokerage Services, Vanguard Voyager Services, Voyager, Vanguard Voyager Select Services, Voyager Select, Vanguard Flagship Services, Flagship, and the ship logo are trademarks of The Vanguard Group, Inc. All other marks are the exclusive property of their respective owners. 94 GLOSSARY OF INVESTMENT TERMS ABSOLUTE RETURN INVESTING. An investment strategy seeking capital appreciation that is independent of stock market returns. ACQUIRED FUND. Any mutual fund whose shares are owned by another fund. BOND. A debt security (IOU) issued by a corporation, government, or government agency in exchange for the money you lend it. In most instances, the issuer agrees to pay back the loan by a specific date and make regular interest payments until that date. CAPITAL GAINS DISTRIBUTION. Payment to mutual fund shareholders of gains realized on securities that a fund has sold at a profit, minus any realized losses. CASH INVESTMENTS. Cash deposits, short-term bank deposits, and money market instruments that include U.S. Treasury bills and notes, bank certificates of deposit (CDs), repurchase agreements, commercial paper, and banker's acceptances. COMMODITIES. Bulk goods or raw materials, such as agricultural products, livestock, precious metals, energy products and industrial metals. Commodities can be purchased for immediate delivery ("on the spot") or delivery on a future date under a standardized agreement. COMMODITY FUTURES CONTRACT. A legally-binding agreement for the purchase or sale of a specified type and quantity of a commodity during a stated delivery month for a fixed price. COMMON STOCK. A security representing ownership rights in a corporation. A stockholder is entitled to share in the company's profits, some of which may be paid out as dividends. CORRELATION. The relationship between two variables, such as the relationship between the prices of stocks and bonds. Investments that are positively correlated have prices that tend to move in the same direction at the same time. Investments that are negatively correlated have prices that tend to move in opposite directions at the same time. DIVIDEND DISTRIBUTION. Payment to mutual fund shareholders of income from interest or dividends generated by a fund's investments. EXPENSE RATIO. The percentage of a fund's average net assets used to pay its expenses during a fiscal year. The expense ratio includes management expenses--such as advisory fees, account maintenance, reporting, accounting, legal, and other administrative expenses--and any 12b-1 distribution fees. It does not include the transaction costs of buying and selling portfolio securities. 95 FIXED INCOME SECURITY. An investment, such as a bond, representing a debt that must be repaid by a specific date, and on which the borrower must pay a fixed variable, or floating rate of interest. FUND OF FUNDS. A mutual fund that pursues its objective by investing in other mutual funds rather than in individual 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. INDEX. An unmanaged group of securities whose overall performance is used as a standard to measure the investment performance of a particular market. INTERNATIONAL STOCK FUND. A mutual fund that invests in the stocks of companies located outside the United States. INVESTMENT ADVISOR. An organization that is responsible for making the day-to-day decisions regarding a fund's investments. INVESTMENT-GRADE BOND. A fixed income security whose credit quality is considered by independent bond-rating agencies, or through independent analysis conducted by a fund's advisor, to be sufficient to ensure timely payment of principal and interest under current economic circumstances. Fixed income securities rated in one of the four highest rating categories are considered "investment-grade"; other fixed income securities may be considered by the advisor to be investment-grade. MARKET NEUTRAL INVESTING. An investment strategy that seeks to generate returns that are independent of the returns and direction of the stock market (called "beta") and driven largely by the value added by the advisor's skill in selecting mispriced stocks (called "alpha"). 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. MUTUAL FUND. An investment company that pools the money of many people and invests it in a variety of securities in an effort to achieve a specific objective over time. NET ASSET VALUE (NAV). The market value of a mutual fund's total assets, minus liabilities, divided by the number of shares outstanding. The value of a single share is also called its share value or share price. 96 NOMINAL RETURN. The total return of an investment without taking into account the expected impact of inflation. RECORD DATE. The date used to determine who is eligible to receive a fund's next distribution of dividends or capital gains. REAL RETURN. The total return of an investment when reduced to take into account the expected impact of inflation. RETURN OF CAPITAL. The portion of a distribution representing the return of your original investment in the Fund. Return of capital reduces your cost basis in the Fund's shares, and is not taxable to you until your cost basis has been reduced to zero. SHORT SALE. A short sale is the sale of a security that the seller does not own. In order to deliver the security to the purchases, the short seller borrows the security, typically from a broker-dealer or an institutional investor. The short seller later closes out the position by returning the security to the lender, typically by purchasing the same security on the open market. TOTAL RETURN. A percentage change, over a specified time period, in a mutual fund's net asset value, assuming the reinvestment of all distributions of dividends and capital gains. VOLATILITY. The fluctuations in value of a mutual fund or other security. The greater a fund's volatility, the wider the fluctuations in its returns. YIELD. Income (interest or dividends) earned by an investment, expressed as a percentage of the investment's price. 97 This page intentionally left blank. [SHIP] VANGUARD /(R)/ P.O. Box 2600 Valley Forge, PA 19482-2600 CONNECT WITH VANGUARD/(R)/ > www.vanguard.com FOR MORE INFORMATION If you would like more information about Vanguard Managed Payout Funds, the following documents are available free upon request: ANNUAL/SEMIANNUAL REPORTS TO SHAREHOLDERS Additional information about the Funds' investments will be available in the Funds' annual and semiannual reports to shareholders. In the annual report, you will find a discussion of the market conditions and investment strategies that significantly affected the Funds' performance during their last fiscal year. STATEMENT OF ADDITIONAL INFORMATION (SAI) The SAI provides more detailed information about the Funds. The current SAI is incorporated by reference into (and is thus legally a part of) this prospectus. To receive a free copy of the latest annual or semiannual report (once available) or the SAI, or to request additional information about the Funds or other Vanguard funds, please visit www.vanguard.com or contact us as follows: The Vanguard Group Investor Information Department P.O. Box 2600 Valley Forge, PA 19482-2600 Telephone: 800-662-7447 (SHIP) Text Telephone for people with hearing impairment: 800-952-3335 If you are a current Vanguard shareholder and would like information about your account, account transactions, and/or account statements, please call: Client Services Department Telephone: 800-662-2739 (CREW) Text Telephone for people with hearing impairment: 800-749-7273 INFORMATION PROVIDED BY THE SECURITIES AND EXCHANGE COMMISSION (SEC) You can review and copy information about the Funds (including the SAI) at the SEC's Public Reference Room in Washington, DC. To find out more about this public service, call the SEC at 202-551-8090. Reports and other information about the Funds are also available in the EDGAR database on the SEC's Internet site at www.sec.gov, or you can receive copies of this information, for a fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the Public Reference Section, Securities and Exchange Commission, Washington, DC 20549-0102. Funds' Investment Company Act file number: 811-7023 (C) 2007 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. P1497 122007 PART B INFORMATION CONTAINED IN THIS STATEMENT OF ADDITIONAL INFORMATION IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT FOR THE VANGUARD MANAGED PAYOUT FUNDS HAS BEEN FILED WITH THE U.S. SECURITIES AND EXCHANGE COMMISSION BUT HAS NOT YET BECOME EFFECTIVE. SHARES OF THE VANGUARD MANAGED PAYOUT FUNDS MAY NOT BE SOLD, NOR MAY OFFERS TO BUY BE ACCEPTED, PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS COMMUNICATION SHALL NOT CONSTITUTE AN OFFER TO SELL, NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION, OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. VANGUARD/(R)/ VALLEY FORGE FUNDS STATEMENT OF ADDITIONAL INFORMATION DECEMBER 11, 2007 This Statement of Additional Information is not a prospectus but should be read in conjunction with each Fund's current prospectus (dated April 27, 2007 for the Vanguard Balanced Index Fund; and December 11, 2007 for the Vanguard Managed Payout Funds). To obtain, without charge, the prospectus or the most recent Annual Report to Shareholders, which contains the Fund's financial statements as hereby incorporated by reference, please call: INVESTOR INFORMATION DEPARTMENT: 800-662-7447 TABLE OF CONTENTS DESCRIPTION OF THE TRUST..............................................B-1 INVESTMENT POLICIES...................................................B-3 INVESTMENT LIMITATIONS................................................B-25 SHARE PRICE...........................................................B-27 PURCHASE AND REDEMPTION OF SHARES.....................................B-27 MANAGEMENT OF THE FUND................................................B-28 INVESTMENT ADVISORY SERVICES..........................................B-38 PORTFOLIO TRANSACTIONS................................................B-40 PROXY VOTING GUIDELINES...............................................B-41 FINANCIAL STATEMENTS..................................................B-46 DESCRIPTION OF BOND RATINGS...........................................B-46 DESCRIPTION OF THE TRUST ORGANIZATION Vanguard Valley Forge Funds (the Trust), formerly known as Vanguard Balanced Index Fund until September 2007, was originally known as Vanguard Balanced Index Fund, Inc. and was organized as a Maryland corporation in 1992. It was reorganized as a Delaware statutory trust in July 1998. The Trust is registered with the United States Securities and Exchange Commission (the SEC) under the Investment Company Act of 1940 (the 1940 Act) as an open-end, diversified management investment company. The Trust currently offers the following funds (and classes thereof):
FUND SHARE CLASSES/1/ - --- ---------------- VANGUARD BALANCED INDEX FUND Investor, Admiral, Signal, and Institutional Shares VANGUARD MANAGED PAYOUT GROWTH FOCUS FUND Investor Shares VANGUARD MANAGED PAYOUT GROWTH AND DISTRIBUTION FUND Investor Shares VANGUARD MANAGED PAYOUT DISTRIBUTION FOCUS Investor Shares 1 Individually, a class; collectively, the classes.
B-1 The Trust has the ability to offer additional funds, which in turn may issue classes of shares. There is no limit on the number of full and fractional shares that may be issued for a single fund or class of shares. Each Fund described in this Statement of Additional Information is a member fund. There are two types of Vanguard funds, member funds and non-member funds. Member funds jointly own The Vanguard Group, Inc. (Vanguard), contribute to Vanguard's capital, and receive services at cost from Vanguard pursuant to a Funds' Service Agreement. Non-member funds do not contribute to Vanguard's capital, but they do receive services pursuant to special services agreements. See "Management of the Fund" for more information. SERVICE PROVIDERS CUSTODIAN. JPMorgan Chase Bank, 270 Park Avenue, New York, NY 10017-2070, serves as the Balanced Index Fund's custodian. Brown Brothers Harriman & Co., 40 Water Street, Boston, MA 02109, serves as the Managed Payout Funds' custodian. A Fund's custodian is responsible for maintaining the Fund's assets, keeping all necessary accounts and records of Fund assets, and appointing any foreign sub-custodians or foreign securities depositories. INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM. PricewaterhouseCoopers LLP, Two Commerce Square, Suite 1700, 2001 Market Street, Philadelphia, PA, 19103-7042, serves as the Balanced Index Fund's independent registered public accounting firm. [NAME], [ADDRESS], serves as the Managed Payout Funds' independent registered public accounting firm. The independent registered public accounting firm audits a Fund's annual financial statements and provides other related services. TRANSFER AND DIVIDEND-PAYING AGENT. The Funds' transfer agent and dividend-paying agent is Vanguard, P.O. Box 2600, Valley Forge, PA 19482. CHARACTERISTICS OF THE FUND'S SHARES RESTRICTIONS ON HOLDING OR DISPOSING OF SHARES. There are no restrictions on the right of shareholders to retain or dispose of the Fund's shares, other than those described in the Fund's current prospectus and elsewhere in this Statement of Additional Information or the possible future termination of the Fund or a share class. The Fund or class may be terminated by reorganization into another mutual fund or class or by liquidation and distribution of the assets of the Fund or class. Unless terminated by reorganization or liquidation, the Fund and share class will continue indefinitely. SHAREHOLDER LIABILITY. The Trust is organized under Delaware law, which provides that shareholders of a statutory trust are entitled to the same limitations of personal liability as shareholders of a corporation organized under Delaware law. Effectively, this means that a shareholder of the Fund will not be personally liable for payment of the Fund's debts except by reason of his or her own conduct or acts. In addition, a shareholder could incur a financial loss as a result of a Fund obligation only if the Fund itself had no remaining assets with which to meet such obligation. We believe that the possibility of such a situation arising is extremely remote. DIVIDEND RIGHTS. The shareholders of each class of a Fund are entitled to receive any dividends or other distributions declared by the Fund for each such class. No shares of a Fund have priority or preference over any other shares of the Fund with respect to distributions. Distributions will be made from the assets of the Fund and will be paid ratably to all shareholders of a particular class according to the number of shares of the class held by shareholders on the record date. The amount of dividends per share may vary between separate share classes of the Fund based upon differences in the net asset values of the different classes and differences in the way that expenses are allocated between share classes pursuant to a multiple class plan. VOTING RIGHTS. Shareholders are entitled to vote on a matter if: (1) a shareholder vote is required under the 1940 Act; (2) the matter concerns an amendment to the Declaration of Trust that would adversely affect to a material degree the rights and preferences of the shares of the Fund or any class; (3) the trustees determine that it is necessary or desirable to obtain a shareholder vote; or (4) a certain type of merger or consolidation, share conversion, share exchange, or sale of assets is proposed. The 1940 Act requires a shareholder vote under various circumstances, including to elect or remove trustees upon the written request of shareholders representing 10% or more of a Fund's net assets and to change any fundamental policy of a Fund. Unless otherwise required by applicable law, shareholders of a Fund receive one vote for each dollar of net asset value owned on the record date, and a fractional vote for each fractional dollar of net asset value owned on the record date. However, only the shares of the Fund or class affected by a particular matter are entitled to vote on that matter. In addition, each class has exclusive voting rights on any matter submitted to B-2 shareholders that relates solely to that class, and each class has separate voting rights on any matter submitted to shareholders in which the interests of one class differ from the interests of another. Voting rights are noncumulative and cannot be modified without a majority vote. LIQUIDATION RIGHTS. In the event that a Fund is liquidated, shareholders will be entitled to receive a pro rata share of the Fund's net assets. In the event that a class of shares is liquidated, shareholders of that class will be entitled to receive a pro rata share of the Fund's net assets that are allocated to that class. Shareholders may receive cash, securities, or a combination of the two. PREEMPTIVE RIGHTS. There are no preemptive rights associated with the Funds' shares. CONVERSION RIGHTS. Shareholders of each Fund may convert their shares into another class of shares of the same Fund upon the satisfaction of any then applicable eligibility requirements. REDEMPTION PROVISIONS. Each Fund's redemption provisions are described in its current prospectus and elsewhere in this Statement of Additional Information. SINKING FUND PROVISIONS. The Fund has no sinking fund provisions. CALLS OR ASSESSMENT. The Funds' shares, when issued, are fully paid and non-assessable. TAX STATUS OF THE FUND The Balanced Index Fund intends to continue to qualify, and each of the Managed Payout Funds intends to qualify, as a "regulated investment company" under Subchapter M of the Internal Revenue Code of 1986, as amended (the IRC). This special tax status means that the Fund will not be liable for federal tax on income and capital gains distributed to shareholders. In order to preserve its tax status, the Fund must comply with certain requirements. If the Fund fails to meet these requirements in any taxable year, it will be subject to tax on its taxable income at corporate rates, and all distributions from earnings and profits, including any distributions of net tax-exempt income and net long-term capital gains, will be taxable to shareholders as ordinary income. In addition, the Fund could be required to recognize unrealized gains, pay substantial taxes and interest, and make substantial distributions before regaining its tax status as a regulated investment company. Each Managed Payout Fund generally expects to distribute to shareholders substantially all of its net income (for example, interest and dividends) as well as substantially all of its net capital gains (for example, from the sale of its holdings or distributions from other funds it holds). In addition, each Managed Payout Fund's distributions may be treated in part as a return of capital. Although each Managed Payout Fund generally expects to distribute substantially all of its net capital gains each year, a Managed Payout Fund may in certain circumstances not do so. Any undistributed net capital gains would be subject to tax at the Managed Payout Fund level, and the Managed Payout Fund may treat its shareholders as receiving their shares of such net capital gains, in which case those shareholders would be entitled to a refundable tax credit on their shares of the taxes paid by the Managed Payout Fund. In addition, a Managed Payout Fund may have limited flexibility to distribute a return of capital during any year it has a capital loss carry forward; in such a year, a distribution that would otherwise be a tax-free return of capital could be treated in part or whole as a taxable ordinary dividend. Dividends received and distributed by the Fund on shares of stock of domestic corporations may be eligible for the dividends-received deduction applicable to corporate shareholders. Corporations must satisfy certain requirements in order to claim the deduction. Capital gains distributed by the Fund are not eligible for the dividends-received deduction. The Managed Payout Funds' distributions are not designed to comply with any required minimum distribution rules applicable to tax-deferred retirement accounts. In any given year, Managed Payout Fund distributions in cash may exceed or may be insufficient to meet the required amount for shareholders who are subject to such rules. Shareholders receiving cash distributions from the Managed Payout Funds within such accounts will need to include such distributions as appropriate in the computation of their annual required minimum distribution. Retirement account investors subject to the required minimum distribution rules should seek advice from their own tax advisors to ensure compliance with tax requirements. A Fund intends to maintain its tax status as a regulated investment company but is otherwise generally managed without regard to tax ramifications to its shareholders. Please consult your tax advisor about the U.S. federal, state, local, and foreign tax aspects of an investment in a fund, including taxes applicable to the acquisition, holding, and disposition of shares. INVESTMENT POLICIES Some of the investment policies described below and in each Fund's prospectus set forth percentage limitations on a Fund's investment in, or holdings of, certain securities or other assets. Unless otherwise required by law, compliance with these policies will be determined immediately after the acquisition of such securities or assets. Subsequent changes in values, net assets, or other circumstances will not be considered when determining whether the investment complies with the Fund's investment policies and limitations. The following policies and explanations supplement each Fund's investment objective and policies set forth in the prospectus. With respect to the different investments discussed below, the Fund may acquire such investments to the extent consistent with its investment objective and policies. ASSET-BACKED SECURITIES. Asset-backed securities are securities that represent a participation in, or are secured by and payable from, pools of underlying assets such as debt securities, bank loans, motor vehicle installment sales B-3 contracts, installment loan contracts, leases of various types of real and personal property, receivables from revolving credit (i.e., credit card) agreements, and other categories of receivables. These underlying assets are securitized through the use of trusts and special purpose entities. Payment of interest and repayment of principal on asset-backed securities may be largely dependent upon the cash flows generated by the underlying assets backing the securities and, in certain cases, may be supported by letters of credit, surety bonds, or other credit enhancements. The rate of principal payments on asset-backed securities is related to the rate of principal payments, including prepayments, on the underlying assets. The credit quality of asset-backed securities depends primarily on the quality of the underlying assets, the level of credit support, if any, provided for the securities, and the credit quality of the credit-support provider, if any. The value of asset-backed securities may be affected by the various factors described above and other factors, such as changes in interest rates, the availability of information concerning the pool and its structure, the creditworthiness of the servicing agent for the pool, the originator of the underlying assets, or the entities providing the credit enhancement. Asset-backed securities are often subject to more rapid repayment than their stated maturity date would indicate, as a result of the pass-through of prepayments of principal on the underlying assets. Prepayments of principal by borrowers or foreclosure or other enforcement action by creditors shorten the term of the underlying assets. The occurrence of prepayments is a function of several factors, such as the level of interest rates, general economic conditions, the location and age of the underlying obligations, and other social and demographic conditions. A fund's ability to maintain positions in asset-backed securities is affected by the reductions in the principal amount of the underlying assets because of prepayments. A fund's ability to reinvest prepayments of principal (as well as interest and other distributions and sale proceeds) at a comparable yield is subject to generally prevailing interest rates at that time. The value of asset-backed securities varies with changes in market interest rates generally and the differentials in yields among various kinds of U.S. government securities, mortgage-backed securities, and asset-backed securities. In periods of rising interest rates, the rate of prepayment tends to decrease, thereby lengthening the average life of the underlying securities. Conversely, in periods of falling interest rates, the rate of prepayment tends to increase, thereby shortening the average life of such assets. Because prepayments of principal generally occur when interest rates are declining, an investor, such as a fund, generally has to reinvest the proceeds of such prepayments at lower interest rates than those at which the assets were previously invested. Therefore, asset-backed securities have less potential for capital appreciation in periods of falling interest rates than other income-bearing securities of comparable maturity. Because asset-backed securities generally do not have the benefit of a security interest in the underlying assets that is comparable to a mortgage, asset-backed securities present certain additional risks that are not present with mortgage-backed securities. For example, revolving credit receivables are generally unsecured and the debtors on such receivables are entitled to the protection of a number of state and federal consumer credit laws, many of which give debtors the right to set-off certain amounts owed, thereby reducing the balance due. Automobile receivables generally are secured, but by automobiles, rather than by real property. Most issuers of automobile receivables permit loan servicers to retain possession of the underlying assets. If the servicer of a pool of underlying assets sells them to another party, there is the risk that the purchaser could acquire an interest superior to that of holders of the asset-backed securities. In addition, because of the large number of vehicles involved in a typical issue of asset-backed securities and technical requirements under state law, the trustee for the holders of the automobile receivables may not have a proper security interest in the automobiles. Therefore, there is the possibility that recoveries on repossessed collateral may not be available to support payments on these securities. BORROWING. A fund's ability to borrow money is limited by its investment policies and limitations, by the 1940 Act, and by applicable exemptions, no-action letters, interpretations, and other pronouncements issued from time to time by the SEC and its staff or any other regulatory authority with jurisdiction. Under the 1940 Act, a fund is required to maintain continuous asset coverage (that is, total assets including borrowings, less liabilities exclusive of borrowings) of 300% of the amount borrowed, with an exception for borrowings not in excess of 5% of the fund's total assets made for temporary or emergency purposes. Any borrowings for temporary purposes in excess of 5% of the fund's total assets must maintain continuous asset coverage. If the 300% asset coverage should decline as a result of market fluctuations or for other reasons, a fund may be required to sell some of its portfolio holdings within three days (excluding Sundays and holidays) to reduce the debt and restore the 300% asset coverage, even though it may be disadvantageous from an investment standpoint to sell securities at that time. Borrowing will tend to exaggerate the effect on net asset value of any increase or decrease in the market value of a fund's portfolio. Money borrowed will be subject to interest costs that may or may not be recovered by earnings on the securities purchased. A fund also may be required to maintain minimum average balances in connection with a borrowing or to pay a commitment or other fee to maintain a line of credit; either of these requirements would increase the cost of borrowing over the stated interest rate. B-4 The SEC takes the position that transactions that have a leveraging effect on the capital structure of a fund or are economically equivalent to borrowing can be viewed as constituting a form of borrowing by the fund for purposes of the 1940 Act. These transactions can include entering into reverse repurchase agreements, engaging in mortgage-dollar-roll transactions, selling securities short (other than short sales "against-the-box"), buying and selling certain derivatives (such as futures contracts), selling (or writing) put and call options, engaging in sale-buybacks, entering into firm-commitment and standby-commitment agreements, engaging in when-issued, delayed-delivery, or forward-commitment transactions, and other trading practices that have a leveraging effect on the capital structure of a fund or are economically equivalent to borrowing (additional discussion about a number of these transactions can be found below). A borrowing transaction will not be considered to constitute the issuance of a "senior security" by a fund, and therefore such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund (1) maintains an offsetting financial position; (2) segregates liquid assets (with such liquidity determined by the advisor in accordance with procedures established by the board of trustees) equal (as determined on a daily mark-to-market basis) in value to the fund's potential economic exposure under the borrowing transaction; or (3) otherwise "covers" the transaction in accordance with applicable SEC guidance (collectively, "covers" the transaction). A fund may have to buy or sell a security at a disadvantageous time or price in order to cover a borrowing transaction. In addition, segregated assets may not be available to satisfy redemptions or for other purposes. COMMODITY FUTURES. Commodities are raw materials used to create the goods that consumers buy. They include a wide range of physical assets, such as agricultural products, livestock, precious metals, energy products and industrial metals. Commodities can be purchased for immediate delivery ("on the spot") or delivery at a specific time in the future under the terms of a commodity futures contract. An exchange-traded commodity futures contract is a derivative that provides for the purchase and sale of a specified type and quantity of a commodity during a stated delivery month for a fixed price. A futures contract on an index of commodities provides for the payment and receipt of cash based on the level of the index at settlement or liquidation of the contract. Futures contracts, by their terms, have stated expirations and, at a specified point in time prior to expiration, trading in a futures contract for the current delivery month will cease. As a result, an investor wishing to maintain its exposure to a futures contract on a particular commodity with the nearest expiration must close out its position in the expiring contract and establish a new position in the contract for the next delivery month, a process referred to as "rolling". The process of rolling a futures contract can be profitable or unprofitable depending in large part on whether the futures price for the next delivery month is less than or more than the price of the expiring contract. If the price for the new futures contract is lower than the price of the expiring contract, then the market for the commodity is said to be in "backwardation". In persistently backwardated markets, futures price curves are upward-sloping, because futures contract prices rise as maturity approaches. In these markets roll returns are positive, because the futures trading gains are accrued when buying longer time-to-maturity contracts and selling these contracts as the time to maturity declines. The term "contango" is used to describe a market in which the price for a new futures contract is greater than the price of the expiring contract. If the market for a commodity future is persistently in contango, the futures price curve slopes downward. Roll returns from a long, passive strategy (such as maintaining exposure to a specific commodity futures contract) will be negative when markets are in contango, because the rolling process involves selling the short time-to-maturity contracts at a loss. Finally, if the market is neither backwardated nor in contango, the roll return would be close to zero. An important aspect of the commodity futures market is that the speculator can profit in either a backwardated or a contango situation. In a backwardated market, the speculator profits from buying the futures contract at a discount. The forward price of a commodity may fluctuate between backwardation and contango. The absence of backwardation, or the existence of contango, in the commodity markets could result in losses for investors in commodity futures. In a contango market, the speculator profits by selling the futures contract at a premium. Commodity futures contracts are subject to the risks of derivatives and futures contracts. Commodity-linked structured notes are subject to the risks of commodity futures contracts and the risks of debt securities. Commodity futures trading is volatile and even a small movement in market prices could cause large losses. Consequently, an investor in commodity futures could lose all or substantially all of its investment in such contracts. The prices of commodity futures are subject to change based on various factors, including, but not limited to, the following: the lack of liquidity; global supply and demand for commodities; congestion; disorderly markets; limitations on deliverable supplies; the participation of hedgers and speculators; domestic and foreign interest rates and investors' expectations concerning interest rates; domestic B-5 and foreign inflation rates and investors' expectations concerning inflation rates; investment and trading activities of institutional investors; global or regional political, economic or financial events and situations; government regulation and intervention; technical and operational or system failures; nuclear accident; terrorism; riots; and acts of God. In addition, U.S. futures exchanges and some foreign exchanges have regulations that limit the amount of fluctuation in futures contract prices that may occur during a single business day. These limits are generally referred to as "daily price fluctuation limits", and the maximum or minimum price of a contract on any given day as a result of these limits is referred to as a "limit price". Once the limit price has been reached in a particular contract, no trades may be made at a different price. It is not certain how long any such price limits may remain in effect. Limit prices may have the effect of precluding trading in a particular contract or forcing the liquidation of contracts at disadvantageous times or prices, consequently affecting the value of commodity futures. While the performance of commodity futures may be largely independent of the general stock and bond markets, there is no assurance that commodity futures will be consistently independent or non-correlated. An investment in commodity futures could increase rather than reduce overall portfolio losses during periods when commodity futures as well as stocks and bonds decline in value. There is no way of predicting whether commodity futures will lose more or less than stocks and bonds in declining markets. COMMON STOCK. Common stock represents an equity or ownership interest in an issuer. Common stock typically entitles the owner to vote on the election of directors and other important matters as well as to receive dividends on such stock. In the event an issuer is liquidated or declares bankruptcy, the claims of owners of bonds, other debt holders, and owners of preferred stock take precedence over the claims of those who own common stock. CONVERTIBLE SECURITIES. Convertible securities are hybrid securities that combine the investment characteristics of bonds and common stocks. Convertible securities typically consist of debt securities or preferred stock that may be converted (on a voluntary or mandatory basis) within a specified period of time (normally for the entire life of the security) into a certain amount of common stock or other equity security of the same or a different issuer at a predetermined price. Convertible securities also include debt securities with warrants or common stock attached and derivatives combining the features of debt securities and equity securities. Other convertible securities with features and risks not specifically referred to herein may become available in the future. Convertible securities involve risks similar to those of both fixed income and equity securities. The market value of a convertible security is a function of its "investment value" and its "conversion value." A security's "investment value" represents the value of the security without its conversion feature (i.e., a nonconvertible fixed income security). The investment value may be determined by reference to its credit quality and the current value of its yield to maturity or probable call date. At any given time, investment value is dependent upon such factors as the general level of interest rates, the yield of similar nonconvertible securities, the financial strength of the issuer, and the seniority of the security in the issuer's capital structure. A security's "conversion value" is determined by multiplying the number of shares the holder is entitled to receive upon conversion or exchange by the current price of the underlying security. If the conversion value of a convertible security is significantly below its investment value, the convertible security will trade like nonconvertible debt or preferred stock and its market value will not be influenced greatly by fluctuations in the market price of the underlying security. In that circumstance, the convertible security takes on the characteristics of a bond, and its price moves in the opposite direction from interest rates. Conversely, if the conversion value of a convertible security is near or above its investment value, the market value of the convertible security will be more heavily influenced by fluctuations in the market price of the underlying security. In that case, the convertible security's price may be as volatile as that of common stock. Because both interest rate and market movements can influence its value, a convertible security generally is not as sensitive to interest rates as a similar fixed income security, nor is it as sensitive to changes in share price as its underlying equity security. Convertible securities are often rated below investment-grade or are not rated, and are generally subject to a high degree of credit risk. While all markets are prone to change over time, the generally high rate at which convertible securities are retired (through mandatory or scheduled conversions by issuers or voluntary redemptions by holders) and replaced with newly issued convertibles may cause the convertible securities market to change more rapidly than other markets. For example, a concentration of available convertible securities in a few economic sectors could elevate the sensitivity of the convertible securities market to the volatility of the equity markets and to the specific risks of those sectors. Moreover, convertible securities with innovative structures, such as mandatory conversion securities and equity-linked securities, have increased the sensitivity of the convertible securities market to the volatility of the equity markets and to the special risks of those innovations, which may include risks different from, and possibly greater than, those associated with traditional convertible securities. B-6 DEBT SECURITIES. A debt security, sometimes called a fixed income security, is a security consisting of a certificate or other evidence of a debt (secured or unsecured) on which the issuing company or governmental body promises to pay the holder thereof a fixed, variable, or floating rate of interest for a specified length of time, and to repay the debt on the specified maturity date. Some debt securities, such as zero coupon bonds, do not make regular interest payments but are issued at a discount to their principal or maturity value. Debt securities include a variety of fixed income obligations, including, but not limited to, corporate bonds, government securities, municipal securities, convertible securities, mortgage-backed securities, and asset-backed securities. Debt securities include investment-grade securities, non-investment-grade securities, and unrated securities. Debt securities are subject to a variety of risks, such as interest rate risk, income risk, call/prepayment risk, inflation risk, credit risk, and (in the case of foreign securities) country risk and currency risk. The reorganization of an issuer under the federal bankruptcy laws may result in the issuer's debt securities being cancelled without repayment, repaid only in part, or repaid in part or in whole through an exchange thereof for any combination of cash, debt securities, convertible securities, equity securities, or other instruments or rights in respect of the same issuer or a related entity. DEBT SECURITIES -- INFLATION-INDEXED SECURITIES. Inflation-indexed securities are debt securities the principal value of which is periodically adjusted to reflect the rate of inflation as indicated by the Consumer Price Index (CPI). Inflation-indexed securities may be issued by the U.S. government, agencies and instrumentalities of the U.S. government, and by corporations. Two structures are common. The U.S. Treasury and some other issuers use a structure that accrues inflation into the principal value of the bond. Most other issuers pay out the CPI accruals as part of a semiannual coupon. The periodic adjustment of U.S. inflation-indexed securities is tied to the CPI, which is calculated monthly by the U.S. Bureau of Labor Statistics. The CPI is a measurement of changes in the cost of living, made up of components such as housing, food, transportation and energy. Inflation-indexed securities issued by a foreign government are generally adjusted to reflect a comparable inflation index, calculated by that government. There can be no assurance that the CPI or any foreign inflation index will accurately measure the real rate of inflation in the prices of goods and services. Moreover, there can be no assurance that the rate of inflation in a foreign country will be correlated to the rate of inflation in the United States. Inflation--a general rise in prices of goods and services--erodes the purchasing power of an investor's portfolio. For example, if an investment provides a "nominal" total return of 5% in a given year and inflation is 2% during that period, the inflation-adjusted, or real, return is 3%. Inflation, as measured by the CPI, has occurred in each of the past 50 years, so investors should be conscious of both the nominal and real returns of their investments. Investors in inflation-indexed securities funds who do not reinvest the portion of the income distribution that is attributable to inflation adjustments will not maintain the purchasing power of the investment over the long term. This is because interest earned depends on the amount of principal invested, and that principal will not grow with inflation if the investor fails to reinvest the principal adjustment paid out as part of a fund's income distributions. While inflation-indexed securities are expected to be protected from long-term inflationary trends, short-term increases in inflation may lead to a decline in value. If interest rates rise due to reasons other than inflation (for example, due to changes in currency exchange rates), investors in these securities may not be protected to the extent that the increase is not reflected in the bond's inflation measure. If the periodic adjustment rate measuring inflation (i.e., the CPI) falls, the principal value of inflation-indexed securities will be adjusted downward, and consequently the interest payable on these securities (calculated with respect to a smaller principal amount) will be reduced. Repayment of the original bond principal upon maturity (as adjusted for inflation) is guaranteed in the case of U.S. Treasury inflation-indexed securities, even during a period of deflation. However, the current market value of the inflation-indexed securities is not guaranteed, and will fluctuate. Other inflation-indexed securities include inflation-related bonds which may or may not provide a similar guarantee. If a guarantee of principal is not provided, the adjusted principal value of the bond repaid at maturity may be less than the original principal. The value of inflation-indexed securities should change in response to changes in real interest rates. Real interest rates in turn are tied to the relationship between nominal interest rates and the rate of inflation. Therefore, if inflation were to rise at a faster rate than nominal interest rates, real interest rates might decline, leading to an increase in value of inflation-indexed securities. In contrast, if nominal interest rates increased at a faster rate than inflation, real interest rates might rise, leading to a decrease in value of inflation-indexed securities. Any increase in principal for an inflation-indexed security resulting from inflation adjustments is considered by Internal Revenue Service (IRS) regulations to be taxable income in the year it occurs. For direct holders of an inflation-indexed security, this means that taxes must be paid on principal adjustments even though these amounts are not received until the bond matures. By contrast, a fund holding these securities distributes both interest income and the income attributable to principal adjustments each quarter in the form of B-7 cash or reinvested shares (which, like principal adjustments, are taxable to shareholders). DEBT SECURITIES -- NON-INVESTMENT-GRADE SECURITIES. Non-investment-grade securities, also referred to as "high-yield securities" or "junk bonds," are debt securities that are rated lower than the four highest rating categories by a nationally recognized statistical rating organization (for example, lower than Baa3 by Moody's Investors Service, Inc. or lower than BBB- by Standard & Poor's) or are determined to be of comparable quality by the fund's advisor. These securities are generally considered to be, on balance, predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation and will generally involve more credit risk than securities in the investment-grade categories. Investment in these securities generally provides greater income and increased opportunity for capital appreciation than investments in higher quality securities, but they also typically entail greater price volatility and principal and income risk. Analysis of the creditworthiness of issuers of high-yield securities may be more complex than for issuers of investment-grade securities. Thus, reliance on credit ratings in making investment decisions entails greater risks for high-yield securities than for investment-grade debt securities. The success of a fund's advisor in managing high-yield securities is more dependent upon its own credit analysis than is the case with investment-grade securities. Some high-yield securities are issued by smaller, less-seasoned companies, while others are issued as part of a corporate restructuring, such as an acquisition, merger, or leveraged buyout. Companies that issue high-yield securities are often highly leveraged and may not have available to them more traditional methods of financing. Therefore, the risk associated with acquiring the securities of such issuers generally is greater than is the case with investment-grade securities. Some high-yield securities were once rated as investment-grade but have been downgraded to junk bond status because of financial difficulties experienced by their issuers. The market values of high-yield securities tend to reflect individual issuer developments to a greater extent than do investment-grade securities, which in general react to fluctuations in the general level of interest rates. High-yield securities also tend to be more sensitive to economic conditions than are investment-grade securities. A projection of an economic downturn or of a sustained period of rising interest rates, for example, could cause a decline in junk bond prices because the advent of a recession could lessen the ability of a highly leveraged company to make principal and interest payments on its debt securities. If an issuer of high-yield securities defaults, in addition to risking payment of all or a portion of interest and principal, a fund investing in such securities may incur additional expenses to seek recovery. The secondary market on which high-yield securities are traded may be less liquid than the market for investment-grade securities. Less liquidity in the secondary trading market could adversely affect the ability of a fund to sell a high-yield security or the price at which a fund could sell a high-yield security, and could adversely affect the daily net asset value of fund shares. When secondary markets for high-yield securities are less liquid than the market for investment-grade securities, it may be more difficult to value the securities because such valuation may require more research, and elements of judgment may play a greater role in the valuation because there is less reliable, objective data available. Except as otherwise provided in a fund's prospectus, if a credit-rating agency changes the rating of a portfolio security held by a fund, the fund may retain the portfolio security if the advisor deems it in the best interests of shareholders. DEBT SECURITIES -- STRUCTURED AND INDEXED SECURITIES. Structured securities (also called "structured notes") and indexed securities are derivative debt securities, the interest rate or principal of which is determined by an unrelated indicator. Indexed securities include structured notes as well as securities other than debt securities, the interest rate or principal of which is determined by an unrelated indicator. The value of the principal of and/or interest on structured and indexed securities is determined by reference to changes in the value of a specific asset, reference rate, or index (the reference) or the relative change in two or more references. The interest rate or the principal amount payable upon maturity or redemption may be increased or decreased, depending upon changes in the applicable reference. The terms of the structured and indexed securities may provide that in certain circumstances no principal is due at maturity and, therefore, may result in a loss of invested capital. Structured and indexed securities may be positively or negatively indexed, so that appreciation of the reference may produce an increase or a decrease in the interest rate or value of the security at maturity. In addition, changes in the interest rate or the value of the structured or indexed security at maturity may be calculated as a specified multiple of the change in the value of the reference; therefore, the value of such security may be very volatile. Structured and indexed securities may entail a greater degree of market risk than other types of debt securities because the investor bears the risk of the reference. Structured or indexed securities may also be more volatile, less liquid, and more difficult to accurately price than less complex securities or more traditional debt securities. B-8 DEBT SECURITIES -- U.S. GOVERNMENT SECURITIES. The term "U.S. Government Securities" refers to a variety of debt securities which are issued or guaranteed by the U.S. Treasury, by various agencies of the U.S. government, and by various instrumentalities which have been established or sponsored by the U.S. government. The term also refers to repurchase agreements collateralized by such securities. U.S. Treasury securities are backed by the full faith and credit of the United States. Other types of securities issued or guaranteed by Federal agencies and U.S. government-sponsored instrumentalities may or may not be backed by the full faith and credit of the United States. The U.S. government, however, does not guarantee the market price of any U.S. government securities. In the case of securities not backed by the full faith and credit of the United States, the investor must look principally to the agency or instrumentality issuing or guaranteeing the obligation for ultimate repayment, and may not be able to assert a claim against the United States itself in the event the agency or instrumentality does not meet its commitment. Some of the U.S. government agencies that issue or guarantee securities include the Government National Mortgage Association, the Export-Import Bank of the United States, the Farmers Home Administration, the Federal Housing Administration, the Maritime Administration, the Small Business Administration, and the Tennessee Valley Authority. An instrumentality of the U.S. government is a government agency organized under Federal charter with government supervision. Instrumentalities issuing or guaranteeing securities include, among others, the Federal Home Loan Banks and the Federal National Mortgage Association. DEBT SECURITIES -- VARIABLE AND FLOATING RATE SECURITIES. Variable and floating rate securities are debt securities that provide for periodic adjustments in the interest rate paid on the security. Variable rate securities provide for a specified periodic adjustment in the interest rate, while floating rate securities have interest rates that change whenever there is a change in a designated benchmark rate or the issuer's credit quality. There is a risk that the current interest rate on variable and floating rate securities may not accurately reflect current market interest rates or adequately compensate the holder for the current creditworthiness of the issuer. Some variable or floating rate securities are structured with liquidity features such as (1) put options or tender options that permit holders (sometimes subject to conditions) to demand payment of the unpaid principal balance plus accrued interest from the issuers or certain financial intermediaries or (2) auction rate features, remarketing provisions, or other maturity-shortening devices designed to enable the issuer to refinance or redeem outstanding debt securities (market-dependent liquidity features). Variable or floating rate securities that include market-dependent liquidity features may have greater liquidity risk than other securities, due to (for example) the failure of a market-dependent liquidity feature to operate as intended (as a result of the issuer's declining creditworthiness, adverse market conditions, or other factors) or the inability or unwillingness of a participating broker-dealer to make a secondary market for such securities. As a result, variable or floating rate securities that include market-dependent liquidity features may lose value and the holders of such securities may be required to retain them until the later of the repurchase date, the resale date, or maturity. A demand instrument with a demand notice exceeding seven days may be considered illiquid if there is no secondary market for such security. DEBT SECURITIES -- ZERO-COUPON AND PAY-IN-KIND SECURITIES. Zero-coupon and pay-in-kind securities are debt securities that do not make regular cash interest payments. Zero-coupon securities generally do not pay interest. Pay-in-kind securities pay interest through the issuance of additional securities. These securities are generally issued at a discount to their principal or maturity value. Because such securities do not pay current cash income, the price of these securities can be volatile when interest rates fluctuate. While these securities do not pay current cash income, federal income tax law requires the holders of zero-coupon and pay-in-kind securities to include in income each year the portion of the original issue discount and other non-cash income on such securities accrued during that year. DEPOSITARY RECEIPTS. Depositary receipts are securities that evidence ownership interests in a security or a pool of securities that have been deposited with a "depository." Depositary receipts may be sponsored or unsponsored and include American Depositary Receipts (ADRs), European Depositary Receipts (EDRs) and Global Depositary Receipts (GDRs). For ADRs, the depository is typically a U.S. financial institution and the underlying securities are issued by a foreign issuer. For other depositary receipts, the depository may be a foreign or a U.S. entity, and the underlying securities may have a foreign or a U.S. issuer. Depositary receipts will not necessarily be denominated in the same currency as their underlying securities. Generally, ADRs are issued in registered form, denominated in U.S. dollars, and designed for use in the U.S. securities markets. Other depositary receipts, such as GDRs and EDRs, may be issued in bearer form and denominated in other currencies, and are generally designed for use in securities markets outside the U.S. Although the two types of depositary receipt facilities (unsponsored or sponsored) are similar, there are differences regarding a holder's rights and obligations and the practices of market B-9 participants. A depository may establish an unsponsored facility without participation by (or acquiescence of) the underlying issuer; typically, however, the depository requests a letter of non-objection from the underlying issuer prior to establishing the facility. Holders of unsponsored depositary receipts generally bear all the costs of the facility. The depository usually charges fees upon the deposit and withdrawal of the underlying securities, the conversion of dividends into U.S. dollars or other currency, the disposition of non-cash distributions, and the performance of other services. The depository of an unsponsored facility frequently is under no obligation to distribute shareholder communications received from the underlying issuer or to pass through voting rights to depositary receipt holders with respect to the underlying securities. Sponsored depositary receipt facilities are created in generally the same manner as unsponsored facilities, except that sponsored depositary receipts are established jointly by a depository and the underlying issuer through a deposit agreement. The deposit agreement sets out the rights and responsibilities of the underlying issuer, the depository, and the depositary receipt holders. With sponsored facilities, the underlying issuer typically bears some of the costs of the depositary receipts (such as dividend payment fees of the depository), although most sponsored depositary receipts holders may bear costs such as deposit and withdrawal fees. Depositories of most sponsored depositary receipts agree to distribute notices of shareholder meetings, voting instructions, and other shareholder communications and information to the depositary receipt holders at the underlying issuer's request. For purposes of a fund's investment policies, investments in depositary receipts will be deemed to be investments in the underlying securities. Thus, a depositary receipt representing ownership of common stock will be treated as common stock. Depositary receipts do not eliminate all of the risks associated with directly investing in the securities of foreign issuers. DERIVATIVES. A derivative is a financial instrument that has a value that is based on--or "derived from"--the values of other assets, reference rates, or indexes. Derivatives may relate to a wide variety of underlying references, such as commodities, stocks, bonds, interest rates, currency exchange rates, and related indexes. Derivatives include futures contracts and options on futures contracts, forward-commitment transactions, options on securities, caps, floors, collars, swap agreements, and other financial instruments. Some derivatives, such as futures contracts and certain options, are traded on U.S. commodity and securities exchanges, while other derivatives, such as swap agreements, are privately negotiated and entered into in the over-the-counter (OTC) market. The risks associated with the use of derivatives are different from, and possibly greater than, the risks associated with investing directly in the securities, assets, or market indexes on which the derivatives are based. Derivatives are used by some investors for speculative purposes. Derivatives also may be used for a variety of purposes that do not constitute speculation, such as hedging, risk management, seeking to stay fully invested, seeking to reduce transaction costs, seeking to simulate an investment in equity or debt securities or other investments, seeking to add value by using derivatives to more efficiently implement portfolio positions when derivatives are favorably priced relative to equity or debt securities or other investments, and for other purposes. There is no assurance that any derivatives strategy used by a fund's advisor will succeed. The counterparties to the funds' derivatives will not be considered the issuers thereof for certain purposes of the 1940 Act and the IRC, although such derivatives may qualify as securities or investments under such laws. The funds' advisors, however, will monitor and adjust, as appropriate, the funds' credit risk exposure to derivative counterparties. Derivative products are highly specialized instruments that require investment techniques and risk analyses different from those associated with stocks, bonds, and other traditional investments. The use of a derivative requires an understanding not only of the underlying instrument but also of the derivative itself, without the benefit of observing the performance of the derivative under all possible market conditions. The use of a derivative involves the risk that a loss may be sustained as a result of the insolvency or bankruptcy of the other party to the contract (usually referred to as a "counterparty") or the failure of the counterparty to make required payments or otherwise comply with the terms of the contract. Additionally, the use of credit derivatives can result in losses if a fund's advisor does not correctly evaluate the creditworthiness of the issuer on which the credit derivative is based. Derivatives may be subject to liquidity risk, which exists when a particular derivative is difficult to purchase or sell. If a derivative transaction is particularly large or if the relevant market is illiquid (as is the case with many OTC derivatives), it may not be possible to initiate a transaction or liquidate a position at an advantageous time or price. Derivatives may be subject to pricing or "basis" risk, which exists when a particular derivative becomes extraordinarily expensive relative to historical prices or the prices of corresponding cash market instruments. Under certain market conditions, it may not be economically feasible to initiate a transaction or liquidate a position in time to avoid a loss or take advantage of an opportunity. B-10 Because many derivatives have a leverage component, adverse changes in the value or level of the underlying asset, reference rate, or index can result in a loss substantially greater than the amount invested in the derivative itself. Certain derivatives have the potential for unlimited loss, regardless of the size of the initial investment. A derivative transaction will not be considered to constitute the issuance of a "senior security" by a fund, and therefore such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." Like most other investments, derivative instruments are subject to the risk that the market value of the instrument will change in a way detrimental to a fund's interest. A fund bears the risk that its advisor will incorrectly forecast future market trends or the values of assets, reference rates, indexes, or other financial or economic factors in establishing derivative positions for the fund. If the advisor attempts to use a derivative as a hedge against, or as a substitute for, a portfolio investment, the fund will be exposed to the risk that the derivative will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the fund. Although hedging strategies involving derivative instruments can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other fund investments. Many derivatives, in particular OTC derivatives, are complex and often valued subjectively. Improper valuations can result in increased cash payment requirements to counterparties or a loss of value to a fund. EXCHANGE-TRADED FUNDS. A fund may purchase shares of exchange-traded funds (ETFs), including ETF shares issued by other Vanguard funds. Typically, a fund would purchase ETF shares for the same reason it would purchase (and as an alternative to purchasing) futures contracts: to obtain exposure to all or a portion of the stock or bond market. ETF shares enjoy several advantages over futures. Depending on the market, the holding period, and other factors, ETF shares can be less costly and more tax-efficient than futures. In addition, ETF shares can be purchased for smaller sums, offer exposure to market sectors and styles for which there is no suitable or liquid futures contract, and do not involve leverage. An investment in an ETF generally presents the same primary risks as an investment in a conventional fund (i.e., one that is not exchange traded) that has the same investment objective, strategies, and policies. The price of an ETF can fluctuate within a wide range, and a fund could lose money investing in an ETF if the prices of the securities owned by the ETF go down. In addition, ETFs are subject to the following risks that do not apply to conventional funds: (1) the market price of the ETF's shares may trade at a discount to their net asset value; (2) an active trading market for an ETF's shares may not develop or be maintained; or (3) trading of an ETF's shares may be halted if the listing exchange's officials deem such action appropriate, the shares are de-listed from the exchange, or the activation of market-wide "circuit breakers" (which are tied to large decreases in stock prices) halts stock trading generally. Most ETFs are investment companies. Therefore, a fund's purchases of ETF shares generally are subject to the limitations on, and the risks of, a fund's investments in other investment companies, which are described below under the heading "Other Investment Companies." Vanguard ETF(TM) *Shares are exchange-traded shares that represent an interest in an investment portfolio held by Vanguard index funds. A fund's investments in Vanguard ETF Shares are also generally subject to the descriptions, limitations, and risks described under the heading "Other Investment Companies, " except as provided by an exemption granted by the SEC that permits registered investment companies to invest in a Vanguard fund that issues ETF Shares beyond the limits of Section 12(d)(1) of the 1940 Act, subject to certain terms and conditions. - --------- * U.S. Pat. No. 6,879,964 B2. FOREIGN SECURITIES. Typically, foreign securities are considered to be equity or debt securities issued by entities organized, domiciled, or with a principal executive office outside the United States, such as foreign corporations and governments. Securities issued by certain companies organized outside the United States may not be deemed to be foreign securities if the company's principal operations are conducted from the United States or when the company's equity securities trade principally on a U.S. stock exchange. Foreign securities may trade in U.S. or foreign securities markets. A fund may make foreign investments either directly by purchasing foreign securities or indirectly by purchasing depositary receipts or depositary shares of similar instruments (depositary receipts) for foreign securities. Depositary receipts are securities that are listed on exchanges or quoted in OTC markets in one country but represent shares of issuers domiciled in another country. Direct investments in foreign securities may be made either on foreign securities exchanges or in the OTC markets. Investing in foreign securities involves certain special risk considerations that are not typically associated with investing in securities of U.S. companies or governments. B-11 Because foreign issuers are not generally subject to uniform accounting, auditing, and financial reporting standards and practices comparable to those applicable to U.S. issuers, there may be less publicly available information about certain foreign issuers than about U.S. issuers. Evidence of securities ownership may be uncertain in many foreign countries. As a result, there is a risk that a fund's trade details could be incorrectly or fraudulently entered at the time of the transaction, resulting in a loss to the fund. Securities of foreign issuers are generally less liquid than securities of comparable U.S. issuers. In certain countries, there is less government supervision and regulation of stock exchanges, brokers, and listed companies than in the U.S. In addition, with respect to certain foreign countries, there is the possibility of expropriation or confiscatory taxation, political or social instability, war, terrorism, nationalization, limitations on the removal of funds or other assets, or diplomatic developments which could affect U.S. investments in those countries. Although an advisor will endeavor to achieve most favorable execution costs for a fund's portfolio transactions in foreign securities under the circumstances, commissions (and other transaction costs) are generally higher than those on U.S. securities. In addition, it is expected that the expenses for custodian arrangements of the fund's foreign securities will be somewhat greater than the expenses for a fund that invests primarily in domestic securities. Certain foreign governments levy withholding taxes against dividend and interest income from foreign securities. Although in some countries a portion of these taxes is recoverable by the fund, the non-recovered portion of foreign withholding taxes will reduce the income received from the companies making up a fund. The value of the foreign securities held by a fund that are not U.S. dollar-denominated may be significantly affected by changes in currency exchange rates. The U.S. dollar value of a foreign security generally decreases when the value of the U.S. dollar rises against the foreign currency in which the security is denominated and tends to increase when the value of the U.S. dollar falls against such currency (as discussed below, a fund may attempt to hedge its currency risks). In addition, the value of fund assets may be affected by losses and other expenses incurred in converting between various currencies in order to purchase and sell foreign securities, and by currency restrictions, exchange control regulation, currency devaluations, and political and economic developments. FOREIGN SECURITIES -- EMERGING MARKET RISK. Investing in emerging market countries involves certain risks not typically associated with investing in the United States, and imposes risks greater than, or in addition to, risks of investing in more developed foreign countries. These risks include, but are not limited to, the following: greater risks of nationalization or expropriation of assets or confiscatory taxation; currency devaluations and other currency exchange rate fluctuations; greater social, economic, and political uncertainty and instability (including amplified risk of war and terrorism); more substantial government involvement in the economy; less government supervision and regulation of the securities markets and participants in those markets; controls on foreign investment and limitations on repatriation of invested capital and on the fund's ability to exchange local currencies for U.S. dollars; unavailability of currency hedging techniques in certain emerging market countries; the fact that companies in emerging market countries may be smaller, less seasoned, and newly organized companies; the difference in, or lack of, auditing and financial reporting standards, which may result in unavailability of material information about issuers; the risk that it may be more difficult to obtain and/or enforce a judgment in a court outside the United States; and greater price volatility, substantially less liquidity, and significantly smaller market capitalization of securities markets. Also, any change in the leadership or politics of emerging market countries, or the countries that exercise a significant influence over those countries, may halt the expansion of or reverse the liberalization of foreign investment policies now occurring and adversely affect existing investment opportunities. Furthermore, high rates of inflation and rapid fluctuations in inflation rates have had, and may continue to have, negative effects on the economies and securities markets of certain emerging market countries. FOREIGN SECURITIES -- FOREIGN CURRENCY TRANSACTIONS. The value in U.S. dollars of a fund's non-dollar-denominated foreign securities may be affected favorably or unfavorably by changes in foreign currency exchange rates and exchange control regulations, and the fund may incur costs in connection with conversions between various currencies. Currency rates in foreign countries may fluctuate significantly over short periods of time and for a number of reasons, B-12 including: national debt levels and trade deficits, domestic and foreign inflation rates and investors' expectations concerning inflation rates, changes in domestic and foreign interest rates and investors' expectations concerning interest rates, investment and trading activities of mutual funds, hedge funds and currency funds, the imposition of currency controls, or other global, regional economic and political developments. These events and actions are unpredictable. As a result, a fund's exposure to foreign currency may reduce the returns of the fund. To seek to minimize the impact of such factors on net asset values, a fund may engage in foreign currency transactions in connection with its investments in foreign securities. Generally, a fund will not speculate in foreign currency and will enter into foreign currency transactions only to attempt to "hedge" the currency risk associated with investing in foreign securities. Although such transactions tend to minimize the risk of loss that would result from a decline in the value of the hedged currency, they also may limit any potential gain that might result should the value of such currency increase. Pursuant to an absolute return strategy, however, a fund may speculate in foreign currency on a long-only basis or on a long/short basis for the purpose of increasing investment returns through the use of currency forward transactions (as described below in "Foreign Securities - Foreign Currency Forward Transactions"), currency futures transactions, and/or currency swaps. Currency exchange transactions may be conducted either on a spot (i.e., cash) basis at the rate prevailing in the currency exchange market, or through forward contracts to purchase or sell foreign currencies. The high volatility of currency exchange rates may materially and adversely affect the market value of a fund's foreign currency exchange transactions, which would then negatively impact the value of the fund's shares. Currency exchange transactions also may be effected through the use of swap agreements or other derivatives. Currency exchange transactions may be considered borrowings. A currency exchange transaction will not be considered to constitute the issuance of a "senior security" by a fund for purposes of the 1940 Act, and therefore such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." A fund may also attempt to hedge its foreign currency exchange rate risk by engaging in currency futures, options, and "cross-hedge" transactions. In cross-hedge transactions, a fund holding securities denominated in one foreign currency will enter into a forward currency contract to buy or sell a different foreign currency (one that the advisor reasonably believes generally tracks the currency being hedged with regard to price movements). The advisor may select the tracking (or substitute) currency rather than the currency in which the security is denominated for various reasons, including in order to take advantage of pricing or other opportunities presented by the tracking currency or because the market for the tracking currency is more liquid or more efficient. Such cross-hedges are expected to help protect a fund against an increase or decrease in the value of the U.S. dollar against certain foreign currencies. The use of cross-hedging transactions may involve special risks, and may leave a fund in a less advantageous position than if such a hedge had not been established. A fund may hold a portion of its assets in bank deposits denominated in foreign currencies, so as to facilitate investment in foreign securities as well as protect against currency fluctuations and the need to convert such assets into U.S. dollars (thereby also reducing transaction costs). To the extent these monies are converted back into U.S. dollars, the value of the assets so maintained will be affected favorably or unfavorably by changes in foreign currency exchange rates and exchange control regulations. Historically, returns from trading currencies on a speculative basis as part of an absolute return strategy have tended to exhibit low correlation with the return of other assets such as stocks and bonds. Although such currency trading has the potential provide a diversification benefit to a traditional balanced portfolio of stocks, bonds, and cash, there is no guarantee that such trading will be profitable or that the future returns from such trading exhibit low correlation to the returns from stocks or bonds. FOREIGN SECURITIES -- FOREIGN CURRENCY FORWARD TRANSACTIONS. A forward currency contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract agreed upon by the parties, at a price set at the time of the contract. These contracts are not traded on exchanges and are not standardized. Rather, they are entered into with large commercial banks or other currency traders who are participants in the interbank market. Forward trading is substantially unregulated, there is no limitation on daily price movements and speculative position limits are not applicable. The principals who deal in the forward markets are not required to make markets in the currencies they trade and these markets can experience significant periods of illiquidity. Any market disruption or illiquidity could result in losses to the funds. B-13 By entering into a forward contract for the purchase or sale of foreign currency involved in underlying security transactions, a fund may be able to protect itself against part or all of the possible loss between trade and settlement dates for that purchase or sale resulting from an adverse change in the relationship between the U.S. dollar and such foreign currency. This practice is sometimes referred to as "transaction hedging." In addition, when the advisor reasonably believes that a particular foreign currency may suffer a substantial decline against the U.S. dollar, a fund may enter into a forward contract to sell an amount of foreign currency approximating the value of some or all of its portfolio securities denominated in such foreign currency. This practice is sometimes referred to as "portfolio hedging." Similarly, when the advisor reasonably believes that the U.S. dollar may suffer a substantial decline against a foreign currency, a fund may enter into a forward contract to buy that foreign currency for a fixed dollar amount. Pursuant to an absolute return strategy, a fund may speculate in foreign currency on a long-only basis or on a long/short basis for the purpose of increasing investment returns through the use of currency forward transactions. The forecasting of currency market movement is extremely difficult, and whether any hedging or speculative strategy will be successful is highly uncertain. Moreover, it is impossible to forecast with precision the market value of portfolio securities at the expiration of a foreign currency forward contract. Accordingly, a fund may be required to buy or sell additional currency on the spot market (and bear the expense of such transaction) if its advisor's predictions regarding the movement of foreign currency or securities markets prove inaccurate. In addition, because foreign currency forward contracts are privately negotiated transactions and trading is substantially unregulated, there can be no assurance that a fund will have flexibility to roll-over a foreign currency forward contract upon its expiration if it desires to do so. Additionally, there can be no assurance that the other party to the contract will perform its services thereunder. FOREIGN SECURITIES -- FOREIGN INVESTMENT COMPANIES. Some of the countries in which a fund may invest may not permit, or may place economic restrictions on, direct investment by outside investors. Fund investments in such countries may be permitted only through foreign government-approved or authorized investment vehicles, which may include other investment companies. Such investments may be made through registered or unregistered closed-end investment companies that invest in foreign securities. Investing through such vehicles may involve frequent or layered fees or expenses and may also be subject to the limitations on, and the risks of, a fund's investments in other investment companies, which are described below under the heading "Other Investment Companies." FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. Futures contracts and options on futures contracts are derivatives. A futures contract is a standardized agreement between two parties to buy or sell at a specific time in the future a specific quantity of a commodity at a specific price. The commodity may consist of an asset, a reference rate, or an index. A security futures contract relates to the sale of a specific quantity of shares of a single equity security or a narrow-based securities index. The value of a futures contract tends to increase and decrease in tandem with the value of the underlying commodity. The buyer of a futures contract enters into an agreement to purchase the underlying commodity on the settlement date and is said to be "long" the contract. The seller of a futures contract enters into an agreement to sell the underlying commodity on the settlement date and is said to be "short" the contract. The price at which a futures contract is entered into is established either in the electronic marketplace or by open outcry on the floor of an exchange between exchange members acting as traders or brokers. Open futures contracts can be liquidated or closed out by physical delivery of the underlying commodity or payment of the cash settlement amount on the settlement date, depending on the terms of the particular contract. Some financial futures contracts (such as security futures) provide for physical settlement at maturity. Other financial futures contracts (such as those relating to interest rates, foreign currencies, and broad-based securities indexes) generally provide for cash settlement at maturity. In the case of cash settled futures contracts, the cash settlement amount is equal to the difference between the final settlement price on the last trading day of the contract and the price at which the contract was entered into. Most futures contracts, however, are not held until maturity but instead are "offset" before the settlement date through the establishment of an opposite and equal futures position. The purchaser or seller of a futures contract is not required to deliver or pay for the underlying commodity unless the contract is held until the settlement date. However, both the purchaser and seller are required to deposit "initial margin" with a futures commission merchant (FCM) when the futures contract is entered into. Initial margin deposits are typically calculated as a percentage of the contract's market value. If the value of either party's position declines, that party will be required to make additional "variation margin" payments to settle the change in value on a daily basis. This process is known B-14 as "marking-to-market." A futures transaction will not be considered to constitute the issuance of a "senior security" by a fund for purposes of the 1940 Act, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." An option on a futures contract (or futures option) conveys the right, but not the obligation, to purchase (in the case of a call option) or sell (in the case of a put option) a specific futures contract at a specific price (called the "exercise" or "strike" price) any time before the option expires. The seller of an option is called an option writer. The purchase price of an option is called the premium. The potential loss to an option buyer is limited to the amount of the premium plus transaction costs. This will be the case, for example, if the option is held and not exercised prior to its expiration date. Generally, an option writer sells options with the goal of obtaining the premium paid by the option buyer. If an option sold by an option writer expires without being exercised, the writer retains the full amount of the premium. The option writer, however, has unlimited economic risk because its potential loss, except to the extent offset by the premium received when the option was written, is equal to the amount the option is "in-the-money" at the expiration date. A call option is in-the-money if the value of the underlying futures contract exceeds the exercise price of the option. A put option is in-the-money if the exercise price of the option exceeds the value of the underlying futures contract. Generally, any profit realized by an option buyer represents a loss for the option writer. A fund that takes the position of a writer of a futures option is required to deposit and maintain initial and variation margin with respect to the option, as described above in the case of futures contracts. A futures option transaction will not be considered to constitute the issuance of a "senior security" by a fund for purposes of the 1940 Act, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." Each fund intends to comply with Rule 4.5 of the Commodity Futures Trading Commission, under which a mutual fund is conditionally excluded from the definition of the term "commodity pool operator." A fund will only enter into futures contracts and futures options that are standardized and traded on a U.S. or foreign exchange, board of trade, or similar entity, or quoted on an automated quotation system. FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS -- RISKS. The risk of loss in trading futures contracts and in writing futures options can be substantial, because of the low margin deposits required, the extremely high degree of leverage involved in futures and options pricing, and the potential high volatility of the futures markets. As a result, a relatively small price movement in a futures position may result in immediate and substantial loss (or gain) to the investor. For example, if at the time of purchase, 10% of the value of the futures contract is deposited as margin, a subsequent 10% decrease in the value of the futures contract would result in a total loss of the margin deposit, before any deduction for the transaction costs, if the account were then closed out. A 15% decrease would result in a loss equal to 150% of the original margin deposit if the contract were closed out. Thus, a purchase or sale of a futures contract, and the writing of a futures option, may result in losses in excess of the amount invested in the position. In the event of adverse price movements, a fund would continue to be required to make daily cash payments to maintain its required margin. In such situations, if the fund has insufficient cash, it may have to sell portfolio securities to meet daily margin requirements (and segregation requirements, if applicable) at a time when it may be disadvantageous to do so. In addition, on the settlement date, a fund may be required to make delivery of the instruments underlying the futures positions it holds. A fund could suffer losses if it is unable to close out a futures contract or a futures option because of an illiquid secondary market. Futures contracts and futures options may be closed out only on an exchange which provides a secondary market for such products. However, there can be no assurance that a liquid secondary market will exist for any particular futures product at any specific time. Thus, it may not be possible to close a futures or option position. Moreover, most futures exchanges limit the amount of fluctuation permitted in futures contract prices during a single trading day. The daily limit establishes the maximum amount that the price of a futures contract may vary either up or down from the previous day's settlement price at the end of a trading session. Once the daily limit has been reached in a particular type of contract, no trades may be made on that day at a price beyond that limit. The daily limit governs only price movement during a particular trading day and therefore does not limit potential losses, because the limit may prevent the liquidation of unfavorable positions. Futures contract prices have occasionally moved to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of future positions and subjecting some futures traders to substantial losses. The inability to close futures and options positions also could have an adverse impact on the ability to hedge a portfolio investment or to establish a substitute for a portfolio investment. Treasury futures are generally not subject to such daily limits. B-15 A fund bears the risk that its advisor will incorrectly predict future market trends. If the advisor attempts to use a futures contract or a futures option as a hedge against, or as a substitute for, a portfolio investment, the fund will be exposed to the risk that the futures position will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the fund. While hedging strategies involving futures products can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other fund investments. A fund could lose margin payments it has deposited with its FCM, if, for example, the FCM breaches its agreement with the fund or becomes insolvent or goes into bankruptcy. In that event, the fund may be entitled to return of margin owed to it only in proportion to the amount received by the FCM's other customers, potentially resulting in losses to the fund. HYBRID INSTRUMENT. A hybrid instrument, or hybrid, is an interest in an issuer that combines the characteristics of an equity security, a debt security, a commodity, and/or a derivative. A hybrid may have characteristics that, on the whole, more strongly suggest the existence of a bond, stock or other traditional investment, but may also have prominent features that are normally associated with a different type of investment. Moreover, hybrid instruments may be treated as a particular type of investment for one regulatory purpose (such as taxation) and may be simultaneously treated as a different type of investment for a different regulatory purpose (such as securities or commodity regulation). Hybrids can be used as an efficient means of pursuing a variety of investment goals, including increased total return, duration management, and currency hedging. Because hybrids combine features of two or more traditional investments, and may involve the use of innovative structures, hybrids present risks that may be similar to, different from, or greater than those associated with traditional investments with similar characteristics. Examples of hybrid instruments include convertible securities, which combine the investment characteristics of bonds and common stocks, and perpetual bonds, which are structured like fixed income securities, have no maturity date, and may be characterized as debt or equity for certain regulatory purposes. Another example of a hybrid is a commodity-linked bond, such as a bond issued by an oil company that pays a small base level of interest with additional interest that accrues in correlation to the extent to which oil prices exceed a certain predetermined level. Such a hybrid would be a combination of a bond and a call option on oil. In the case of hybrids that are structured like fixed income securities (such as structured notes), the principal amount or interest rate is generally tied (positively or negatively) to the price of some commodity, currency, securities index, interest rate, or other economic factor (each a benchmark). For some hybrids, the principal amount payable at maturity or interest rate may be increased or decreased, depending on changes in the value of the benchmark. Other hybrids do not bear interest or pay dividends. The value of a hybrid or its interest rate may be a multiple of a benchmark and, as a result, may be leveraged and move (up or down) more steeply and rapidly than the benchmark. These benchmarks may be sensitive to economic and political events, such as commodity shortages and currency devaluations, which cannot be readily foreseen by the purchaser of a hybrid. Under certain conditions, the redemption value of a hybrid could be zero. Thus, an investment in a hybrid may entail significant market risks that are not associated with a similar investment in a traditional, U.S. dollar-denominated bond with a fixed principal amount that pays a fixed rate or floating rate of interest. The purchase of hybrids also exposes a fund to the credit risk of the issuer of the hybrids. Depending on the level of a fund's investment in hybrids, these risks may cause significant fluctuations in the fund's net asset value. Certain issuers of hybrid instruments known as structured products may be deemed to be investment companies as defined in the 1940 Act. As a result, the funds' investments in these products may be subject to limits described below under the heading "Other Investment Companies." INTERFUND BORROWING AND LENDING. The SEC has granted an exemption permitting the Vanguard funds to participate in Vanguard's interfund lending program. This program allows the Vanguard funds to borrow money from and lend money to each other for temporary or emergency purposes. The program is subject to a number of conditions, including, among other things, the requirement that: (1) no fund may borrow or lend money through the program unless it receives a more favorable interest rate than is typically available from a bank for a comparable transaction; (2) no equity, taxable bond, or money market fund may loan funds if the loan would cause its aggregate outstanding loans through the program to exceed 5%, 7.5%, or 10%, respectively, of its net assets at the time of the loan; and (3) a fund's interfund loans to any one fund shall not exceed 5% of the lending fund's net assets. In addition, a Vanguard fund may participate in the program only if and to the extent that such participation is consistent with the fund's investment objective and other investment policies. The boards of B-16 trustees of the Vanguard funds are responsible for overseeing the interfund lending program. Any delay in repayment to a lending fund could result in a lost investment opportunity or additional borrowing costs. LOAN INTERESTS AND DIRECT DEBT INSTRUMENTS. Loan interests and direct debt instruments are interests in amounts owed by a corporate, governmental, or other borrower to lenders or lending syndicates (in the case of loans and loan participations), to suppliers of goods or services (in the case of trade claims or other receivables), or to other parties. These investments involve a risk of loss in case of the default, insolvency, or bankruptcy of the borrower and may offer less legal protection to the purchaser in the event of fraud or misrepresentation, or there may be a requirement that a purchaser supply additional cash to a borrower on demand. Purchasers of loans and other forms of direct indebtedness depend primarily upon the creditworthiness of the borrower for payment of interest and repayment of principal. If scheduled interest or principal payments are not made, or are not made in a timely manner, the value of the instrument may be adversely affected. Loans that are fully secured provide more protections than unsecured loans in the event of failure to make scheduled interest or principal payments. However, there is no assurance that the liquidation of collateral from a secured loan would satisfy the borrower's obligation, or that the collateral could be liquidated. Indebtedness of borrowers whose creditworthiness is poor involves substantially greater risks and may be highly speculative. Borrowers that are in bankruptcy or restructuring may never pay off their indebtedness, or may pay only a small fraction of the amount owed. Direct indebtedness of developing countries also involves a risk that the governmental entities responsible for the repayment of the debt may be unable, or unwilling, to pay interest and repay principal when due. Investments in loans through direct assignment of a financial institution's interests with respect to a loan may involve additional risks. For example, if a loan is foreclosed, the purchaser could become part owner of any collateral, and would bear the costs and liabilities associated with owning and disposing of the collateral. In addition, it is at least conceivable that under emerging legal theories of lender liability, a purchaser could be held liable as a co-lender. Direct debt instruments may also involve a risk of insolvency of the lending bank or other intermediary. A loan is often administered by a bank or other financial institution that acts as agent for all holders. The agent administers the terms of the loan, as specified in the loan agreement. Unless the purchaser has direct recourse against the borrower, the purchaser may have to rely on the agent to apply appropriate credit remedies against a borrower under the terms of the loan or other indebtedness. If assets held by the agent for the benefit of a purchaser were determined to be subject to the claims of the agent's general creditors, the purchaser might incur certain costs and delays in realizing payment on the loan or loan participation and could suffer a loss of principal or interest. Direct indebtedness may include letters of credit, revolving credit facilities, or other standby financing commitments that obligate purchasers to make additional cash payments on demand. These commitments may have the effect of requiring a purchaser to increase its investment in a borrower at a time when it would not otherwise have done so, even if the borrower's condition makes it unlikely that the amount will ever be repaid. A fund's investment policies will govern the amount of total assets that it may invest in any one issuer or in issuers within the same industry. For purposes of these limitations, a fund generally will treat the borrower as the "issuer" of indebtedness held by the fund. In the case of loan participations where a bank or other lending institution serves as financial intermediary between a fund and the borrower, if the participation does not shift to the fund the direct debtor-creditor relationship with the borrower, SEC interpretations require the fund, in some circumstances, to treat both the lending bank or other lending institution and the borrower as "issuers" for purposes of the fund's investment policies. Treating a financial intermediary as an issuer of indebtedness may restrict a fund's ability to invest in indebtedness related to a single financial intermediary, or a group of intermediaries engaged in the same industry, even if the underlying borrowers represent many different companies and industries. MORTGAGE DOLLAR ROLLS. A mortgage dollar roll is a transaction in which a fund sells a mortgage-backed security to a dealer and simultaneously agrees to repurchase a similar security (but not the same security) in the future at a pre-determined price. A mortgage-dollar-roll program may be structured to simulate an investment in mortgage-backed securities at a potentially lower cost, or with potentially reduced administrative burdens, than directly holding mortgage-backed securities. A mortgage dollar roll can be viewed, like a reverse repurchase agreement, as a collateralized borrowing in which a fund pledges a mortgage-backed security to a dealer to obtain cash. Unlike the dealer of reverse repurchase agreements, the dealer with which a fund enters into a mortgage-dollar-roll transaction is not obligated to return the same securities as those originally sold by the fund, but rather only securities which are "substantially identical." To be considered substantially identical, the securities returned to a fund generally must: (1) be collateralized by the same types of underlying mortgages; (2) be issued by the same agency and be part of the same program; (3) have similar original stated maturities; (4) have identical net coupon rates; (5) have similar market yields (and therefore B-17 prices); and (6) satisfy "good delivery" requirements, meaning that the aggregate principal amounts of the securities delivered and received back must be within a certain percentage of the initial amount delivered. A mortgage dollar roll may be considered to constitute a borrowing transaction. A mortgage-dollar-roll transaction will not be considered to constitute the issuance of a "senior security" by a fund for purposes of the 1940 Act, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements, and is subject to the risks, described above under the heading "Borrowing." Mortgage dollar rolls will be used only if consistent with a fund's investment objective and strategies and will not be used to leverage a fund's assets or change its risk profile. The proceeds of mortgage-dollar-roll transactions will be invested in high-quality, short-term fixed income securities. MORTGAGE-BACKED SECURITIES. Mortgage-backed securities are securities that represent direct or indirect participation in, or are collateralized by and payable from, mortgage loans secured by real property or instruments derived from such loans. Mortgage-backed securities include various types of securities such as government stripped mortgage-backed securities, adjustable rate mortgage-backed securities and collateralized mortgage obligations. Generally, mortgage-backed securities represent interests in pools of mortgage loans assembled for sale to investors by various governmental agencies, such as the Government National Mortgage Association (GNMA), by government-related organizations, such as the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC), as well as by private issuers, such as commercial banks, savings and loan institutions and mortgage bankers. The average maturity of pass-through pools of mortgage-backed securities in which a fund may invest varies with the maturities of the underlying mortgage instruments. In addition, a pool's average maturity may be shortened by unscheduled payments on the underlying mortgages. Factors affecting mortgage prepayments include the level of interest rates, general economic and social conditions, the location of the mortgaged property and age of the mortgage. Because prepayment rates of individual mortgage pools vary widely, the average life of a particular pool cannot be predicted accurately. (See "Debt Securities - - U.S. Government Securities" above.) Mortgage-backed securities may be classified as private, government, or government-related, depending on the issuer or guarantor. Private mortgage-backed securities represent interest in pass-through pools consisting principally of conventional residential mortgage loans created by non-government issuers, such as commercial banks and savings and loan associations and private mortgage insurance companies. Government mortgage-backed securities are backed by the full faith and credit of the United States. GNMA, the principal U.S. guarantor of these securities, is a wholly-owned U.S. government corporation within the Department of Housing and Urban Development. Government-related mortgage-backed securities are not backed by the full faith and credit of the United States. Issuers include FNMA and FHLMC. FNMA is a congressionally chartered corporation owned entirely by private stockholders, and is subject to general regulation by the Secretary of Housing and Urban Development. Pass-through securities issued by FNMA are guaranteed as to timely payment of principal and interest by FNMA. FHLMC is a stockholder-owned government-sponsored enterprise established by Congress. Participation certificates representing interests in mortgages from FHLMC's national portfolio are guaranteed as to the timely payment of interest and principal by FHLMC. Private, government, or government-related entities may create mortgage loan pools offering pass-through investments in addition to those described above. The mortgages underlying these securities may be alternative mortgage instruments, that is, mortgage instruments whose principal or interest payments may vary or whose terms to maturity may be shorter than customary. Mortgage-backed securities are often subject to more rapid repayment than their stated maturity date would indicate as a result of the pass-through of prepayments of principal on the underlying loans. Prepayments of principal by mortgagors or mortgage foreclosures shorten the term of the mortgage pool underlying the mortgage-backed security. The occurrence of prepayments is a function of several factors including the level of interest rates, general economic conditions, the location of the mortgaged property, the age of the mortgage or other underlying obligations, and other social and demographic conditions. Because prepayment rates of individual mortgage pools vary widely, the average life of a particular pool cannot be predicted accurately. A fund's ability to maintain positions in mortgage-backed securities is affected by the reductions in the principal amount of such securities resulting from prepayments. A fund's ability to reinvest prepayments of principal at comparable yield is subject to generally prevailing interest rates at that time. The values of mortgage-backed securities vary with changes in market interest rates generally and the differentials in yields among various kinds of U.S. government B-18 securities, mortgage-backed securities, and asset-backed securities. In periods of rising interest rates, the rate of prepayment tends to decrease, thereby lengthening the average life of a pool of mortgages supporting a mortgage-backed security. Conversely, in periods of falling interest rates, the rate of prepayment tends to increase thereby shortening the average life of such a pool. Because prepayments of principal generally occur when interest rates are declining, an investor, such as a fund, generally has to reinvest the proceeds of such prepayments at lower interest rates than those at which its assets were previously invested. Therefore, mortgage-backed securities have less potential for capital appreciation in periods of falling interest rates than other income-bearing securities of comparable maturity. MORTGAGE-BACKED SECURITIES -- ADJUSTABLE RATE MORTGAGE-BACKED SECURITIES. Adjustable rate mortgage-backed securities (ARMBSs) have interest rates that reset at periodic intervals. Acquiring ARMBSs permits a fund to participate in increases in prevailing current interest rates through periodic adjustments in the coupons of mortgages underlying the pool on which ARMBSs are based. Such ARMBSs generally have higher current yield and lower price fluctuations than is the case with more traditional fixed income debt securities of comparable rating and maturity. In addition, when prepayments of principal are made on the underlying mortgages during periods of rising interest rates, a fund can reinvest the proceeds of such prepayments at rates higher than those at which they were previously invested. Mortgages underlying most ARMBSs, however, have limits on the allowable annual or lifetime increases that can be made in the interest rate that the mortgagor pays. Therefore, if current interest rates rise above such limits over the period of the limitation, a fund holding an ARMBS does not benefit from further increases in interest rates. Moreover, when interest rates are in excess of coupon rates (i.e., the rates being paid by mortgagors) of the mortgages, ARMBSs behave more like fixed income securities and less like adjustable rate securities and are subject to the risks associated with fixed income securities. In addition, during periods of rising interest rates, increases in the coupon rate of adjustable rate mortgages generally lag current market interest rates slightly, thereby creating the potential for capital depreciation on such securities. MORTGAGE-BACKED SECURITIES -- COLLATERALIZED MORTGAGE OBLIGATIONS. Collateralized mortgage obligations (CMOs) are mortgage-backed securities that are collateralized by whole loan mortgages or mortgage pass-through securities. The bonds issued in a CMO transaction are divided into groups, and each group of bonds is referred to as a "tranche." Under the traditional CMO structure, the cash flows generated by the mortgages or mortgage pass-through securities in the collateral pool are used to first pay interest and then pay principal to the CMO bondholders. The bonds issued under a traditional CMO structure are retired sequentially as opposed to the pro-rata return of principal found in traditional pass-through obligations. Subject to the various provisions of individual CMO issues, the cash flow generated by the underlying collateral (to the extent it exceeds the amount required to pay the stated interest) is used to retire the bonds. Under a CMO structure, the repayment of principal among the different tranches is prioritized in accordance with the terms of the particular CMO issuance. The "fastest-pay" tranches of bonds, as specified in the prospectus for the issuance, would initially receive all principal payments. When those tranches of bonds are retired, the next tranche, or tranches, in the sequence, as specified in the prospectus, receive all of the principal payments until they are retired. The sequential retirement of bond groups continues until the last tranche is retired. Accordingly, the CMO structure allows the issuer to use cash flows of long maturity, monthly-pay collateral to formulate securities with short, intermediate, and long final maturities and expected average lives and risk characteristics. In recent years, new types of CMO tranches have evolved. These include floating rate CMOs, planned amortization classes, accrual bonds and CMO residuals. These newer structures affect the amount and timing of principal and interest received by each tranche from the underlying collateral. Under certain of these new structures, given classes of CMOs have priority over others with respect to the receipt of prepayments on the mortgages. Therefore, depending on the type of CMOs in which a fund invests, the investment may be subject to a greater or lesser risk of prepayment than other types of mortgage-backed securities. The primary risk of CMOs is the uncertainty of the timing of cash flows that results from the rate of prepayments on the underlying mortgages serving as collateral and from the structure of the particular CMO transaction (that is, the priority of the individual tranches). An increase or decrease in prepayment rates (resulting from a decrease or increase in mortgage interest rates) will affect the yield, average life, and price of CMOs. The prices of certain CMOs, depending on their structure and the rate of prepayments, can be volatile. Some CMOs may also not be as liquid as other securities. MORTGAGE-BACKED SECURITIES--HYBRID ARMS. A hybrid adjustable-rate mortgage (hybrid ARM) is a type of mortgage in which the interest rate is fixed for a specified period and then resets periodically, or floats, for the remaining mortgage term. Hybrid ARMs are usually referred to by their fixed and floating B-19 periods. For example, a 5/1 ARM refers to a mortgage with a 5-year fixed interest rate period, followed by a 1-year interest rate adjustment period. During the initial interest period (i.e., the initial five years for a 5/1 hybrid ARM), hybrid ARMs behave more like fixed income securities and are subject to the risks associated with fixed income securities. All hybrid ARMs have reset dates. A reset date is the date when a hybrid ARM changes from a fixed interest rate to a floating interest rate. At the reset date, a hybrid ARM can adjust by a maximum specified amount based on a margin over an identified index. Like ARMBSs, hybrid ARMs have periodic and lifetime limitations on the increases that can be made to the interest rates that mortgagors pay. Therefore, if during a floating rate period interest rates rise above the interest rate limits of the hybrid ARM, a fund holding the hybrid ARM does not benefit from further increases in interest rates. MORTGAGE-BACKED SECURITIES -- STRIPPED MORTGAGE-BACKED SECURITIES. Stripped mortgage-backed securities (SMBSs) are derivative multi-class mortgage-backed securities. SMBSs may be issued by agencies or instrumentalities of the U.S. government, or by private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage banks, commercial banks, investment banks, and special purpose entities formed or sponsored by any of the foregoing. SMBSs are usually structured with two classes that receive different proportions of the interest and principal distributions on a pool of mortgage assets. A common type of SMBS will have one class receiving some of the interest and most of the principal from the mortgage assets, while the other class will receive most of the interest and the remainder of the principal. In the most extreme case, one class will receive all of the interest (the "IO" class), while the other class will receive all of the principal (the principal-only or "PO" class). The price and yield-to-maturity on an IO class is extremely sensitive to the rate of principal payments (including prepayments) on the related underlying mortgage assets, and a rapid rate of principal payments may have a material adverse effect on a fund's yield to maturity from these securities. If the underlying mortgage assets experience greater than anticipated prepayments of principal, a fund may fail to recoup some or all of its initial investment in these securities, even if the security is in one of the highest rating categories. Although SMBSs are purchased and sold by institutional investors through several investment banking firms acting as brokers or dealers, these securities were only recently developed. As a result, established trading markets have not yet developed and, accordingly, these securities may be deemed "illiquid" and subject to a fund's limitations on investment in illiquid securities. OPTIONS. An option is a derivative. An option on a security (or index) is a contract that gives the holder of the option, in return for the payment of a "premium," the right, but not the obligation, to buy from (in the case of a call option) or sell to (in the case of a put option) the writer of the option the security underlying the option (or the cash value of the index) at a specified exercise price prior to the expiration date of the option. The writer of an option on a security has the obligation upon exercise of the option (1) to deliver the underlying security upon payment of the exercise price (in the case of a call option) or (2) to pay the exercise price upon delivery of the underlying security (in the case of a put option). The writer of an option on an index has the obligation upon exercise of the option to pay an amount equal to the cash value of the index minus the exercise price, multiplied by the specified multiplier for the index option. The multiplier for an index option determines the size of the investment position the option represents. Unlike exchange-traded options, which are standardized with respect to the underlying instrument, expiration date, contract size, and strike price, the terms of OTC options (options not traded on exchanges) generally are established through negotiation with the other party to the option contract. While this type of arrangement allows the purchaser or writer greater flexibility to tailor an option to its needs, OTC options generally involve greater credit risk than exchange-traded options, which are guaranteed by the clearing organization of the exchanges where they are traded. The buyer (or holder) of an option is said to be "long" the option, while the seller (or writer) of an option is said to be "short" the option. A call option grants to the holder the right to buy (and obligates the writer to sell) the underlying security at the strike price. A put option grants to the holder the right to sell (and obligates the writer to buy) the underlying security at the strike price. The purchase price of an option is called the "premium." The potential loss to an option buyer is limited to the amount of the premium plus transaction costs. This will be the case if the option is held and not exercised prior to its expiration date. Generally, an option writer sells options with the goal of obtaining the premium paid by the option buyer, but that person could also seek to profit from an anticipated rise or decline in option prices. If an option sold by an option writer expires without being exercised, the writer retains the full amount of the premium. The option writer, however, has unlimited economic risk because its potential loss, except to the extent offset by the premium received when the option was written, is equal to the amount the option is "in-the-money" at the expiration date. A call option is in-the-money B-20 if the value of the underlying position exceeds the exercise price of the option. A put option is in-the-money if the exercise price of the option exceeds the value of the underlying position. Generally, any profit realized by an option buyer represents a loss for the option writer. The writing of an option will not be considered to constitute the issuance of a "senior security" by a fund for purposes of the 1940 Act, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." If a trading market in particular options were to become unavailable, investors in those options (such as the funds) would be unable to close out their positions until trading resumes, and they may be faced with substantial losses if the value of the underlying interest moves adversely during that time. Even if the market were to remain available, there may be times when options prices will not maintain their customary or anticipated relationships to the prices of the underlying interests and related interests. Lack of investor interest, changes in volatility, or other factors or conditions might adversely affect the liquidity, efficiency, continuity, or even the orderliness of the market for particular options. A fund bears the risk that its advisor will not accurately predict future market trends. If the advisor attempts to use an option as a hedge against, or as a substitute for, a portfolio investment, the fund will be exposed to the risk that the option will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the fund. While hedging strategies involving options can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other fund investments. Many options, in particular OTC options, are complex and often valued based on subjective factors. Improper valuations can result in increased cash payment requirements to counterparties or a loss of value to a fund. OTHER INVESTMENT COMPANIES. A fund may invest in other investment companies to the extent permitted by applicable law or SEC exemption. Under Section 12(d)(1) of the 1940 Act, a fund generally may invest up to 10% of its assets in shares of investment companies and up to 5% of its assets in any one investment company, as long as no investment represents more than 3% of the voting stock of an acquired investment company. The 1940 Act and related rules provide certain exemptions from these restrictions. For example, Section 12(d)(1)(G) permits a mutual fund to acquire an unlimited amount of shares of mutual funds that are part of the same group of investment companies as the acquiring fund. Furthermore, Rule 12d1-2 conditionally permits an affiliated fund of funds to: (1) acquire securities of funds that are not part of the same group of investment companies (subject to certain percentage limits), (2) invest directly in stocks, bonds and other types of securities and (3) invest in affiliated or unaffiliated money market funds. If a fund invests in other investment companies, shareholders will bear not only their proportionate share of the fund's expenses (including operating expenses and the fees of the advisor), but also, indirectly, the similar expenses of the underlying investment companies. Shareholders would also be exposed to the risks associated not only to the investments of the fund but also to the portfolio investments of the underlying investment companies. Certain types of investment companies, such as closed-end investment companies, issue a fixed number of shares that typically trade on a stock exchange or over-the-counter at a premium or discount to their net asset value. Others are continuously offered at net asset value but also may be traded on the secondary market. PREFERRED STOCK. Preferred stock represents an equity or ownership interest in an issuer. Preferred stock normally pays dividends at a specified rate and has precedence over common stock in the event the issuer is liquidated or declares bankruptcy. However, in the event an issuer is liquidated or declares bankruptcy, the claims of owners of bonds take precedence over the claims of those who own preferred and common stock. Preferred stock, unlike common stock, often has a stated dividend rate payable from the corporation's earnings. Preferred stock dividends may be cumulative or non-cumulative, participating, or auction rate. "Cumulative" dividend provisions require all or a portion of prior unpaid dividends to be paid before dividends can be paid to the issuer's common stock. "Participating" preferred stock may be entitled to a dividend exceeding the stated dividend in certain cases. If interest rates rise, the fixed dividend on preferred stocks may be less attractive, causing the price of such stocks to decline. Preferred stock may have mandatory sinking fund provisions, as well as provisions allowing the stock to be called or redeemed, which can limit the benefit of a decline in interest rates. Preferred stock is subject to many of the risks to which common stock and debt securities are subject. REPURCHASE AGREEMENTS. A repurchase agreement is an agreement under which a fund acquires a fixed income security (generally a security issued by the U.S. government or an agency thereof, a banker's acceptance, or a certificate of deposit) from a commercial bank, broker, or dealer, and simultaneously agrees to resell such security to the seller at an agreed upon price and date (normally, the next business day). Because the security purchased constitutes collateral for the repurchase obligation, a repurchase agreement may be considered a loan that is collateralized by the security purchased. The resale price reflects an B-21 agreed upon interest rate effective for the period the instrument is held by a fund and is unrelated to the interest rate on the underlying instrument. In these transactions, the securities acquired by a fund (including accrued interest earned thereon) must have a total value in excess of the value of the repurchase agreement and be held by a custodian bank until repurchased. In addition, the investment advisor will monitor a fund's repurchase agreement transactions generally and will evaluate the creditworthiness of any bank, broker, or dealer party to a repurchase agreement relating to a fund. The aggregate amount of any such agreements is not limited except to the extent required by law. The use of repurchase agreements involves certain risks. One risk is the seller's ability to pay the agreed-upon repurchase price on the repurchase date. If the seller defaults, the fund may incur costs in disposing of the collateral, which would reduce the amount realized thereon. If the seller seeks relief under the bankruptcy laws, the disposition of the collateral may be delayed or limited. For example, if the other party to the agreement becomes insolvent and subject to liquidation or reorganization under the bankruptcy or other laws, a court may determine that the underlying security is collateral for a loan by the fund not within its control and therefore the realization by the fund on such collateral may be automatically stayed. Finally, it is possible that the fund may not be able to substantiate its interest in the underlying security and may be deemed an unsecured creditor of the other party to the agreement. RESTRICTED AND ILLIQUID SECURITIES. Illiquid securities are securities that cannot be sold or disposed of in the ordinary course of business within seven business days at approximately the value at which they are being carried on a fund's books. Illiquid securities may include a wide variety of investments, such as: (1) repurchase agreements maturing in more than seven days; (2) OTC options contracts and certain other derivatives (including certain swap agreements); (3) fixed time deposits that are not subject to prepayment or do not provide for withdrawal penalties upon prepayment (other than overnight deposits); (4) participation interests in loans; (5) municipal lease obligations; (6) commercial paper issued pursuant to Section 4(2) of the Securities Act of 1933 (the 1933 Act); and (7) securities whose disposition is restricted under the federal securities laws. Illiquid securities include restricted, privately placed securities that, under the federal securities laws, generally may be resold only to qualified institutional buyers. If a substantial market develops for a restricted security (or other illiquid investment) held by a fund, it may be treated as a liquid security, in accordance with procedures and guidelines approved by the board of trustees. This generally includes securities that are unregistered, that can be sold to qualified institutional buyers in accordance with Rule 144A under the 1933 Act, or that are exempt from registration under the 1933 Act, such as commercial paper. While a fund's advisor monitors the liquidity of restricted securities on a daily basis, the board of trustees oversees and retains ultimate responsibility for the advisor's liquidity determinations. Several factors that the trustees consider in monitoring these decisions include the valuation of a security, the availability of qualified institutional buyers, brokers, and dealers that trade in the security, and the availability of information about the security's issuer. REVERSE REPURCHASE AGREEMENTS. In a reverse repurchase agreement, a fund sells a security to another party, such as a bank or broker-dealer, in return for cash and agrees to repurchase that security at an agreed-upon price and time. Under a reverse repurchase agreement, the fund continues to receive any principal and interest payments on the underlying security during the term of the agreement. Reverse repurchase agreements involve the risk that the market value of securities retained by the fund may decline below the repurchase price of the securities sold by the fund which it is obligated to repurchase. A reverse repurchase agreement may be considered a borrowing transaction for purposes of the 1940 Act. A reverse repurchase agreement transaction will not be considered to constitute the issuance of a "senior security" by a fund, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." A fund will enter into reverse repurchase agreements only with parties whose creditworthiness has been reviewed and found satisfactory by the advisor. SECURITIES LENDING. A fund may lend its investment securities to qualified institutional investors (typically brokers, dealers, banks, or other financial institutions) who may need to borrow securities in order to complete certain transactions, such as covering short sales, avoiding failures to deliver securities, or completing arbitrage operations. By lending its investment securities, a fund attempts to increase its net investment income through the receipt of interest on the securities lent. Any gain or loss in the market price of the securities lent that might occur during the term of the loan would be for the account of the fund. If the borrower defaults on its obligation to return the securities lent because of insolvency or other reasons, a fund could experience delays and costs in recovering the securities lent or in gaining access to the collateral. These delays and costs could be greater for foreign securities. If a fund is not able to recover the securities lent, a fund may sell the collateral and purchase a replacement investment in the market. The value of the collateral could decrease below the value of the replacement B-22 investment by the time the replacement investment is purchased. Cash received as collateral through loan transactions may be invested in other eligible securities. Investing this cash subjects that investment to market appreciation or depreciation. The terms and the structure and the aggregate amount of securities loans must be consistent with the 1940 Act, and the rules or interpretations of the SEC thereunder. These provisions limit the amount of securities a fund may lend to 33 1/3% of the fund's total assets, and require that (1) the borrower pledge and maintain with the fund collateral consisting of cash, an irrevocable letter of credit or securities issued or guaranteed by the U.S. government having at all times not less than 100% of the value of the securities lent; (2) the borrower add to such collateral whenever the price of the securities lent rises (i.e., the borrower "marks-to-market" on a daily basis); (3) the loan be made subject to termination by the fund at any time; and (4) the fund receive reasonable interest on the loan (which may include the fund's investing any cash collateral in interest bearing short-term investments), any distribution on the lent securities, and any increase in their market value. Loan arrangements made by each fund will comply with all other applicable regulatory requirements, including the rules of the New York Stock Exchange, which presently require the borrower, after notice, to redeliver the securities within the normal settlement time of three business days. The advisor will consider the creditworthiness of the borrower, among other things, in making decisions with respect to the lending of securities, subject to oversight by the board of trustees. At the present time, the SEC does not object if an investment company pays reasonable negotiated fees in connection with lent securities, so long as such fees are set forth in a written contract and approved by the investment company's trustees. In addition, voting rights pass with the lent securities, but if a fund has knowledge that a material event will occur affecting securities on loan, and in respect of which the holder of the securities will be entitled to vote or consent, the lender must be entitled to call the loaned securities in time to vote or consent. SHORT SALES. In a short sale of securities, an investor sells stock which it does not own, making delivery with securities "borrowed" from a broker. The investor is then obligated to replace the borrowed security by purchasing it at the market price at the time of replacement. This price may or may not be less than the price at which the security was sold by the investor. Until the security is replaced, the investor is required to pay the lender any dividends or interest which accrues during the period of the loan. In order to borrow the security, the investor may also have to pay a fee which would increase the cost of the security sold. Generally speaking, the proceeds of the short sale will be retained by the broker, to the extent necessary to meet margin requirements, until the short position is closed out. An investor will incur a loss as a result of a short sale if the price of the security increases between the date of the short sale and the date on which the investor replaces the borrowed security. Excluding any interest payments, the investor will realize a gain if the security declines in price between those two dates. The amount of any gain will be decreased and the amount of any loss will be increased by any interest the investor may be required to pay in connection with the short sale. A short sale theoretically creates the risk of an unlimited loss, as the price of the underlying securities could theoretically increase without limit, thus increasing the cost of buying those securities to cover the short position. There can be no assurance that the security needed to cover a short position will be available for purchase. Purchasing securities to close out the short position can itself cause the price of the securities to rise further, thereby exacerbating the loss. An investor may also engage in short sales if at the time of the short sale the investor owns or has the right to obtain without additional cost an equal amount of the security being sold short. This investment technique is known as a short sale "against the box." For example, an investor may make a short sale against the box as a hedge because the investor believes that the price of a security may decline, causing a decline in the value of a security owned by the investor (or a security convertible or exchangeable for such security), or when the investor wants to sell the security at an attractive current price. In such case, any future losses in the investor's long position should be offset by a gain in the short position and, conversely, any gain in the long position should be reduced by a loss in the short position. The extent to which such gains or losses are reduced will depend upon the amount of the security sold short relative to the amount the investor owns. If an investor sells securities short "against the box," it may protect unrealized gains, but will lose the opportunity to profit on such securities if the price rises. The successful use of short selling as a hedging strategy may be adversely affected by imperfect correlation between movements in the price of the security sold short and the securities being hedged. SWAP AGREEMENTS. A swap agreement is a derivative. A swap agreement is an agreement between two parties (counterparties) to exchange payments at specified dates (periodic payment dates) on the basis of a specified amount (notional amount) with the payments calculated with reference to a specified asset, reference rate, or index. B-23 Examples of swap agreements include, but are not limited to, interest rate swaps, credit default swaps, equity swaps, commodity swaps, foreign currency swaps, index swaps, excess return swaps, and total return swaps. Most swap agreements provide that when the periodic payment dates for both parties are the same, payments are netted, and only the net amount is paid to the counterparty entitled to receive the net payment. Consequently, a fund's current obligations (or rights) under a swap agreement will generally be equal only to the net amount to be paid or received under the agreement, based on the relative values of the positions held by each counterparty. Swap agreements allow for a wide variety of transactions. For example, fixed rate payments may be exchanged for floating rate payments; U.S. dollar-denominated payments may be exchanged for payments denominated in a different currency; and payments tied to the price of one asset, reference rate, or index may be exchanged for payments tied to the price of another asset, reference rate, or index. An option on a swap agreement, also called a "swaption," is an option that gives the buyer the right, but not the obligation, to enter into a swap on a future date in exchange for paying a market-based "premium." A receiver swaption gives the owner the right to receive the total return of a specified asset, reference rate, or index. A payer swaption gives the owner the right to pay the total return of a specified asset, reference rate, or index. Swaptions also include options that allow an existing swap to be terminated or extended by one of the counterparties. The use of swap agreements by a fund entails certain risks, which may be different from, or possibly greater than, the risks associated with investing directly in the securities and other investments that are the referenced asset for the swap agreement. Swaps are highly specialized instruments that require investment techniques, risk analyses, and tax planning different from those associated with stocks, bonds, and other traditional investments. The use of a swap requires an understanding not only of the referenced asset, reference rate, or index but also of the swap itself, without the benefit of observing the performance of the swap under all possible market conditions. Swap agreements may be subject to liquidity risk, which exists when a particular swap is difficult to purchase or sell. If a swap transaction is particularly large or if the relevant market is illiquid (as is the case with many OTC swaps), it may not be possible to initiate a transaction or liquidate a position at an advantageous time or price, which may result in significant losses. In addition, swap transactions may be subject to a fund's limitation on investments in illiquid securities. Swap agreements may be subject to pricing risk, which exists when a particular swap becomes extraordinarily expensive (or cheap) relative to historical prices or the prices of corresponding cash market instruments. Under certain market conditions, it may not be economically feasible to initiate a transaction or liquidate a position in time to avoid a loss or take advantage of an opportunity or to realize the intrinsic value of the swap agreement. Because some swap agreements have a leverage component, adverse changes in the value or level of the underlying asset, reference rate, or index can result in a loss substantially greater than the amount invested in the swap itself. Certain swaps have the potential for unlimited loss, regardless of the size of the initial investment. A leveraged swap transaction will not be considered to constitute the issuance of a "senior security" by a fund, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by a fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." Like most other investments, swap agreements are subject to the risk that the market value of the instrument will change in a way detrimental to a fund's interest. A fund bears the risk that its advisor will not accurately forecast future market trends or the values of assets, reference rates, indexes, or other economic factors in establishing swap positions for the fund. If the advisor attempts to use a swap as a hedge against, or as a substitute for, a portfolio investment, the fund will be exposed to the risk that the swap will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the fund. While hedging strategies involving swap instruments can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other fund investments. Many swaps, in particular OTC swaps, are complex and often valued subjectively. Improper valuations can result in increased cash payment requirements to counterparties or a loss of value to a fund. The use of a swap agreement also involves the risk that a loss may be sustained as a result of the insolvency or bankruptcy of the counterparty or the failure of the counterparty to make required payments or otherwise comply with the terms of the agreement. Additionally, the use of credit default swaps can result in losses if a fund's advisor does not correctly evaluate the creditworthiness of the issuer on which the credit swap is based. The swaps market is a relatively new market and is largely unregulated. It is possible that developments in the swaps market, including potential government regulation, could adversely affect a fund's ability to terminate existing swap agreements or to realize amounts to be received under such agreements. B-24 TAX MATTERS -- FEDERAL TAX TREATMENT OF DERIVATIVES AND SHORT SALES. A fund must generally recognize any net unrealized gains and losses on certain futures contracts and certain options traded on U.S. exchanges as of the end of each taxable year, as well as any gains and loses actually realized during the year. A fund must treat such gains and losses as 60% long-term and 40% short-term, regardless of how long it held the positions. A fund must generally treat any gain from a short sale as short-term capital gain (unless closed with a security held for longer than a year before the sale) and may recognize income, gains, or both in respect of any swaps positions. A fund's investments may be subject to federal income tax rules that may, among other things, disallow, suspend, or otherwise limit the allowance of certain losses or deductions, convert long-term capital gains into short-term capital gains or ordinary income, convert an ordinary loss or a deduction into a capital loss, or require the capitalization of certain expenses. For example, if it holds both long and short positions in the same security, a fund may be required to apply the straddle or constructive sales rules, which could affect the character and timing of gains and losses fund realized, as well as its holding period for the securities involved. In order for a fund to continue to qualify for federal income tax treatment as a regulated investment company, it must meet a diversification test and at least 90% of its gross income for each taxable year must be derived from qualifying income--i.e., dividends, interest, income derived from securities loans, gains from the sale of securities or foreign currencies, other income derived with respect to the fund's business of investing in securities or currencies, or income from qualified publicly traded partnerships. It is anticipated that any net gain or other investment income recognized on futures contracts, options, short sales, swaps or other derivatives will either be considered qualifying income for purposes of the 90% requirement or not exceed, when aggregated with other non-qualifying income the fund may have, 10% of gross income. A fund generally will distribute to shareholders annually any net capital gains and other investment income recognized, including from futures contracts, options, short sales, swaps, or other derivaties, and will report to its shareholders on the nature of those distributions. TAX MATTERS -- FEDERAL TAX TREATMENT OF CURRENCY TRANSACTIONS. Special rules govern the federal income tax treatment of certain transactions denominated in a currency other than the U.S. dollar or determined by reference to the value of one or more currencies other than the U.S. dollar. The types of transactions covered by the special rules include the following: (1) the acquisition of, or becoming the obligor under, a bond or other debt instrument (including, to the extent provided in Treasury regulations, preferred stock); (2) the accruing of certain trade receivables and payables; and (3) the entering into or acquisition of any forward contract, futures contract, option, or similar financial instrument if such instrument is not marked to market. The disposition of a currency other than the U.S. dollar by a taxpayer whose functional currency is the U.S. dollar is also treated as a transaction subject to the special currency rules. However, foreign currency-related regulated futures contracts and non-equity options are generally not subject to the special currency rules if they are or would be treated as sold for their fair market value at year-end under the marking-to-market rules applicable to other futures contracts unless an election is made to have such currency rules apply. With respect to transactions covered by the special rules, foreign currency gain or loss is calculated separately from any gain or loss on the underlying transaction and is normally taxable as ordinary income or loss. A taxpayer may elect to treat as capital gain or loss foreign currency gain or loss arising from certain identified forward contracts, futures contracts, and options that are capital assets in the hands of the taxpayer and which are not part of a straddle. The Treasury Department issued regulations under which certain transactions subject to the special currency rules that are part of a "section 988 hedging transaction" (as defined in the IRC and the Treasury regulations) will be integrated and treated as a single transaction or otherwise treated consistently for purposes of the IRC. Any gain or loss attributable to the foreign currency component of a transaction engaged in by a fund which is not subject to the special currency rules (such as foreign equity investments other than certain preferred stocks) will be treated as capital gain or loss and will not be segregated from the gain or loss on the underlying transaction. It is anticipated that some of the non-U.S. dollar-denominated investments and foreign currency contracts a fund may make or enter into will be subject to the special currency rules described above. Treasury has statutory authority, which it has not yet exercised, to write regulations from qualifying income foreign currency gains that are not directly related to a fund's principal business of investing in stock or securities. TAX MATTERS -- FOREIGN TAX CREDIT. Foreign governments may withhold taxes on dividends and interest paid with respect to foreign securities held by a fund. Foreign governments may also impose taxes on other payments or gains with respect to foreign securities. If, at the close of its fiscal year, more than B-25 50% of a fund's total assets are invested in securities of foreign issuers, the fund may elect to pass through foreign taxes paid, and thereby allow shareholders to take a deduction or, if they meet certain holding period requirements, a tax credit on their tax returns. If shareholders do not meet the holding period requirements, they may still be entitled to a deduction for certain gains that were actually distributed by the fund, but will also show the amount of the available offsetting credit or deduction. TEMPORARY INVESTMENTS. A fund may take temporary defensive positions that are inconsistent with the fund's normal fundamental or non-fundamental investment policies and strategies in response to adverse market, economic, political, or other conditions as determined by the advisor. Such measures could include, but are not limited to, investments in (1) highly liquid short-term fixed income securities issued by or on behalf of municipal or corporate issuers, obligations of the U.S. government and its agencies, commercial paper, and bank certificates of deposit; (2) repurchase agreements involving any such securities; and (3) other money market instruments. There is no limit on the extent to which the fund may take temporary defensive measures. In taking such measures, the fund may fail to achieve its investment objective. WARRANTS. Warrants are instruments that give the holder the right, but not the obligation, to buy an equity security at a specific price for a specific period of time. Changes in the value of a warrant do not necessarily correspond to changes in the value of its underlying security. The price of a warrant may be more volatile than the price of its underlying security, and a warrant may offer greater potential for capital appreciation as well as capital loss. Warrants do not entitle a holder to dividends or voting rights with respect to the underlying security and do not represent any rights in the assets of the issuing company. A warrant ceases to have value if it is not exercised prior to its expiration date. These factors can make warrants more speculative than other types of investments. WHEN-ISSUED, DELAYED-DELIVERY, AND FORWARD-COMMITMENT TRANSACTIONS. When-issued, delayed-delivery, and forward-commitment transactions involve a commitment to purchase or sell specific securities at a predetermined price or yield in which payment and delivery take place after the customary settlement period for that type of security. Typically, no interest accrues to the purchaser until the security is delivered. When purchasing securities pursuant to one of these transactions, payment for the securities is not required until the delivery date. However, the purchaser assumes the rights and risks of ownership, including the risks of price and yield fluctuations and the risk that the security will not be issued as anticipated. When a fund has sold a security pursuant to one of these transactions, the fund does not participate in further gains or losses with respect to the security. If the other party to a delayed-delivery transaction fails to deliver or pay for the securities, the fund could miss a favorable price or yield opportunity or suffer a loss. A fund may renegotiate a when-issued or forward-commitment transaction and may sell the underlying securities before delivery, which may result in capital gains or losses for the fund. When-issued, delayed-delivery, and forward-commitment transactions will not be considered to constitute the issuance of a "senior security" by a fund, and such transaction will not be subject to the 300% asset coverage requirement otherwise applicable to borrowings by the fund, if the fund covers the transaction in accordance with the requirements, and subject to the risks, described above under the heading "Borrowing." INVESTMENT LIMITATIONS VANGUARD BALANCED INDEX FUND The Fund is subject to the following fundamental investment limitations, which cannot be changed in any material way without the approval of the holders of a majority of the Fund's shares. For these purposes, a "majority" of shares means shares representing the lesser of: (1) 67% or more of the Fund's net assets voted, so long as shares representing more than 50% of the Fund's net assets are present or represented by proxy; or (2) more than 50% of the Fund's net assets. BORROWING. The Fund may not borrow money in excess of 15% of its net assets, and any borrowings by the Fund must comply with all applicable regulatory requirements. COMMODITIES. The Fund may not invest in commodities, except that it may invest in bond and stock futures contracts, bond and stock options, and options on bond and stock futures contracts. No more than 5% of the Fund's total assets may be used as initial margin deposit for futures contracts, and no more than 20% of the Fund's total assets may be invested in futures contracts or options at any time. DIVERSIFICATION. With respect to 75% of its total assets, the Fund may not: (1) purchase more than 10% of the outstanding voting securities of any one issuer; or (2) purchase securities of any issuer if, as a result, more than 5% of the Fund's total assets would be invested in that issuer's securities. This limitation does not apply to obligations of the U.S. government or its agencies or instrumentalities. ILLIQUID SECURITIES. The Fund may not acquire any security if, as a result, more than 15% of its net assets would be invested in securities that are illiquid. B-26 INDUSTRY CONCENTRATION. The Fund may not invest more than 25% of its total assets in any one industry. INVESTING FOR CONTROL. The Fund may not invest in a company for purposes of controlling its management. LOANS. The Fund may not lend money to any person except by purchasing fixed income securities, by entering into repurchase agreements, by lending its portfolio securities, or through Vanguard's interfund lending program. MARGIN. The Fund may not purchase securities on margin or sell securities short, except as permitted by the Fund's investment policies relating to commodities. OIL, GAS, MINERALS. The Fund may not invest in interests in oil, gas, or other mineral exploration or development programs. PLEDGING ASSETS. The Fund may not pledge, mortgage, or hypothecate more than 15% of its net assets. REAL ESTATE. The Fund may not invest directly in real estate, although it may invest in securities of companies that deal in real estate and bonds secured by real estate. RELATED PARTY TRANSACTIONS. The Fund may not have dealings on behalf of the Fund with officers and trustees, except for the purchase or sale of securities on an agency or commission basis. The Fund may not make loans to any officers, trustees, or employees of the Fund. SENIOR SECURITIES. The Fund may not issue senior securities, except in compliance with the 1940 Act. UNDERWRITING. The Fund may not act as an underwriter of another issuer's securities, except to the extent that the Fund may be deemed to be an underwriter within the meaning of the 1933 Act, in connection with the purchase and sale of portfolio securities. VANGUARD MANAGED PAYOUT FUNDS Each Fund is subject to the following fundamental investment limitations, which cannot be changed in any material way without the approval of the holders of a majority of the Fund's shares. For these purposes, a "majority" of shares means shares representing the lesser of: (1) 67% or more of the Fund's net assets voted, so long as shares representing more than 50% of the Fund's net assets are present or represented by proxy; or (2) more than 50% of the Fund's net assets. BORROWING. The Fund may borrow money or issue senior securities only as permitted under the 1940 Act. COMMODITIES. The Fund may not purchase or sell physical commodities unless acquired as a result of ownership of securities or other instruments. This limitation shall not prevent the Fund from purchasing, selling, or entering into securities or other instruments backed by or linked to the returns of physical commodities, including, but not limited to, futures contracts, options on futures contracts, swap agreements, foreign currencies, foreign currency forward contracts, foreign currency options, or other derivative instruments, subject to compliance with applicable provisions of the federal securities and commodities laws. DIVERSIFICATION. The Fund may not change its classification as a "management company" or its subclassification as an "open-end company" and as a "diversified company" as each such term is defined in the 1940 Act. ILLIQUID SECURITIES. The Fund may not acquire any security if, as a result, more than 15% of its net assets would be invested in securities that are illiquid. INDUSTRY CONCENTRATION. The Fund may not concentrate its investments in a particular industry or group of industries, within the meaning of the 1940 Act. LOANS. The Fund may not lend money to any person except by purchasing fixed income securities, by entering into repurchase aggreements, by lending its portfolio securities, or through Vanguard's interfund lending program. REAL ESTATE. The Fund may not purchase or sell real estate unless acquired as a result of ownership of securities or other instruments. This limitation shall not prevent the Fund from investing in securities or other instruments backed by real estate or securities issued by any company engaged in the real estate business. SENIOR SECURITIES. The Fund may not issue senior securities, except in compliance with the 1940 Act. UNDERWRITING. The Fund may not act as an underwriter of another issuer's securities, except to the extent that the Fund may be deemed to be an underwriter within the meaning of the 1933 Act, in connection with the purchase and sale of portfolio securities. B-27 ALL FUNDS Compliance with the investment limitations for each Fund set forth above are generally measured at the time the securities are purchased. Unless otherwise required by the 1940 Act, if a percentage restriction is adhered to at the time the investment is made, a later change in percentage resulting from a change in the market value of assets will not constitute a violation of such restriction. All investment limitations must comply with applicable regulatory requirements. For more details, see "Investment Policies." None of these limitations prevents the Fund from having an ownership interest in Vanguard. As a part owner of Vanguard, the Fund may own securities issued by Vanguard, make loans to Vanguard, and contribute to Vanguard's costs or other financial requirements. See "Management of the Fund" for more information. SHARE PRICE Each Fund's share price, called its net asset value, or NAV, is calculated each business day as of the close of regular trading on the New York Stock Exchange (the Exchange), generally 4 p.m., Eastern time. NAV per share is computed by dividing the net assets allocated to each share class by the number of Fund shares outstanding for that class. The Exchange typically observes the following holidays: New Year's Day, Martin Luther King Jr. Day, Presidents' Day (Washington's Birthday), Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. Although the Fund expects the same holidays to be observed in the future, the Exchange may modify its holiday schedule or hours of operation at any time. PURCHASE AND REDEMPTION OF SHARES PURCHASE OF SHARES The purchase price of shares of each Fund is the NAV per share next determined after the purchase request is received in good order, as defined in the Fund's prospectus. Each Fund reserves the right to deduct a purchase fee of 0.08% from an investor's cumulative purchases over $250 million. The Fund may incur substantial transaction costs in absorbing very large investments, and the fee (paid directly to the Fund) is intended to protect existing shareholders from being unfairly impacted by such costs. The Fund's advisor will consider several factors in determining whether to apply the fee, including the following: - - The transaction costs of buying securities, determined in part by the availability of securities at that time. - - The offsetting effect of any Fund redemptions occurring at that time. - - The Fund's then current rate of growth. REDEMPTION OF SHARES The redemption price of shares of the Fund is the NAV next determined after the redemption request is received in good order, as defined in the Fund's prospectus. Each Fund may suspend redemption privileges or postpone the date of payment for redeemed shares: (1) during any period that the Exchange is closed or trading on the Exchange is restricted as determined by the SEC; (2) during any period when an emergency exists, as defined by the SEC, as a result of which it is not reasonably practicable for the Fund to dispose of securities it owns or to fairly determine the value of its assets; and (3) for such other periods as the SEC may permit. Each Fund has filed a notice of election with the SEC to pay in cash all redemptions requested by any shareholder of record limited in amount during any 90-day period to the lesser of $250,000 or 1% of the net assets of the Fund at the beginning of such period. If Vanguard determines that it would be detrimental to the best interests of the remaining shareholders of the Fund to make payment wholly or partly in cash, the Fund may pay the redemption price in whole or in part by a distribution in kind of readily marketable securities held by the Fund in lieu of cash in conformity with applicable rules of the SEC. Investors may incur brokerage charges on the sale of such securities received in payment of redemptions. B-28 Each Fund does not charge a redemption fee. Shares redeemed may be worth more or less than what was paid for them, depending on the market value of the securities held by the Fund. RIGHT TO CHANGE POLICIES Vanguard reserves the right to (1) alter, add, or discontinue any conditions of purchase (including eligibility requirements), redemption, exchange, conversion, service, or privilege at any time without prior notice; (2) accept initial purchases by telephone; (3) freeze any account and/or suspend account services when Vanguard has received reasonable notice of a dispute regarding the assets in an account, including notice of a dispute between the registered or beneficial account owners or when we reasonably believe a fraudulent transaction may occur or has occurred; (4) temporarily freeze any account and/or suspend account services upon Vanguard's initial notification of the death of the shareholder until Vanguard receives required documentation in good order; (5) alter, impose, discontinue, or waive any redemption fee, low-balance account fee, account maintenance fee, or other fees charged to a group of shareholders; and (6) redeem an account, without the owner's permission to do so, in cases of threatening conduct or suspicious, fraudulent, or illegal activity. Changes may affect any or all investors. These actions will be taken when, at the sole discretion of Vanguard management, we reasonably believe they are deemed to be in the best interest of a fund. INVESTING WITH VANGUARD THROUGH OTHER FIRMS Each Fund has authorized certain agents to accept on its behalf purchase and redemption orders, and those agents are authorized to designate other intermediaries to accept purchase and redemption orders on the Fund's behalf (collectively, Authorized Agents). The Fund will be deemed to have received a purchase or redemption order when an Authorized Agent accepts the order in accordance with the Fund's instructions. In most instances, a customer order that is properly transmitted to an Authorized Agent will be priced at the Fund's NAV next determined after the order is received by the Authorized Agent. When intermediaries establish accounts in Vanguard funds for their clients, we cannot always monitor the trading activity of individual clients. However, we review trading activity at the omnibus level, and if we detect suspicious activity, we will seek to investigate and take appropriate action. If necessary, Vanguard may prohibit additional purchases of fund shares by an intermediary or by certain of the intermediary's clients. Intermediaries may also monitor their clients' trading activities in the Vanguard funds. For those Vanguard funds that charge purchase or redemption fees, intermediaries will be asked to assess purchase and redemption fees on shareholder and participant accounts and remit these fees to the funds. The application of purchase and redemption fees and frequent-trading policies may vary among intermediaries. There are no assurances that Vanguard will successfully identify all intermediaries or that intermediaries will properly assess purchase and redemption fees or administer frequent-trading policies. If you invest with Vanguard through an intermediary, please read that firm's materials carefully to learn of any other rules or fees that may apply. MANAGEMENT OF THE FUND VANGUARD SPECIAL SERVICE AGREEMENT (FOR THE VANGUARD MANAGED PAYOUT FUNDS). The Managed Payout Funds are part of the Vanguard group of investment companies, however, they operate under a Special Service Agreement. Under the Special Service Agreement, Vanguard provides each Managed Payout Fund with administrative and distribution services, including dividend disbursing, shareholder servicing, and transfer agency services. The Agreement provides that each Managed Payout Fund pays Vanguard for the cost of providing these services, and bears the cost of services provided by outside parties, such as auditors, custodians, and outside legal counsel, as well as taxes and other direct expenses. The Agreement further provides that each Managed Payout Fund's expenses will be offset, in whole or in part, by reimbursement from Vanguard for (1) contributions made by the Managed Payout Funds to the cost of operating the Vanguard funds in which the Funds invest, and (2) certain savings in administrative and marketing costs that Vanguard is expected to derive from the operation of the Managed Payout Funds. The Trust's board of trustees believes that the reimbursements to be made by Vanguard to the Target Retirement Funds should be sufficient to offset most or all of the expenses incurred by each Managed Payout Fund. Therefore, the Managed Payout Funds are expected to operate at a very low--or zero--expense ratio. Of course, there is no guarantee that this will always be the case. B-29 Although the Managed Payout Funds are expected to operate at a zero expense ratio after reimbursement, they will bear indirectly, as shareholders of the underlying Vanguard funds, the costs associated with operating those funds. SERVICE AGREEMENT FOR VANGUARD BALANCED INDEX FUND. The Balanced Index Fund is part of the Vanguard group of investment companies, which consists of more than 140 funds. Through their jointly-owned subsidiary, Vanguard, the funds obtain at cost virtually all of their corporate management, administrative, and distribution services. Vanguard also provides investment advisory services on an at-cost basis to several of the Vanguard funds. Vanguard employs a supporting staff of management and administrative personnel needed to provide the requisite services to the funds and also furnishes the funds with necessary office space, furnishings, and equipment. Each fund pays its share of Vanguard's total expenses, which are allocated among the funds under methods approved by the board of trustees of each fund. In addition, each fund bears its own direct expenses, such as legal, auditing, and custodian fees. The funds' officers are also officers and employees of Vanguard. Vanguard, Vanguard Marketing Corporation, the funds' advisors, and the funds have adopted Codes of Ethics designed to prevent employees who may have access to nonpublic information about the trading activities of the funds (access persons) from profiting from that information. The Codes permit access persons to invest in securities for their own accounts, including securities that may be held by a fund, but place substantive and procedural restrictions on the trading activities of access persons. For example, the Codes require that access persons receive advance approval for most securities trades to ensure that there is no conflict with the trading activities of the funds. The Codes also limit the ability of Vanguard employees to engage in short-term trading of Vanguard funds. Vanguard was established and operates under an Amended and Restated Funds' Service Agreement. The Amended and Restated Funds' Service Agreement provides as follows: (1) each Vanguard fund may be called upon to invest up to 0.40% of its current net assets in Vanguard, and (2) there is no other limitation on the dollar amount that each Vanguard fund may contribute to Vanguard's capitalization. The amounts that each fund has invested are adjusted from time to time in order to maintain the proportionate relationship between each fund's relative net assets and its contribution to Vanguard's capital. As of December 31, 2006, the Fund contributed $899,000 to Vanguard, which represented 0.01% of the Fund's net assets and was 0.90% of Vanguard's capitalization. MANAGEMENT. Corporate management and administrative services include: (1) executive staff; (2) accounting and financial; (3) legal and regulatory; (4) shareholder account maintenance; (5) monitoring and control of custodian relationships; (6) shareholder reporting; and (7) review and evaluation of advisory and other services provided to the funds by third parties. DISTRIBUTION. Vanguard Marketing Corporation (VMC), 400 Devon Park Drive A39, Wayne, PA 19087, a wholly-owned subsidiary of Vanguard, is the principal underwriter for the funds and in that capacity performs and finances marketing, promotional, and distribution activities (collectively, marketing and distribution activities) that are primarily intended to result in the sale of the funds' shares. VMC performs marketing and distribution activities at cost in accordance with the terms and conditions of a 1981 SEC exemptive order that permits the Vanguard funds to internalize and jointly finance the marketing, promotion, and distribution of their shares. Under the terms of the SEC order, the funds' trustees review and approve the marketing and distribution expenses incurred on their behalf, including the nature and cost of the activities and the desirability of each fund's continued participation in the joint arrangement. To ensure that each fund's participation in the joint arrangement falls within a reasonable range of fairness, each fund contributes to VMC's marketing and distribution expenses in accordance with an SEC-approved formula. Under that formula, one half of the marketing and distribution expenses are allocated among the funds based upon their relative net assets. The remaining half of those expenses is allocated among the funds based upon each fund's sales for the preceding 24 months relative to the total sales of the funds as a group; provided, however, that no fund's aggregate quarterly rate of contribution for marketing and distribution expenses shall exceed 125% of the average marketing and distribution expense rate for Vanguard, and that no fund shall incur annual marketing and distribution expenses in excess of 0.20 of 1% of its average month-end net assets. As of December 31, 2006, none of the Vanguard funds' allocated share of VMC's marketing and distribution expenses was greater than 0.03% of the fund's average month-end net assets. Each fund's contribution to these marketing and distribution expenses helps to maintain and enhance the attractiveness and viability of the Vanguard complex as a whole, which benefits all of the funds and their shareholders. VMC's principal marketing and distribution expenses are for advertising, promotional materials, and marketing personnel. Other marketing and distribution B-30 activities that VMC undertakes on behalf of the funds may include, but are not limited to: - - Conducting or publishing Vanguard-generated research and analysis concerning the funds, other investments, the financial markets, or the economy; - - Providing views, opinions, advice, or commentary concerning the funds, other investments, the financial markets, or the economy; - - Providing analytical, statistical, performance, or other information concerning the funds, other investments, the financial markets, or the economy; - - Providing administrative services in connection with investments in the funds or other investments, including, but not limited to, shareholder services, recordkeeping services, and educational services; - - Providing products or services that assist investors or financial service providers (as defined below) in the investment decision-making process; - - Providing promotional discounts, commission-free trading, fee waivers, and other benefits to clients of Vanguard Brokerage Services/(R)/ who maintain qualifying investments in the funds; and - - Sponsoring, jointly sponsoring, financially supporting, or participating in conferences, programs, seminars, presentations, meetings, or other events involving fund shareholders, financial service providers, or others concerning the funds, other investments, the financial markets, or the economy, such as industry conferences, prospecting trips, due diligence visits, training or education meetings, and sales presentations. VMC performs most marketing and distribution activities itself. Some activities may be conducted by third parties pursuant to shared marketing arrangements under which VMC agrees to share the costs and performance of marketing and distribution activities in concert with a financial service provider. Financial service providers include, but are not limited to, investment advisors, broker-dealers, financial planners, financial consultants, banks, and insurance companies. Under these cost- and performance-sharing arrangements, VMC may pay or reimburse a financial service provider (or a third party it retains) for marketing and distribution activities that VMC would otherwise perform. VMC's cost- and performance-sharing arrangements may be established in connection with Vanguard investment products or services offered or provided to or through the financial service providers. VMC's arrangements for shared marketing and distribution activities may vary among financial service providers, and its payments or reimbursements to financial service providers in connection with shared marketing and distribution activities may be significant. VMC does not participate in the offshore arrangement Vanguard has established for qualifying Vanguard funds to be distributed in certain foreign countries on a private-placement basis to government-sponsored and other institutional investors through a third-party "asesor de inversiones" (investment advisor), which includes incentive-based remuneration. In connection with its marketing and distribution activities, VMC may give financial service providers (or their representatives): (1) promotional items of nominal value that display Vanguard's logo, such as golf balls, shirts, towels, pens, and mouse pads; (2) gifts that do not exceed $100 per person annually and are not preconditioned on achievement of a sales target; (3) an occasional meal, a ticket to a sporting event or the theater, or comparable entertainment which is neither so frequent nor so extensive as to raise any question of propriety and is not preconditioned on achievement of a sales target; and (4) reasonable travel and lodging accommodations to facilitate participation in marketing and distribution activities. VMC, as a matter of policy, does not pay asset-based fees, sales-based fees, or account-based fees to financial service providers in connection with its marketing and distribution activities for the Vanguard funds. VMC policy also prohibits marketing and distribution activities that are intended, designed, or likely to compromise suitability determinations by, or the fulfillment of any fiduciary duties or other obligations that apply to, financial service providers. Nonetheless, VMC's marketing and distribution activities are primarily intended to result in the sale of the funds' shares, and as such its activities, including shared marketing and distribution activities, may influence participating financial service providers (or their representatives) to recommend, promote, include, or invest in a Vanguard fund or share class. In addition, Vanguard or any of its subsidiaries may retain a financial service provider to provide consulting or other services, and that financial service provider also may provide services to investors. Investors should consider the possibility that any of these activities or relationships may influence a financial service provider's (or its representatives') decision to recommend, promote, include, or invest in a Vanguard fund or share class. Each financial service provider should consider its suitability determinations, fiduciary duties, and other legal obligations (or those of its representatives) in connection with any decision to consider, recommend, promote, include, or invest in a Vanguard fund or share class. The following table describes the expenses of Vanguard and VMC that are shared by the funds on an at-cost basis under the terms of two SEC exemptive orders. Amounts captioned "Management and Administrative Expenses" include a fund's allocated share of expenses associated with the management, administrative, and B-31 transfer agency services Vanguard provides to the funds. Amounts captioned "Marketing and Distribution Expenses" include a fund's allocated share of expenses associated with the marketing and distribution activities that VMC conducts on behalf of the Vanguard funds. As is the case with all mutual funds, transaction costs incurred by the Fund for buying and selling securities are not reflected in the table. Annual Shared Fund Operating Expenses are based on expenses incurred in the fiscal years ended December 31, 2004, 2005, and 2006, and are presented as a percentage of the Fund's average month-end net assets.
ANNUAL SHARED FUND OPERATING EXPENSES (SHARED EXPENSES DEDUCTED FROM FUND ASSETS) ------------------------------------------- FISCAL YEAR ENDED FISCAL YEAR ENDED FISCAL YEAR ENDED FUND DECEMBER 31, 2004 DECEMBER 31, 2005 DECEMBER 31, 2006 - ---- VANGUARD BALANCED INDEX FUND Management and Administrative Expenses: 0.14% 0.13% 0.12% Marketing and Distribution Expenses: 0.02 0.02 0.02 Vanguard Managed Payout Funds did not commence operations until December 11, 2007.
OFFICERS AND TRUSTEES The Fund is governed by the board of trustees to the Trust and a single set of officers. The officers manage the day-to-day operations of the Fund under the direction of the Fund's board of trustees. The trustees set broad policies for the Fund; select investment advisors; monitor fund operations, performance, and costs; nominate and select new trustees; and elect fund officers. Each trustee serves the Fund until its termination; until the trustee's retirement, resignation, or death; or as otherwise specified in the Trust's organizational documents. Any trustee may be removed at a meeting of shareholders by a vote representing two-thirds of the total net asset value of all shares of the Fund. Each trustee also serves as a director of Vanguard. The following chart shows 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.
NUMBER OF VANGUARD PRINCIPAL OCCUPATION(S) AND OUTSIDE VANGUARD FUNDS POSITION(S) FUNDS' TRUSTEE/ DIRECTORSHIPS OVERSEEN BY NAME, YEAR OF BIRTH HELD WITH FUNDS OFFICER SINCE DURING THE PAST FIVE YEARS TRUSTEE/OFFICER - ------------------- --------------- -------------- -------------------------- ---------------- INTERESTED TRUSTEE John J. Brennan/1/ Chairman of the May 1987 Chairman of the Board, Chief 155 (1954) Board, Chief Executive Officer, and Director Executive Officer, (Trustee) of Vanguard, and of each of the and Trustee investment companies served by Vanguard. INDEPENDENT TRUSTEES Charles D. Ellis Trustee January 2001 Applecore Partners (pro bono ventures in 155 (1937) education); Senior Advisor to Greenwich Associates (international business strategy consulting); Successor Trustee of Yale University; Overseer of the Stern School of Business at New York University; Trustee of 1 Officers of the Fund are "interested persons" as defined in the 1940 Act.
B-32
NUMBER OF VANGUARD PRINCIPAL OCCUPATION(S) AND OUTSIDE VANGUARD FUNDS POSITION(S) FUNDS' TRUSTEE/ DIRECTORSHIPS OVERSEEN BY NAME, YEAR OF BIRTH HELD WITH FUNDS OFFICER SINCE DURING THE PAST FIVE YEARS TRUSTEE/OFFICER - ------------------- --------------- -------------- -------------------------- ---------------- Rajiv L. Gupta Trustee December 2001 Chairman, President and Chief Executive 155 (1945) Officer of Rohm and Haas Co. (chemicals); Board Member of American Chemistry Council; Director of Tyco International, Ltd. (diversified manufacturing and services) since 2005; Trustee of Drexel University and of the Chemical Heritage Foundation. Amy Gutmann Trustee June 2006 President of the University of Pennsylvania 155 (1949) since 2004; Professor in the School of Arts and Sciences, Annenberg School for Communi- cation, and Graduate School of Education of the University of Pennsylvania since 2004; Provost (2001 - 2004) and Laurance S. Rockefeller Professor of Politics and the University Center for Human Values (1990 - 2004), Princeton University; Director of Carnegie Corporation of New York since 2005, and of Schuylkill River Development Corporation and Greater Philadelphia Chamber of Commerce since 2004. JoAnn Heffernan Heisen Trustee July 1998 Corporate Vice President and Chief Global 155 (1950) Diversity Officer since 2006, Vice President and Chief Information Officer (1997 - 2005), and Member of the Executive Committee of Johnson & Johnson (pharmaceuticals/consumer products); Director of the University Medical Center at Princeton and Women's Research and Education Institute. Andre F. Perold Trustee December 2004 George Gund Professor of Finance and Banking, 155 (1952) Harvard Business School; Senior Associate Dean, Director of Faculty Recruiting, and Chair of Finance Faculty, Harvard Business School; Director and Chairman of UNX, Inc. (equities trading firm) since 2003; Chair of the Investment Committee of HighVista Strategies LLC (private investment firm) since 2005. Alfred M. Rankin, Jr. Trustee January 1993 Chairman, President, Chief Executive Officer, 155 (1941) and Director of NACCO Industries, Inc. (forklift trucks/ housewares/lignite); Director of Goodrich Corporation (industrial products/aircraft systems and services). J. Lawrence Wilson Trustee April 1985 Retired Chairman, Chief Executive Officer, 155 (1936) and President of Rohm and Haas Co. (chemicals); Director of Cummins Inc. (diesel engines), and AmerisourceBergen Corp.(pharmaceutical distribution); Trustee of Vanderbilt University and Culver Educational Foundation. - ------------------------------------------------------------------------------------------------------------------------------------ EXECUTIVE OFFICERS Heidi Stam/1/ Secretary July 2005 Managing Director of Vanguard since 2006; 155 (1956) General Counsel of Vanguard since 2005; Secretary of Vanguard, and of each of the investment companies served by Vanguard, since 2005; Principal of Vanguard (1997-2006). Thomas J. Higgins/1/ Treasurer July 1998 Principal of Vanguard; Treasurer of each of 155 (1957) the investment companies served by Vanguard. 1 Officers of the Funds are "interested persons" as defined in the 1940 Act.
B-33 Mr. Ellis is a Senior Advisor to Greenwich Associates, a firm that consults on business strategy to professional financial services organizations in markets around the world. A large number of financial service providers, including Vanguard, subscribe to programs of research-based consulting. During 2005 and 2006, Vanguard paid Greenwich subscription fees amounting to less than $400,000. Vanguard's subscription rates are similar to those of other subscribers. Board Committees: the Trust's board has the following committees: - - Audit Committee: This committee oversees the accounting and financial reporting policies, the systems of internal controls, and the independent audits of each fund and Vanguard. All independent trustees serve as members of the committee. The committee held two meetings during the Fund's last fiscal year. - - Compensation Committee: This committee oversees the compensation programs established by each fund and Vanguard for the benefit of their employees, officers, and trustees/directors. All independent trustees serve as members of the committee. The committee held three meetings during the Fund's last fiscal year. - - Nominating Committee: This committee nominates candidates for election to Vanguard's board of directors and the board of trustees of each fund (collectively, the Vanguard boards). The committee also has the authority to recommend the removal of any director or trustee from the Vanguard boards. All independent trustees serve as members of the committee. The committee held five meetings during the Fund's last fiscal year. The Nominating Committee will consider shareholder recommendations for trustee nominees. Shareholders may send recommendations to Mr. Rankin, Chairman of the Committee. TRUSTEE COMPENSATION The same individuals serve as trustees of all Vanguard funds and each fund pays a proportionate share of the trustees' compensation. The funds also employ their officers on a shared basis; however, officers are compensated by Vanguard, not the funds. INDEPENDENT TRUSTEES. The funds compensate their independent trustees (i.e., the ones who are not also officers of the funds) in three ways: - - The independent trustees receive an annual fee for their service to the funds, which is subject to reduction based on absences from scheduled board meetings. - - The independent trustees are reimbursed for the travel and other expenses that they incur in attending board meetings. - - Upon retirement (after attaining age 65 and completing five years of service), the independent trustees who began their service prior to January 1, 2001, receive a retirement benefit under a separate account arrangement. As of January 1, 2001, the opening balance of each eligible trustee's separate account was generally equal to the net present value of the benefits he or she had accrued under the trustees' former retirement plan. Each eligible trustee's separate account will be credited annually with interest at a rate of 7.5% until the trustee receives his or her final distribution. Those independent trustees who began their service on or after January 1, 2001, are not eligible to participate in the plan. "INTERESTED" TRUSTEE. Mr. Brennan serves as a trustee, but is not paid in this capacity. He is, however, paid in his role as an officer of Vanguard. COMPENSATION TABLE. The following table provides compensation details for each of the trustees. We list the amounts paid as compensation and accrued as retirement benefits by the Fund for each trustee. In addition, the table shows the total amount of benefits that we expect each trustee to receive from all Vanguard funds upon retirement, and the total amount of compensation paid to each trustee by all Vanguard funds. B-34 VANGUARD VALLEY FORGE FUNDS TRUSTEES' COMPENSATION TABLE
PENSION OR ACCRUED ANNUAL TOTAL COMPENSATION AGGREGATE RETIREMENT BENEFITS RETIREMENT FROM ALL COMPENSATION ACCRUED AS PART OF BENEFIT AT VANGUARD FUNDS TRUSTEE FROM THIS FUND/1/ THIS FUND'S EXPENSES /1/ JANUARY 1,2006 PAID TO TRUSTEES/3/ - ------- John J. Brennan . . . -- -- -- -- Charles D. Ellis $1,294 -- -- $140,000 Rajiv L. Gupta 1,257 -- -- 136,000 Amy Gutmann/4/ 666 -- -- 72,000 JoAnn Heffernan Heisen 1,294 $24 $2,365 140,000 Andre F. Perold 1,294 -- -- 140,000 Alfred M. Rankin, Jr. 1,407 46 4,634 152,250 J. Lawrence Wilson. 1,339 67 6,735 144,750
1 The amounts shown in this column are based on the Vanguard Balanced Index Fund's fiscal year ended December 31, 2006. The Vanguard Managed Payout Funds did not commence operations until December 11, 2007. 2 Each trustee is eligible to receive retirement benefits only after completing at least 5 years (60 consecutive months) of service as a trustee for the Vanguard funds. The annual retirement benefit will be paid in monthly installments, beginning with the month following the trustee's retirement from service, and will cease after 10 years of payments (120 monthly installments). Trustees who began their service on or after January 1, 2001, are not eligible to participate in the retirement benefit plan. 3 The amounts reported in this column reflect the total compensation paid to each trustee for his or her service as trustee of 145 Vanguard funds for the 2006 calendar year. 4 Dr. Gutmann became a member of the Fund's board effective June 2006. OWNERSHIP OF FUND SHARES All trustees allocate their investments among the various Vanguard funds based on their own investment needs. The following table shows each trustee's ownership of shares of the Fund and of all Vanguard funds served by the trustee as of December 31, 2006.
AGGREGATE DOLLAR DOLLAR RANGE OF FUND RANGE OF VANGUARD FUND FUND SHARES SHARES OWNED BY TRUSTEE - ---- TRUSTEE OWNED BY TRUSTEE Vanguard Balanced Index Fund John J. Brennan $50,001-$100,000 Over $100,000 Charles D. Ellis -- Over $100,000 Rajiv L. Gupta -- Over $100,000 Amy Gutmann -- Over $100,000 JoAnn Heffernan Heisen -- Over $100,000 Andre F. Perold -- Over $100,000 Alfred M. Rankin, Jr. -- Over $100,000 J. Lawrence Wilson -- Over $100,000 Vanguard Managed Payout Funds did not commence operations until December 11, 2007.
As of November 30, 2007, the trustees and executive officers of the Balanced Index Fund owned, in the aggregate, less than 1% of each class of each fund's outstanding shares. As of November 30, 2007, those listed below owned of record 5% or more of each class' outstanding shares: Vanguard Balanced Index Fund--[INSERT TABLE] B-35 PORTFOLIO HOLDINGS DISCLOSURE POLICIES AND PROCEDURES INTRODUCTION Vanguard and the Boards of Trustees of the Vanguard funds (Boards) have adopted Portfolio Holdings Disclosure Policies and Procedures (Policies and Procedures) to govern the disclosure of the portfolio holdings of each Vanguard fund. Vanguard and the Boards considered each of the circumstances under which Vanguard fund portfolio holdings may be disclosed to different categories of persons under the Policies and Procedures. Vanguard and the Boards also considered actual and potential material conflicts that could arise in such circumstances between the interests of Vanguard fund shareholders, on the one hand, and those of the fund's investment advisor, distributor, or any affiliated person of the fund, its investment advisor, or its distributor, on the other. After giving due consideration to such matters and after the exercise of their fiduciary duties and reasonable business judgment, Vanguard and the Boards determined that the Vanguard funds have a legitimate business purpose for disclosing portfolio holdings to the persons described in each of the circumstances set forth in the Policies and Procedures and that the Policies and Procedures are reasonably designed to ensure that disclosure of portfolio holdings and information about portfolio holdings is in the best interests of fund shareholders and appropriately addresses the potential for material conflicts of interest. The Boards exercise continuing oversight of the disclosure of Vanguard fund portfolio holdings by (1) overseeing the implementation and enforcement of the Policies and Procedures, the Code of Ethics, and the Policies and Procedures Designed to Prevent the Misuse of Inside Information (collectively, the portfolio holdings governing policies) by the Chief Compliance Officer of Vanguard and the Vanguard funds; (2) considering reports and recommendations by the Chief Compliance Officer concerning any material compliance matters (as defined in Rule 38a-1 under the 1940 Act and Rule 206(4)-7 under the Investment Advisers Act of 1940) that may arise in connection with any portfolio holdings governing policies; and (3) considering whether to approve or ratify any amendment to any portfolio holdings governing policies. Vanguard and the Boards reserve the right to amend the Policies and Procedures at any time and from time to time without prior notice in their sole discretion. For purposes of the Policies and Procedures, the term "portfolio holdings" means the equity and debt securities (e.g., stocks and bonds) held by a Vanguard fund and does not mean the cash investments, derivatives, and other investment positions (collectively, other investment positions) held by the fund. ONLINE DISCLOSURE OF TEN LARGEST STOCK HOLDINGS Each of the Vanguard equity funds and Vanguard balanced funds generally will seek to disclose the fund's ten largest stock portfolio holdings and the percentages that each of these ten largest stock portfolio holdings represent of the fund's total assets as of the most recent calendar-quarter-end (quarter-end ten largest stock holdings) online at www.vanguard.com in the "Holdings" section of the fund's Profile page, 15 calendar days after the end of the calendar quarter. In addition, those funds generally will seek to disclose the fund's ten largest stock portfolio holdings as of the most recent month-end (month-end ten largest stock holdings, and together with quarter-end ten largest stock holdings, ten largest stock holdings) online at www.vanguard.com in the "Holdings" section of the fund's Profile page, 10 business days after the end of the month. Online disclosure of the ten largest stock holdings is made to all categories of persons, including individual investors, institutional investors, intermediaries, third-party service providers, rating and ranking organizations, affiliated persons of a Vanguard fund, and all other persons. ONLINE DISCLOSURE OF COMPLETE PORTFOLIO HOLDINGS Each of the Vanguard funds, excluding Vanguard money market funds, generally will seek to disclose the fund's complete portfolio holdings (complete portfolio holdings) as of the most recent calendar-quarter-end online at www.vanguard.com in the "Holdings" section of the fund's Profile page, 30 calendar days after the end of the calendar quarter. Online disclosure of complete portfolio holdings is made to all categories of persons, including individual investors, institutional investors, intermediaries, third-party service providers, rating and ranking organizations, affiliated persons of a Vanguard fund, and all other persons. Vanguard's Portfolio Review Department will review complete portfolio holdings before online disclosure is made as described above and, after consultation with a Vanguard fund's investment advisor, may withhold any portion of the fund's complete portfolio holdings from online disclosure as described above when deemed to be in the best interests of the fund. B-36 DISCLOSURE OF COMPLETE PORTFOLIO HOLDINGS TO SERVICE PROVIDERS SUBJECT TO CONFIDENTIALITY AND TRADING RESTRICTIONS Vanguard, for legitimate business purposes, may disclose Vanguard fund complete portfolio holdings at times it deems necessary and appropriate to rating and ranking organizations, financial printers, proxy voting service providers, pricing information vendors, third-parties that deliver analytical, statistical, or consulting services, and other third parties that provide services (collectively, Service Providers) to Vanguard, Vanguard subsidiaries, and/or the Vanguard funds. Disclosure of complete portfolio holdings to a Service Provider is conditioned on the Service Provider being subject to a written agreement imposing a duty of confidentiality, including a duty not to trade on the basis of any material nonpublic information. The frequency with which complete portfolio holdings may be disclosed to a Service Provider, and the length of the lag, if any, between the date of the information and the date on which the information is disclosed to the Service Provider, is determined based on the facts and circumstances, including, without limitation, the nature of the portfolio holdings information to be disclosed, the risk of harm to the funds and their shareholders, and the legitimate business purposes served by such disclosure. The frequency of disclosure to a Service Provider varies and may be as frequent as daily, with no lag. Disclosure of Vanguard fund complete portfolio holdings by Vanguard to a Service Provider must be authorized by a Vanguard fund officer or a Principal in Vanguard's Portfolio Review or Legal Department. Any disclosure of Vanguard fund complete portfolio holdings to a Service Provider as previously described may also include a list of the other investment positions that make up the fund, such as cash investments and derivatives. As of December 31, 2006, Vanguard fund complete portfolio holdings are disclosed to the following Service Providers as part of ongoing arrangements that serve legitimate business purposes: Abel/Noser Corporation, Advisor Software, Inc., Alcom Printing Group Inc., Apple Press, L.C., Automatic Data Processing, Inc., Brown Brothers Harriman & Co., FactSet Research Systems Inc., Intelligencer Printing Company, Investment Technology Group, Inc., McMunn Associates Inc., Pitney Bowes Management Services, Reuters America Inc., R.R. Donnelley, Inc., State Street Investment Manager Solutions, Triune Color Corporation, and Tursack Printing Inc. DISCLOSURE OF COMPLETE PORTFOLIO HOLDINGS TO VANGUARD AFFILIATES AND CERTAIN FIDUCIARIES SUBJECT TO CONFIDENTIALITY AND TRADING RESTRICTIONS Vanguard fund complete portfolio holdings may be disclosed between and among the following persons (collectively, Affiliates and Fiduciaries) for legitimate business purposes within the scope of their official duties and responsibilities, subject to such persons' continuing legal duty of confidentiality and legal duty not to trade on the basis of any material nonpublic information, as such duties are imposed under the Code of Ethics, the Policies and Procedures Designed to Prevent the Misuse of Inside Information, by agreement, or under applicable laws, rules, and regulations: (1) persons who are subject to the Code of Ethics or the Policies and Procedures Designed to Prevent the Misuse of Inside Information; (2) an investment advisor, distributor, administrator, transfer agent, or custodian to a Vanguard fund; (3) an accounting firm, an auditing firm or outside legal counsel retained by Vanguard, a Vanguard subsidiary, or a Vanguard fund; (4) an investment advisor to whom complete portfolio holdings are disclosed for due diligence purposes when the advisor is in merger or acquisition talks with a Vanguard fund's current advisor; and (5) a newly hired investment advisor or sub-advisor to whom complete portfolio holdings are disclosed prior to the time it commences its duties. The frequency with which complete portfolio holdings may be disclosed between and among Affiliates and Fiduciaries, and the length of the lag, if any, between the date of the information and the date on which the information is disclosed between and among the Affiliates and Fiduciaries, is determined by such Affiliates and Fiduciaries based on the facts and circumstances, including, without limitation, the nature of the portfolio holdings information to be disclosed, the risk of harm to the funds and their shareholders, and the legitimate business purposes served by such disclosure. The frequency of disclosure between and among Affiliates and Fiduciaries varies and may be as frequent as daily, with no lag. Any disclosure of Vanguard fund complete portfolio holdings to any Affiliates and Fiduciaries as previously described may also include a list of the other investment positions that make up the fund, such as cash investments and derivatives. Disclosure of Vanguard fund complete portfolio holdings or other investment positions by Vanguard, Vanguard Marketing Corporation, or a Vanguard fund to Affiliates and Fiduciaries must be authorized by a Vanguard fund officer or a Principal of Vanguard. As of December 31, 2006, Vanguard fund complete portfolio holdings are disclosed to the following Affiliates and Fiduciaries as part of ongoing arrangements that serve legitimate business purposes: Vanguard and each investment advisor, custodian, and independent registered public accounting firm identified in this Statement of Additional Information. B-37 DISCLOSURE OF PORTFOLIO HOLDINGS TO BROKER-DEALERS IN THE NORMAL COURSE OF MANAGING A FUND'S ASSETS An investment advisor, administrator, or custodian for a Vanguard fund may, for legitimate business purposes within the scope of its official duties and responsibilities, disclose portfolio holdings (whether partial portfolio holdings or complete portfolio holdings) and other investment positions that make up the fund to one or more broker-dealers during the course of, or in connection with, normal day-to-day securities and derivatives transactions with or through such broker-dealers subject to the broker-dealer's legal obligation not to use or disclose material nonpublic information concerning the fund's portfolio holdings, other investment positions, securities transactions, or derivatives transactions without the consent of the fund or its agents. The Vanguard funds have not given their consent to any such use or disclosure and no person or agent of Vanguard is authorized to give such consent except as approved in writing by the Boards of the Vanguard funds. Disclosure of portfolio holdings or other investment positions by Vanguard to broker-dealers must be authorized by a Vanguard fund officer or a Principal of Vanguard. DISCLOSURE OF NON-MATERIAL INFORMATION The Policies and Procedures permit Vanguard fund officers, Vanguard fund portfolio managers, and other Vanguard representatives (collectively, Approved Vanguard Representatives) to disclose any views, opinions, judgments, advice, or commentary, or any analytical, statistical, performance, or other information, in connection with or relating to a Vanguard fund or its portfolio holdings and/or other investment positions (collectively, commentary and analysis) or any changes in the portfolio holdings of a Vanguard fund that occurred after the most recent calendar-quarter end (recent portfolio changes) to any person if (1) such disclosure serves a legitimate business purpose, (2) such disclosure does not effectively result in the disclosure of the complete portfolio holdings of any Vanguard fund (which can be disclosed only in accordance with the Policies and Procedures), and (3) such information does not constitute material nonpublic information. Disclosure of commentary and analysis or recent portfolio changes by Vanguard, Vanguard Marketing Corporation, or a Vanguard fund must be authorized by a Vanguard fund officer or a Principal of Vanguard. An Approved Vanguard Representative must make a good faith determination whether the information constitutes material nonpublic information, which involves an assessment of the particular facts and circumstances. Vanguard believes that in most cases recent portfolio changes that involve a few or even several securities in a diversified portfolio or commentary and analysis would be immaterial and would not convey any advantage to a recipient in making an investment decision concerning a Vanguard fund. Nonexclusive examples of commentary and analysis about a Vanguard fund include (1) the allocation of the fund's portfolio holdings and other investment positions among various asset classes, sectors, industries, and countries; (2) the characteristics of the stock and bond components of the fund's portfolio holdings and other investment positions; (3) the attribution of fund returns by asset class, sector, industry, and country; and (4) the volatility characteristics of the fund. An Approved Vanguard Representative may in its sole discretion determine whether to deny any request for information made by any person, and may do so for any reason or for no reason. "Approved Vanguard Representatives" include, for purposes of the Policies and Procedures, persons employed by or associated with Vanguard or a subsidiary of Vanguard who have been authorized by Vanguard's Portfolio Review Department to disclose recent portfolio changes and/or commentary and analysis in accordance with the Policies and Procedures. As of December 31, 2006, Vanguard non-material portfolio holdings information is disclosed to KPMG, LLP, and R.V. Kuhns & Associates. DISCLOSURE OF PORTFOLIO HOLDINGS RELATED INFORMATION TO THE ISSUER OF A SECURITY FOR LEGITIMATE BUSINESS PURPOSES Vanguard, in its sole discretion, may disclose portfolio holdings information concerning a security held by one or more Vanguard funds to the issuer of such security if the issuer presents, to the satisfaction of Fund Financial Services, convincing evidence that the issuer has a legitimate business purpose for such information. Disclosure of this information to an issuer is conditioned on the issuer being subject to a written agreement imposing a duty of confidentiality, including a duty not to trade on the basis of any material nonpublic information. The frequency with which portfolio holdings information concerning a security may be disclosed to the issuer of such security, and the length of the lag, if any, between the date of the information and the date on which the information is disclosed to the issuer, is determined based on the facts and circumstances, including, without limitation, the nature of the portfolio holdings information to be disclosed, the risk of harm to the funds and their B-38 shareholders, and the legitimate business purposes served by such disclosure. The frequency of disclosure to an issuer cannot be determined in advance of a specific request and will vary based upon the particular facts and circumstances and the legitimate business purposes, but in unusual situations could be as frequent as daily, with no lag. Disclosure of portfolio holdings information concerning a security held by one or more Vanguard funds to the issuer of such security must be authorized by a Vanguard fund officer or a Principal in Vanguard's Portfolio Review or Legal Department. DISCLOSURE OF PORTFOLIO HOLDINGS AS REQUIRED BY APPLICABLE LAW Vanguard fund portfolio holdings (whether partial portfolio holdings or complete portfolio holdings) and other investment positions that make up a fund shall be disclosed to any person as required by applicable laws, rules, and regulations. Examples of such required disclosure include, but are not limited to, disclosure of Vanguard fund portfolio holdings (1) in a filing or submission with the SEC or another regulatory body, (2) in connection with seeking recovery on defaulted bonds in a federal bankruptcy case, (3) in connection with a lawsuit, or (4) as required by court order. Disclosure of portfolio holdings or other investment positions by Vanguard, Vanguard Marketing Corporation, or a Vanguard fund as required by applicable laws, rules, and regulations must be authorized by a Vanguard fund officer or a Principal of Vanguard. PROHIBITIONS ON DISCLOSURE OF PORTFOLIO HOLDINGS No person is authorized to disclose Vanguard fund portfolio holdings or other investment positions (whether online at www.vanguard.com, in writing, by fax, by e-mail, orally, or by other means) except in accordance with the Policies and Procedures. In addition, no person is authorized to make disclosure pursuant to the Policies and Procedures if such disclosure is otherwise unlawful under the antifraud provisions of the federal securities laws (as defined in Rule 38a-1 under the 1940 Act). Furthermore, Vanguard's management, in its sole discretion, may determine not to disclose portfolio holdings or other investment positions that make up a Vanguard fund to any person who would otherwise be eligible to receive such information under the Policies and Procedures, or may determine to make such disclosures publicly as provided by the Policies and Procedures. PROHIBITIONS ON RECEIPT OF COMPENSATION OR OTHER CONSIDERATION The Policies and Procedures prohibit a Vanguard fund, its investment advisor, and any other person to pay or receive any compensation or other consideration of any type for the purpose of obtaining disclosure of Vanguard fund portfolio holdings or other investment positions. "Consideration" includes any agreement to maintain assets in the fund or in other investment companies or accounts managed by the investment advisor or by any affiliated person of the investment advisor. INVESTMENT ADVISORY SERVICES Each Fund receives all investment advisory services from Vanguard, through its Quantitative Equity and Fixed Income Groups. These services are provided on an at-cost basis from an experienced advisory staff employed directly by Vanguard. The compensation and other expenses of the advisory staff are allocated among the funds utilizing these services. During the fiscal years ended December 31, 2004, 2005, and 2006, the Balanced Index Fund incurred advisory expenses of approximately $125,000, $169,000, and $124,000, respectively. Vanguard Managed Payout Funds did not commence operations until December 11, 2007. The investment management staff is supervised by the senior officers of the Fund. The senior officers are directly responsible to the board of trustees of the Fund. OTHER ACCOUNTS MANAGED Gregory Davis managed the bond portion of the Balanced Index Fund; the Fund, as of October 31, 2006, held assets of $10.4 billion. As of October 31, 2006, Mr. Davis managed one other registered investment company with total assets of $6.3 billion and five other pooled investment vehicles with total assets of $5.6 billion. Michael Perre managed the stock portion of the Balanced Index Fund; the Fund, as of October 31, 2006, held assets of $10.4 billion. As of October 31, 2006, Mr. Perre managed all or a portion of eight other registered investment companies with total assets of $16.2 billion and three other pooled investment vehicles with total assets of $30.6 billion. Michael Buek manages the Vanguard Managed Payout Funds. As of October 31, 2007, Mr. Buek managed all or a portion of seven other registered investment companies with total assets of $174.9 billion and six other pooled investment vehicles with total assets of $4.7 billion B-39 MATERIAL CONFLICTS OF INTEREST At Vanguard, individual portfolio managers may manage multiple accounts for multiple clients. In addition to mutual funds, these other accounts may include separate accounts, collective trusts, or offshore funds. Managing multiple accounts may give rise to potential conflicts of interest including for example, conflicts among investment strategies and conflicts in the allocation of investment opportunities. Vanguard manages potential conflicts between funds or with other types of accounts through allocation policies and procedures, internal review processes and oversight by directors and independent third parties. Vanguard has developed trade allocation procedures and controls to ensure that no one client, regardless of type, is intentionally favored at the expense of another. Allocation policies are designed to address potential conflicts in situations where two or more funds or accounts participate in investment decisions involving the same securities. DESCRIPTION OF COMPENSATION Each Fund's portfolio managers are Vanguard employees. This section describes the compensation of the Vanguard employees who manage Vanguard mutual funds. As of December 31, 2006, a Vanguard portfolio manager's compensation generally consists of base salary, bonus, and payments under Vanguard's long-term incentive compensation program. In addition, portfolio managers are eligible for the standard retirement benefits and health and welfare benefits available to all Vanguard employees. Also, certain portfolio managers may be eligible for additional retirement benefits under several supplemental retirement plans that Vanguard adopted in the 1980's to restore dollar-for-dollar the benefits of management employees that had been cut back solely as a result of tax law changes. These plans are structured to provide the same retirement benefits as the standard retirement benefits. In the case of portfolio managers responsible for managing multiple Vanguard funds or accounts, the method used to determine their compensation is the same for all funds and investment accounts. A portfolio manager's base salary is determined by the manager's experience and performance in the role, taking into account the ongoing compensation benchmark analyses performed by the Vanguard Human Resources Department. A portfolio manager's base salary is generally a fixed amount that may change as a result of an annual review, upon assumption of new duties, or when a market adjustment of the position occurs. A portfolio manager's bonus is determined by a number of factors. One factor is gross, pre-tax performance of the fund relative to expectations for how the fund should have performed, given the fund's investment objective, policies, strategies, and limitations, and the market environment during the measurement period. The performance factor is not based on the value of assets held in the fund's portfolio. For the Balanced Index Fund, the performance factor depends on how closely each portfolio manager tracks his component index of the Fund's overall benchmark composite index over a one-year period. Specifically, Mr. Davis's performance with respect to the bond portion of the Fund is compared to that of the Lehman Brothers Aggregate Bond Index, while Mr. Perre's performance with respect to the stock portion is compared to that of the MSCI US Broad Market Index. Additional factors include the portfolio manager's contributions to the investment management functions within the sub-asset class, contributions to the development of other investment professionals and supporting staff, and overall contributions to strategic planning and decisions for the investment group. The target bonus is expressed as a percentage of base salary. The actual bonus paid may be more or less than the target bonus, based on how well the manager satisfies the objectives stated above. The bonus is paid on an annual basis. Under the long-term incentive compensation program, all full-time employees receive a payment from Vanguard's long term incentive compensation plan based on their years of service, job level and, if applicable, management responsibilities. Each year, Vanguard's independent directors determine the amount of the long-term incentive compensation award for that year based on the investment performance of the Vanguard funds relative to competitors and Vanguard's operating efficiencies in providing services to the Vanguard funds. OWNERSHIP OF SECURITIES Vanguard employees, including portfolio managers, allocate their investments among the various Vanguard funds based on their own individual investment needs and goals. Vanguard employees as a group invest a sizeable portion of their personal assets in Vanguard funds. As of October 31, 2007, Vanguard employees collectively invested more than $2.2 billion in Vanguard funds. John J. Brennan, Chairman and Chief Executive Officer of Vanguard and the Vanguard funds, and George U. Sauter, Managing Director and Chief Investment Officer, invest substantially all of their personal B-40 financial assets in Vanguard funds. As of December 31, 2006, the portfolio managers did not own any shares of the Balanced Index Fund. Vanguard Managed Payout Funds did not commence operations until December 11, 2007. DURATION AND TERMINATION OF INVESTMENT ADVISORY ARRANGEMENTS The Fourth Amended and Restated Funds' Service Agreement, which governs the at-cost investment advisory services provided to the Funds, will continue in full force and effect until terminated or amended by mutual agreement of the Funds and Vanguard. PORTFOLIO TRANSACTIONS The advisor decides which securities to buy and sell on behalf of the Fund and then selects the brokers or dealers that will execute the trades on an agency basis or the dealers with whom the trades will be effected on a principal basis. For each trade, the advisor must select a broker-dealer that it believes will provide "best execution." Best execution does not necessarily mean paying the lowest spread or commission rate available. In seeking best execution, the SEC has said that an advisor should consider the full range of a broker-dealer's services. The factors considered by the advisor in seeking best execution include, but are not limited to, the broker-dealer's execution capability, clearance and settlement services, commission rate, trading expertise, willingness and ability to commit capital, ability to provide anonymity, financial responsibility, reputation and integrity, responsiveness, access to underwritten offerings and secondary markets, and access to company management, as well as the value of any research provided by the broker-dealer. In assessing which broker-dealer can provide best execution for a particular trade, the advisor also may consider the timing and size of the order and available liquidity and current market conditions. Subject to applicable legal requirements, the advisor may select a broker based partly on brokerage or research services provided to the advisor and its clients, including the Fund. The advisor may cause the Fund to pay a higher commission than other brokers would charge if the advisor determines in good faith that the amount of the commission is reasonable in relation to the value of services provided. An advisor also may receive brokerage or research services from broker-dealers that are provided at no charge in recognition of the volume of trades directed to the broker. To the extent research services or products may be a factor in selecting brokers, services and products may include written research reports analyzing performance or securities, discussions with research analysts, meetings with corporate executives to obtain oral reports on company performance, and market data. Some securities that are considered for investment by the Fund may also be appropriate for other Vanguard funds or for other clients served by the advisor. If such securities are compatible with the investment policies of the Fund and one or more of the advisor's other clients, and are considered for purchase or sale at or about the same time, then transactions in such securities will be aggregated by the advisor and the purchased securities or sale proceeds will be allocated among the participating Vanguard funds and the other participating clients of the advisor in a manner deemed equitable by the advisor. Although there may be no specified formula for allocating such transactions, the allocation methods used, and the results of such allocations, will be subject to periodic review by the Fund's board of trustees. B-41 As of December 31, 2006, the Balanced Index Fund held securities of its "regular brokers or dealers," as that term is defined in Rule 10b-1 of the 1940 Act, as follows:
REGULAR BROKER OR DEALER (OR PARENT) AGGREGATE HOLDINGS Banc of America Securities LLC $ 96,132,000 Barclays Capital Inc. 344,000 Bear, Stearns & Co. Inc. 14,947,000 Citigroup Global Markets Inc. 113,354,000 Credit Suisse Securities (USA) LLC 15,363,000 Goldman, Sachs & Co. 43,554,000 HSBC Securities (USA) Inc. 18,626,000 ITG, Inc. 658,000 J.P. Morgan Securities Inc. 72,197,000 Merrill Lynch, Pierce Fenner & Smith Inc. 35,631,000 Morgan Stanley 41,347,000 UBS Financial Services Inc. 2,005,000
The Fund's bond investments are generally purchased and sold through principal transactions, meaning that the Fund normally purchases bonds directly from the issuer or a primary market-maker acting as principal for the bonds, on a net basis. Explicit brokerage commissions are not paid on these transactions, although purchases of new issues from underwriters of bonds typically include a commission or concession paid by the issuer to the underwriter, and purchases from dealers serving as market-makers typically include a dealer's mark-up (i.e., a spread between the bid and the asked prices). When the Fund purchases a newly issued bond at a fixed price, the advisor may designate certain members of the underwriting syndicate to receive compensation associated with that transaction. Certain dealers have agreed to rebate a portion of such compensation directly to the Fund to offset the Fund's management expenses. As previously explained, the types of bonds that the Fund purchases do not normally involve the payment of explicit brokerage commissions. If any such brokerage commissions are paid, however, the advisor will evaluate their reasonableness by considering: (1) historical commission rates; (2) rates which other institutional investors are paying, based upon publicly available information; (3) rates quoted by brokers and dealers; (4) the size of a particular transaction, in terms of the number of shares, dollar amount, and number of clients involved; (5) the complexity of a particular transaction in terms of both execution and settlement; (6) the level and type of business done with a particular firm over a period of time; and (7) the extent to which the broker or dealer has capital at risk in the transaction. During the fiscal years ended December 31, 2004, 2005, and 2006, the Balanced Index Fund paid the following amounts in brokerage commissions: $194,000, $265,000, and $177,000, respectively. Vanguard Managed Payout Funds did not commence operations until December 11, 2007. PROXY VOTING GUIDELINES The Board of Trustees (the Board) of each Vanguard fund that invests in stocks has adopted proxy voting procedures and guidelines to govern proxy voting by the fund. The Board has delegated oversight of proxy voting to the Proxy Oversight Committee (the Committee), composed of senior officers of Vanguard, a majority of whom are also officers of each Vanguard fund, and subject to the operating procedures and guidelines described below. The Committee reports directly to the Board. Vanguard is subject to these guidelines to the extent the guidelines call for Vanguard to administer the voting process and implement the resulting voting decisions, and for these purposes have been approved by the Board of Directors of Vanguard. The overarching objective in voting is simple: to support proposals and director nominees that maximize the value of a fund's investments--and those of fund shareholders--over the long term. While the goal is simple, the proposals the funds receive are varied and frequently complex. As such, the guidelines adopted by the Board provide a rigorous framework for assessing each proposal. Under the guidelines, each proposal must be evaluated on its merits, based on the particular facts and circumstances as presented. B-42 For ease of reference, the procedures and guidelines often refer to all funds, however, our processes and practices seek to ensure that proxy voting decisions are suitable for individual funds. For most proxy proposals, particularly those involving corporate governance, the evaluation will result in the same position being taken across all of the funds and the funds voting as a block. In some cases, however, a fund may vote differently, depending upon the nature and objective of the fund, the composition of its portfolio and other factors. The guidelines do not permit the Board to delegate voting responsibility to a third party that does not serve as a fiduciary for the funds. Because many factors bear on each decision, the guidelines incorporate factors the Committee should consider in each voting decision. A fund may refrain from voting if that would be in the fund's and its shareholders' best interests. These circumstances may arise, for example, when the expected cost of voting exceeds the expected benefits of voting, or exercising the vote results in the imposition of trading or other restrictions. In evaluating proxy proposals, we consider information from many sources, including but not limited to the investment advisor for the fund, management or shareholders of a company presenting a proposal, and independent proxy research services. We will give substantial weight to the recommendations of the company's board, absent guidelines or other specific facts that would support a vote against management. In all cases, however, the ultimate decision rests with the members of the Proxy Oversight Committee, who are accountable to the fund's Board. While serving as a framework, the following guidelines cannot contemplate all possible proposals with which a fund may be presented. In the absence of a specific guideline for a particular proposal (e.g., in the case of a transactional issue or contested proxy), the Committee will evaluate the issue and cast the fund's vote in a manner that, in the Committee's view, will maximize the value of the fund's investment, subject to the individual circumstances of the fund. I. THE BOARD OF DIRECTORS A. ELECTION OF DIRECTORS Good governance starts with a majority-independent board, whose key committees are composed entirely of independent directors. As such, companies should attest to the independence of directors who serve on the Compensation, Nominating, and Audit committees. In any instance in which a director is not categorically independent, the basis for the independence determination should be clearly explained in the proxy statement. While the funds will generally support the board's nominees, the following factors will be taken into account in determining each fund's vote:
FACTORS FOR APPROVAL FACTORS AGAINST APPROVAL - -------------------- ------------------------ Nominated slate results in board comprised of a Nominated slate results in board comprised of a majority of non- majority of independent directors. independent directors. All members of Audit, Nominating, and Compensation Audit, Nominating, and/or Compensation committees include non- committees are independent of management. independent members. Incumbent board member failed to attend at least 75% of meetings in the previous year. Actions of committee(s) on which nominee serves are inconsistent with other guidelines (e.g., excessive option grants, substantial non-audit fees, lack of board independence).
B. CONTESTED DIRECTOR ELECTIONS In the case of contested board elections, we will evaluate the nominees' qualifications, the performance of the incumbent board, as well as the rationale behind the dissidents' campaign, to determine the outcome that we believe will maximize shareholder value. C. CLASSIFIED BOARDS The funds will generally support proposals to declassify existing boards (whether proposed by management or shareholders), and will block efforts by companies to adopt classified board structures, in which only part of the board is elected each year. B-43 II. APPROVAL OF INDEPENDENT AUDITORS The relationship between the company and its auditors should be limited primarily to the audit, although it may include certain closely related activities that do not, in the aggregate, raise any appearance of impaired independence. The funds will generally support management's recommendation for the ratification of the auditor, except in instances where audit and audit-related fees make up less than 50% of the total fees paid by the company to the audit firm. We will evaluate on a case-by-case basis instances in which the audit firm has a substantial non-audit relationship with the company (regardless of its size relative to the audit fee) to determine whether independence has been compromised. III. COMPENSATION ISSUES A. STOCK-BASED COMPENSATION PLANS Appropriately designed stock-based compensation plans, administered by an independent committee of the board and approved by shareholders, can be an effective way to align the interests of long-term shareholders and the interests of management, employees, and directors. Conversely, the funds oppose plans that substantially dilute their ownership interest in the company, provide participants with excessive awards, or have inherently objectionable structural features. An independent compensation committee should have significant latitude to deliver varied compensation to motivate the company's employees. However, we will evaluate compensation proposals in the context of several factors (a company's industry, market capitalization, competitors for talent, etc.) to determine whether a particular plan or proposal balances the perspectives of employees and the company's other shareholders. We will evaluate each proposal on a case-by-case basis, taking all material facts and circumstances into account. The following factors will be among those considered in evaluating these proposals.
FACTORS FOR APPROVAL FACTORS AGAINST APPROVAL - -------------------- ------------------------ Company requires senior executives to hold a minimum amount of company Total potential dilution (including all stock-based plans) stock (frequently expressed as a multiple of salary). shares outstanding. Company requires stock acquired through option exercise to be held for Annual option grants have exceeded 2% of shares a certain period of time. outstanding. Compensation program includes performance-vesting awards, indexed Plan permits repricing or replacement of options without options, or other performance-linked grants. shareholder approval. Concentration of option grants to senior executives is limited Plan provides for the issuance of reload options. (indicating that the plan is very broad-based). Stock-based compensation is clearly used as a substitute for cash in Plan contains automatic share replenishment (evergreen)fea- delivering market-competitive total pay. ture
B. BONUS PLANS Bonus plans, which must be periodically submitted for shareholder approval to qualify for deductibility under Section 162(m) of the IRC, should have clearly defined performance criteria and maximum awards expressed in dollars. Bonus plans with awards that are excessive, in both absolute terms and relative to a comparative group, generally will not be supported. C. EMPLOYEE STOCK PURCHASE PLANS The funds will generally support the use of employee stock purchase plans to increase company stock ownership by employees, provided that shares purchased under the plan are acquired for no less than 85% of their market value and that shares reserved under the plan make up less than 5% of the outstanding shares. D. EXECUTIVE SEVERANCE AGREEMENTS (GOLDEN PARACHUTES) While executives' incentives for continued employment should be more significant than severance benefits, there are instances--particularly in the event of a change in control--in which severance arrangements may be appropriate. Severance benefits triggered by a change in control that do not exceed three times an executive's salary and bonus may generally be approved by the compensation committee of the board without submission to shareholders. Any such arrangement under which the beneficiary receives more than three times salary and bonus--or where severance is guaranteed absent a change in control--should be submitted for shareholder approval. IV. CORPORATE STRUCTURE AND SHAREHOLDER RIGHTS The exercise of shareholder rights, in proportion to economic ownership, is a fundamental privilege of stock ownership that should not be unnecessarily limited. Such limits may be placed on shareholders' ability to act by corporate charter or by-law provisions, or by the adoption of certain takeover provisions. In general, the market for corporate control should be allowed to function without undue interference from these artificial barriers. The funds' positions on a number of the most commonly presented issues in this area are as follows: A. SHAREHOLDER RIGHTS PLANS (POISON PILLS) A company's adoption of a so-called poison pill effectively limits a potential acquirer's ability to buy a controlling interest without the approval of the target's board of directors. Such a plan, in conjunction with other takeover defenses, may serve to entrench incumbent management and directors. However, in other cases, a poison pill may force a suitor to negotiate with the board and result in the payment of a higher acquisition premium. In general, shareholders should be afforded the opportunity to approve shareholder rights plans within a year of their adoption. This provides the board with the ability to put a poison pill in place for legitimate defensive purposes, subject to subsequent approval by shareholders. In evaluating the approval of proposed shareholder rights plans, we will consider the following factors: B-44
FACTORS FOR APPROVAL FACTORS AGAINST APPROVAL - -------------------- ------------------------ Plan is relatively short-term (3-5 years). Plan is long term (>5 years). Plan requires shareholder approval Renewal of plan is automatic or does not require shareholder approval. for renewal. Plan incorporates review by a committee Ownership trigger is less than 15%. of independent directors at least every three years (so-called TIDE provisions). Plan includes permitted bid/qualified offer Classified board. feature (chewable pill) that mandates shareholder vote in certain situations. Ownership trigger is reasonable (15-20%). Board with limited independence. Highly independent, non-classified board.
B. CUMULATIVE VOTING The funds are generally opposed to cumulative voting under the premise that it allows shareholders a voice in director elections that is disproportionate to their economic investment in the corporation. C. SUPERMAJORITY VOTE REQUIREMENTS The funds support shareholders' ability to approve or reject matters presented for a vote based on a simple majority. Accordingly, the funds will support proposals to remove supermajority requirements and oppose proposals to impose them. D. RIGHT TO CALL MEETINGS AND ACT BY WRITTEN CONSENT The funds support shareholders' right to call special meetings of the board (for good cause and with ample representation) and to act by written consent. The funds will generally vote for proposals to grant these rights to shareholders and against proposals to abridge them. E. CONFIDENTIAL VOTING The integrity of the voting process is enhanced substantially when shareholders (both institutions and individuals) can vote without fear of coercion or retribution based on their votes. As such, the funds support proposals to provide confidential voting. F. DUAL CLASSES OF STOCK We are opposed to dual class capitalization structures that provide disparate voting rights to different groups of shareholders with similar economic investments. We will oppose the creation of separate classes with different voting rights and will support the dissolution of such classes. B-45 V. CORPORATE AND SOCIAL POLICY ISSUES Proposals in this category, initiated primarily by shareholders, typically request that the company disclose or amend certain business practices. The Board generally believes that these are "ordinary business matters" that are primarily the responsibility of management and should be evaluated and approved solely by the corporation's board of directors. Often, proposals may address concerns with which the Board philosophically agrees, but absent a compelling economic impact on shareholder value (e.g., proposals to require expensing of stock options), the funds will typically abstain from voting on these proposals. This reflects the belief that regardless of our philosophical perspective on the issue, these decisions should be the province of company management unless they have a significant, tangible impact on the value of a fund's investment and management is not responsive to the matter. VI. VOTING IN FOREIGN MARKETS Corporate governance standards, disclosure requirements, and voting mechanics vary greatly among the markets outside the United States in which the funds may invest. Each fund's votes will be used, where applicable, to advocate for improvements in governance and disclosure by each fund's portfolio companies. We will evaluate issues presented to shareholders for each fund's foreign holdings in the context with the guidelines described above, as well as local market standards and best practices. The funds will cast their votes in a manner believed to be philosophically consistent with these guidelines, while taking into account differing practices by market. In addition, there may be instances in which the funds elect not to vote, as described below. Many foreign markets require that securities be "blocked" or reregistered to vote at a company's meeting. Absent an issue of compelling economic importance, we will generally not subject the fund to the loss of liquidity imposed by these requirements. The costs of voting (e.g., custodian fees, vote agency fees) in foreign markets may be substantially higher than for U.S. holdings. As such, the fund may limit its voting on foreign holdings in instances where the issues presented are unlikely to have a material impact on shareholder value. VII. VOTING ON A FUND'S HOLDINGS OF OTHER VANGUARD FUNDS Certain Vanguard funds (owner funds) may, from time to time, own shares of other Vanguard funds (underlying funds). If an underlying fund submits a matter to a vote of its shareholders, votes for and against such matters on behalf of the owner funds will be cast in the same proportion as the votes of the other shareholders in the underlying fund. VIII. THE PROXY VOTING GROUP The Board has delegated the day-to-day operations of the funds' proxy voting process to the Proxy Voting Group, which the Committee oversees. While most votes will be determined, subject to the individual circumstances of each fund, by reference to the guidelines as separately adopted by each of the funds, there may be circumstances when the Proxy Voting Group will refer proxy issues to the Committee for consideration. In addition, at any time, the Board has the authority to vote proxies, when, in the Board's or the Committee's discretion, such action is warranted. The Proxy Voting Group performs the following functions: (1) managing proxy voting vendors; (2) reconciling share positions; (3) analyzing proxy proposals using factors described in the guidelines; (4) determining and addressing potential or actual conflicts of interest that may be presented by a particular proxy; and (5) voting proxies. The Proxy Voting Group also prepares periodic and special reports to the Board, and any proposed amendments to the procedures and guidelines. IX. THE PROXY OVERSIGHT COMMITTEE The Board, including a majority of the independent trustees, appoints the members of the Committee who are senior officers of Vanguard, a majority of whom are also officers of each Vanguard fund. The Committee does not include anyone whose primary duties include external client relationship management or sales. This clear separation between the proxy voting and client relationship functions is intended to eliminate any potential conflict of interest in the proxy voting process. In the unlikely event that a member of the Committee believes he or she might have a conflict of interest regarding a proxy vote, that member must recuse him or herself from the committee meeting at which the matter is addressed, and not participate in the voting decision. B-46 The Committee works with the Proxy Voting Group to provide reports and other guidance to the Board regarding proxy voting by the funds. The Committee has an obligation to conduct its meetings and exercise its decision-making authority subject to the fiduciary standards of good faith, fairness and Vanguard's Code of Ethics. The Committee shall authorize proxy votes that the Committee determines, in its sole discretion, to be in the best interests of each fund's shareholders. In determining how to apply the guidelines to a particular factual situation, the Committee may not take into account any interest that would conflict with the interest of fund shareholders in maximizing the value of their investments. The Board may review these procedures and guidelines and modify them from time to time. The procedures and guidelines are available on Vanguard's website at www.vanguard.com. You may obtain a free copy of a report that details how the funds voted the proxies relating to the portfolio securities held by the funds for the prior 12-month period ended June 30 by logging on to Vanguard's internet site, at www.vanguard.com, or the SEC's website at www.sec.gov. FINANCIAL STATEMENTS The Balanced Index Fund's Financial Statements for the fiscal year ended December 31, 2006, appearing in the Balanced Index Fund's 2006 Annual Report to Shareholders, and the report thereon of PricewaterhouseCoopers LLP, an independent registered public accounting firm, also appearing therein, and the unaudited Financial Statements for the six months ended June 30, 2007, appearing in the Balanced Index Fund's semiannual report to shareholders, are incorporated by reference in this Statement of Additional Information. For a more complete discussion of the Fund's performance, please see the Fund's Annual and Semiannual Reports to Shareholders, which may be obtained without charge. DESCRIPTION OF BOND RATINGS THE FOLLOWING ARE EXCERPTS FROM MOODY'S INVESTORS SERVICE, INC.'S DESCRIPTION OF ITS FOUR HIGHEST BOND RATINGS: AAA--Judged to be of the best quality. They carry the smallest degree of investment risk. AA--Judged to be of high quality by all standards. Together with the Aaa group they make up what are generally known as high-grade bonds. A--Possess many favorable investment attributes and are to be considered as "upper-medium-grade obligations." BAA--Considered as medium-grade obligations (i.e., they are neither highly protected nor poorly secured). Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and, in fact, have speculative characteristics as well. Moody's also supplies numerical indicators (1, 2, and 3) to rating categories. The modifier 1 indicates that the security is in the higher end of its rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a ranking toward the lower end of the category. THE FOLLOWING ARE EXCERPTS FROM STANDARD & POOR'S DESCRIPTION OF ITS FOUR HIGHEST BOND RATINGS: AAA--Highest grade obligations. The capacity to pay interest and repay principal is extremely strong. AA--Also qualify as high-grade obligations. They have a strong capacity to pay interest and repay principal, and they differ from AAA issues only in small degree. A--Regarded as upper-medium-grade. They have a strong capacity to pay interest and repay principal although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher rated categories. BBB--Regarded as having an adequate capacity to pay interest and repay principal. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher rated categories. This group is the lowest that qualifies for commercial bank investment. Standard & Poor's applies indicators "+", or "-", or no character, to its rating categories. The indicators show relative standing within the major rating categories. B-47 LEGAL DISCLAIMER THE FUND IS NOT SPONSORED, ENDORSED, SOLD OR PROMOTED BY MORGAN STANLEY CAPITAL INTERNATIONAL INC. ("MSCI"), ANY OF ITS AFFILIATES, ANY OF ITS INFORMATION PROVIDERS OR ANY OTHER THIRD PARTY INVOLVED IN, OR RELATED TO, COMPILING, COMPUTING OR CREATING ANY MSCI INDEX (COLLECTIVELY, THE "MSCI PARTIES"). THE MSCI INDEXES ARE THE EXCLUSIVE PROPERTY OF MSCI. MSCI AND THE MSCI INDEX NAMES ARE SERVICE MARK(S) OF MSCI OR ITS AFFILIATES AND HAVE BEEN LICENSED FOR USE FOR CERTAIN PURPOSES BY VANGUARD. NONE OF THE MSCI PARTIES MAKES ANY REPRESENTATION OR WARRANTY, EXPRESS OR IMPLIED, TO THE OWNERS OF THE FUND OR ANY MEMBER OF THE PUBLIC REGARDING THE ADVISABILITY OF INVESTING IN FUNDS GENERALLY OR IN THIS FUND PARTICULARLY OR THE ABILITY OF ANY MSCI INDEX TO TRACK CORRESPONDING STOCK MARKET PERFORMANCE. MSCI OR ITS AFFILIATES ARE THE LICENSORS OF CERTAIN TRADEMARKS, SERVICE MARKS AND TRADE NAMES AND OF THE MSCI INDEXES WHICH ARE DETERMINED, COMPOSED AND CALCULATED BY MSCI WITHOUT REGARD TO THIS FUND OR THE ISSUER OR OWNER OF THIS FUND. NONE OF THE MSCI PARTIES HAS ANY OBLIGATION TO TAKE THE NEEDS OF THE ISSUERS OR OWNERS OF THIS FUND INTO CONSIDERATION IN DETERMINING, COMPOSING OR CALCULATING THE MSCI INDEXES. NONE OF THE MSCI PARTIES IS RESPONSIBLE FOR OR HAS PARTICIPATED IN THE DETERMINATION OF THE TIMING OF, PRICES AT, OR QUANTITIES OF THIS FUND TO BE ISSUED OR IN THE DETERMINATION OR CALCULATION OF THE EQUATION BY WHICH THIS FUND IS REDEEMABLE FOR CASH. NONE OF THE MSCI PARTIES HAS ANY OBLIGATION OR LIABILITY TO THE OWNERS OF THIS FUND IN CONNECTION WITH THE ADMINISTRATION, MARKETING OR OFFERING OF THIS FUND. ALTHOUGH MSCI SHALL OBTAIN INFORMATION FOR INCLUSION IN OR FOR USE IN THE CALCULATION OF THE MSCI INDEXES FROM SOURCES WHICH MSCI CONSIDERS RELIABLE, NONE OF THE MSCI PARTIES WARRANTS OR GUARANTEES THE ORIGINALITY, ACCURACY AND/OR THE COMPLETENESS OF ANY MSCI INDEX OR ANY DATA INCLUDED THEREIN. NONE OF THE MSCI PARTIES MAKES ANY WARRANTY, EXPRESS OR IMPLIED, AS TO RESULTS TO BE OBTAINED BY LICENSEE, LICENSEE'S CUSTOMERS OR COUNTERPARTIES, ISSUERS OF THIS FUND, OWNERS OF THIS FUND, OR ANY OTHER PERSON OR ENTITY, FROM THE USE OF ANY MSCI INDEX OR ANY DATA INCLUDED THEREIN IN CONNECTION WITH THE RIGHTS LICENSED HEREUNDER OR FOR ANY OTHER USE. NONE OF THE MSCI PARTIES SHALL HAVE ANY LIABILITY FOR ANY ERRORS, OMISSIONS OR INTERRUPTIONS OF OR IN CONNECTION WITH ANY MSCI INDEX OR ANY DATA INCLUDED THEREIN. FURTHER, NONE OF THE MSCI PARTIES MAKES ANY EXPRESS OR IMPLIED WARRANTIES OF ANY KIND, AND THE MSCI PARITES HEREBY EXPRESSLY DISCLAIM ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE, WITH RESPECT TO ANY MSCI INDEX AND ANY DATA INCLUDED THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL ANY OF THE MSCI PARTIES HAVE ANY LIABILITY FOR ANY DIRECT, INDIRECT, SPECIAL, PUNITIVE, CONSEQUENTIAL OR ANY OTHER DAMAGES (INCLUDING WITHOUT LIMITATION LOST PROFITS) EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES. NO PURCHASER, SELLER OR HOLDER OF THE SECURITY, PRODUCT OR FUND, OR ANY OTHER PERSON OR ENTITY, SHOULD USE OR REFER TO ANY MSCI TRADE NAME, TRADEMARK OR SERVICE MARK TO SPONSOR, ENDORSE, MARKET OR PROMOTE THE SECURITY WITHOUT FIRST CONTACTING MSCI TO DETERMINE WHETHER MSCI'S PERMISSION IS REQUIRED. UNDER NO CIRCUMSTANCES MAY ANY PERSON OR ENTITY CLAIM ANY AFFILIATION WITH MSCI WITHOUT THE PRIOR WRITTEN PERMISSION OF MSCI. SAI002 122007 PART C VANGUARD VALLEY FORGE FUNDS OTHER INFORMATION ITEM 23. EXHIBITS (a) Articles of Incorporation, Amended and Restated Agreement and Declaration of Trust, is filed herewith. (b) By-Laws, is filed herewith. (c) Instruments Defining Rights of Security Holders, reference is made to Articles III and V of the Registrant's Declaration of Trust, incorporated by reference in Item 23(a) of this post-effective amendment. (d) Investment Advisory Contract, The Vanguard Group, Inc., provides investment advisory services to the Registrant at cost pursuant to the Amended and Restated Funds' Service Agreement, filed on February 28, 2003, Post-Effective Amendment No. 20, is hereby incorporated by reference. (e) Underwriting Contracts, not applicable. (f) Bonus or Profit Sharing Contracts, reference is made to the section entitled "Management of the Fund" in the Registrant's Statement of Additional Information. (g) Custodian Agreement for JPMorgan Chase Bank, filed on April 20, 2007, Post-Effective Amendment No. 31, is hereby incorporated by reference. Filed herewith for Brown Brothers Harriman & Co. (h) Other Material Contracts, Form of Amended and Restated Funds' Service Agreement, is filed herewith. (i) Legal Opinion, not applicable. (j) Other Opinions, Consent of Independent Registered Public Accounting Firm, to be filed by Amendment. (k) Omitted Financial Statements, not applicable. (l) Initial Capital Agreements, not applicable. (m) Rule 12(b)-1 Plan, not applicable. (n) Rule 18f-3 Plan, is filed herewith. (o) Reserved, not applicable. (p) Code of Ethics, filed on April 20, 2007, Post-Effective Amendment No. 31, is hereby incorporated by reference. ITEM 24. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT Registrant is not controlled by or under common control with any person. ITEM 25. INDEMNIFICATION The Registrant's organizational documents contain provisions indemnifying Trustees and officers against liability incurred in their official capacity. Article VII, Section 2 of the Declaration of Trust provides that the Registrant may indemnify and hold harmless each and every Trustee and officer from and against any and all claims, demands, costs, losses, expenses, and damages whatsoever arising out of or related to the performance of his or her duties as a Trustee or officer. However, this provision does not cover any liability to which a Trustee or officer would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his or her office. Article VI of the By-Laws generally provides that the Registrant shall indemnify its Trustees and officers from any liability arising out of their past or present service in that capacity. Among other things, this provision excludes any liability arising by reason of willful misfeasance, bad faith, gross negligence, or the reckless disregard of the duties involved in the conduct of the Trustee's or officer's office with the Registrant. C-1 ITEM 26. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER The Vanguard Group, Inc. (Vanguard), is an investment adviser registered under the Investment Advisers Act of 1940, as amended. The list required by this Item 26 of officers and directors of Vanguard, together with any information as to any business profession, vocation or employment of a substantial nature engaged in by such officers and directors during the past two years, is incorporated herein by reference from Schedules B and D of Form ADV filed by Vanguard pursuant to the Advisers Act (SEC File No. 801-11953). ITEM 27. PRINCIPAL UNDERWRITERS (a)Vanguard Marketing Corporation, a wholly-owned subsidiary of The Vanguard Group, Inc., is the principal underwriter of each fund within the Vanguard group of investment companies, a family of 37 investment companies with more than 150 funds. (b)The principal business address of each named director and officer of Vanguard Marketing Corporation is 100 Vanguard Boulevard, Malvern, PA 19355.
Name Positions and Office with Underwriter Positions and Office with Funds - ---- ------------------------------------- ------------------------------- R. Gregory Barton Director and Senior Vice President None John J. Brennan Director Trustee, Chairman, President, and Chief Executive Officer Mortimer J. Buckley Director and Senior Vice President None F. William McNabb III Director and Senior Vice President None Michael S. Miller Director and Managing Director None Ralph K. Packard Director None George U. Sauter Director and Senior Vice President None Heidi Stam Director and Senior Vice President Secretary Richard D. Carpenter Treasurer None David L. Cermak Principal None Joseph Colaizzo Financial and Operations Principal and None Assistant Treasurer Patti Colby Principal None Michael L. Kimmel Secretary None Sean P. Hagerty Principal None Jack T. Wagner Assistant Treasurer None Jennifer M. Halliday Assistant Treasurer None Brian P. McCarthy Senior Registered Options Principal None Deborah McCracken Assistant Secretary None Miranda O'Keefe Compliance Registered Options Principal None Joseph F. Miele Registered Municipal Securities Principal None Jane K. Myer Principal None Pauline C. Scalvino Chief Compliance Officer Chief Compliance Officer
(c)Not Applicable. C-2 ITEM 28. LOCATION OF ACCOUNTS AND RECORDS The books, accounts, and other documents required to be maintained by Section 31 (a) of the Investment Company Act and the rules promulgated thereunder will be maintained at the offices of the Registrant, 100 Vanguard Boulevard, Malvern, PA 19355; the Registrant's Transfer Agent, The Vanguard Group, Inc., 100 Vanguard Boulevard, Malvern, PA 19355; and the Registrant's Custodian, JPMorgan Chase Bank, 270 Park Avenue, New York, NY 10017-2070. ITEM 29. MANAGEMENT SERVICES Other than as set forth in the section entitled "Management of the Fund" in Part B of this Registration Statement, the Registrant is not a party to any management-related service contract. ITEM 30. UNDERTAKINGS Not Applicable. C-3 SIGNATURES Pursuant to the requirements of the Securities Act of 1933 and the Investment Company Act of 1940, the Registrant hereby certifies that it has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the Town of Malvern and the Commonwealth of Pennsylvania, on the 30th day of November, 2007. VANGUARD VALLEY FORGE FUNDS BY:_____________(signature)________________ (HEIDI STAM) JOHN J. BRENNAN* CHAIRMAN AND CHIEF EXECUTIVE OFFICER Pursuant to the requirements of the Securities Act of 1933, this Post-Effective Amendment to the Registration Statement has been signed below by the following persons in the capacities and on the date indicated:
SIGNATURE TITLE DATE -------------------------------------------------------------------------------- By: /S/ JOHN J. BRENNAN President, Chairman, Chief November 30, 2007 ------------------------------ Executive Officer, and Trustee (Heidi Stam) John J. Brennan* By: /S/ CHARLES D. ELLIS Trustee November 30, 2007 ------------------------------ (Heidi Stam) Charles D. Ellis* By: /S/ RAJIV L. GUPTA Trustee November 30, 2007 ------------------------------ (Heidi Stam) Rajiv L. Gupta* By: /S/ AMY GUTMANN Trustee November 30, 2007 ------------------------------ (Heidi Stam) Amy Gutmann* By: /S/ JOANN HEFFERNAN HEISEN Trustee November 30, 2007 ------------------------------ (Heidi Stam) JoAnn Heffernan Heisen* By: /S/ ANDRE F. PEROLD Trustee November 30, 2007 ------------------------------ (Heidi Stam) Andre F. Perold* By: /S/ ALFRED M. RANKIN, JR. Trustee November 30, 2007 ------------------------------ (Heidi Stam) Alfred M. Rankin, Jr.* By: /S/ J. LAWRENCE WILSON Trustee November 30, 2007 ------------------------------ (Heidi Stam) J. Lawrence Wilson* By: /S/ THOMAS J. HIGGINS Treasurer and Principal November 30, 2007 ------------------------------ Financial Officer and (Heidi Stam) Principal Accounting Officer Thomas J. Higgins*
*By Power of Attorney. Filed on August 22. 2007. see File Number 333-145624. Incorporated by Reference. INDEX TO EXHIBITS DECLARATION OF TRUST...........................................EX-99.A BY-LAWS........................................................EX-99.B CUSTODIAN AGREEMENT............................................EX-99.G FORM OF FUNDS' SERVICE AGREEMENT...............................Ex-99.H RULE 18F-3 PLAN................................................EX-99.N EX-99.A 2 valleyforgedot.txt DECLARATION OF TRUST Effective as of January 23, 1998 As amended July 19, 2002 Name change September 27, 2007 AMENDED AND RESTATED AGREEMENT AND DECLARATION OF TRUST of VANGUARD VALLEY FORGE FUNDS (formerly VANGUARD BALANCED INDEX FUND) a Delaware Business Trust Principal Place of Business: 100 Vanguard Boulevard Malvern, Pennsylvania 19355 AGREEMENT AND DECLARATION OF TRUST OF VANGUARD VALLEY FORGE FUNDS (formerly VANGUARD BALANCED INDEX FUND) WHEREAS, this AGREEMENT AND DECLARATION OF TRUST is made and entered into as of the date set forth below by the Trustees named hereunder for the purpose of forming a Delaware business trust in accordance with the provisions hereinafter set forth, NOW, THEREFORE, the Trustees hereby direct that a Certificate of Trust be filed with the Office of the Secretary of State of the State of Delaware and do hereby declare that the Trustees will hold IN TRUST all cash, securities and other assets which the Trust now possesses or may hereafter acquire from time to time in any manner and manage and dispose of the same upon the following terms and conditions for the pro rata benefit of the holders of Shares in this Trust. ARTICLE I. Name and Definitions Section 1. Name. This trust shall be known as "VANGUARD BALANCED INDEX FUND" and the Trustees shall conduct the business of the Trust under that name or any other name as they may from time to time determine. Section 2. Definitions. Whenever used herein, unless otherwise required by the context or specifically provided: (a) The "Trust" refers to the Delaware business trust established by this Agreement and Declaration of Trust, as amended from time to time; (b) The "Trust Property" means any and all property, real or personal, tangible or intangible, which is owned or held by or for the account of the Trust; (c) "Trustees" refers to the persons who have signed this Agreement and Declaration of Trust, so long as they continue in office in accordance with the terms hereof, and all other persons who may from time to time be duly elected or appointed to serve on the Board of Trustees in accordance with the provisions hereof, and reference herein to a Trustee or the Trustees shall refer to such person or persons in their capacity as trustees hereunder; (d) "Shares" means the shares of beneficial interest into which the beneficial interest in the Trust shall be divided from time to time and includes fractions of Shares as well as whole Shares; (e) "Shareholder" means a record owner of outstanding Shares; (f) "Person" means and includes individuals, corporations, partnerships, trusts, foundations, plans, associations, joint ventures, estates and other entities, whether or not legal entities, and governments and agencies and political subdivisions thereof, whether domestic or foreign; (g) The "1940 Act" refers to the Investment Company Act of 1940 and the Rules and Regulations thereunder, all as amended from time to time. References herein to specific sections of the 1940 Act shall be deemed to include such Rules and Regulations as are applicable to such sections as determined by the Trustees or their designees; (h) The terms "Commission" and "Principal Underwriter" shall have the respective meanings given them in Section 2(a)(7) and Section (2)(a)(29) of the 1940 Act; (i) "Declaration of Trust" shall mean this Agreement and Declaration of Trust, as amended or restated from time to time; (j) "By-Laws" shall mean the By-Laws of the Trust as amended from time to time; (k) The term "Interested Person" has the meaning given it in Section 2(a)(19) of the 1940 Act; (l) "Investment Adviser" or "Adviser" means a party furnishing services to the Trust pursuant to any contract described in Article IV, Section 7(a) hereof; (m) "Series" refers to each Series of Shares established and designated under or in accordance with the provisions of Article III. ARTICLE II. Purpose of Trust The purpose of the Trust is to conduct, operate and carry on the business of a management investment company registered under the 1940 Act through one or more Series investing primarily in securities. 2 ARTICLE III. Shares Section 1. Division of Beneficial Interest. The beneficial interest in the Trust shall at all times be divided into an unlimited number of Shares, with a par value of $ .001 per Share. The Trustees may authorize the division of Shares into separate Series and the division of Series into separate classes of Shares. The different Series shall be established and designated, and the variations in the relative rights and preferences as between the different Series shall be fixed and determined, by the Trustees. If only one Series shall be established, the Shares shall have the rights and preferences provided for herein and in Article III, Section 6 hereof to the extent relevant and not otherwise provided for herein. Subject to the provisions of Section 6 of this Article III, each Share shall have voting rights as provided in Article V hereof, and holders of the Shares of any Series shall be entitled to receive dividends, when, if and as declared with respect thereto in the manner provided in Article VI, Section 1 hereof. No Share shall have any priority or preference over any other Share of the same Series with respect to dividends or distributions of the Trust or otherwise. All dividends and distributions shall be made ratably among all Shareholders of a Series (or class) from the assets held with respect to such Series according to the number of Shares of such Series (or class) held of record by such Shareholders on the record date for any dividend or distribution or on the date of termination of the Trust, as the case may be. Shareholders shall have no preemptive or other right to subscribe to any additional Shares or other securities issued by the Trust or any Series. The Trustees may from time to time divide or combine the Shares of a Series into a greater or lesser number of Shares of such Series without thereby materially changing the proportionate beneficial interest of such Shares in the assets held with respect to that Series or materially affecting the rights of Shares of any other Series. Section 2. Ownership of Shares. The ownership of Shares shall be recorded on the books of the Trust or a transfer or similar agent for the Trust, which books shall be maintained separately for the Shares of each Series. No certificates evidencing the ownership of Shares shall be issued except as the Board of Trustees may otherwise determine from time to time. The Trustees may make such rules as they consider appropriate for the transfer of Shares of each Series (or class) and similar matters. The record books of the Trust as kept by the Trust or any transfer or similar agent, as the case may be, shall be conclusive as to the identity of the Shareholders of each Series and as to the number of Shares of each Series held from time to time by each Shareholder. Section 3. Investments in the Trust. Investments may be accepted by the Trust from such Persons, at such times, on such terms, and for such consideration as the Trustees from time to time may authorize. Each investment shall be credited to the Shareholder's account in the form of full and fractional Shares of the Trust, in such Series (or class) as the purchaser shall select, at the net asset value per Share next determined for such Series (or class) after receipt of the investment; provided, however, that the Trustees may, in their sole discretion, impose a sales charge or reimbursement fee upon investments in the Trust. 3 Section 4. Status of Shares and Limitation of Personal Liability. Shares shall be deemed to be personal property giving only the rights provided in this instrument and the By-Laws of the Trust. Every Shareholder by virtue of having become a Shareholder shall be held to have expressly assented and agreed to the terms hereof. The death of a Shareholder during the existence of the Trust shall not operate to terminate the Trust, nor entitle the representative of any deceased Shareholder to an accounting or to take any action in court or elsewhere against the Trust or the Trustees, but shall entitle such representative only to the rights of said deceased Shareholder under this Declaration of Trust. Ownership of Shares shall not entitle a Shareholder to any title in or to the whole or any part of the Trust Property or right to call for a partition or division of the same or for an accounting, nor shall the ownership of Shares constitute the Shareholders as partners or joint venturers. Neither the Trust nor the Trustees, nor any officer, employee or agent of the Trust shall have any power to bind personally any Shareholder, or to call upon any Shareholder for the payment of any sum of money or assessment whatsoever other than such as the Shareholder may at any time agree to pay. Section 5. Power of Board of Trustees to Change Provisions Relating to Shares. Notwithstanding any other provision of this Declaration of Trust to the contrary, and without limiting the power of the Board of Trustees to amend the Declaration of Trust as provided elsewhere herein, the Board of Trustees shall have the power to amend this Declaration of Trust, at any time and from time to time, in such manner as the Board of Trustees may determine in their sole discretion, without the need for Shareholder action, so as to add to, delete, replace or otherwise modify any provisions relating to the Shares contained in this Declaration of Trust, provided that before adopting any such amendment without Shareholder approval the Board of Trustees shall determine that it is consistent with the fair and equitable treatment of all Shareholders and that Shareholder approval is not required by the 1940 Act or other applicable law. If Shares have been issued, Shareholder approval shall be required to adopt any amendments to this Declaration of Trust which would adversely affect to a material degree the rights and preferences of the Shares of any Series (or class) or to increase or decrease the par value of the Shares of any Series (or class). Section 6. Establishment and Designation of Shares. The establishment and designation of any Series (or class) of Shares shall be effective upon the adoption by a majority of the Trustees, of a resolution which sets forth such establishment and designation and the relative rights and preferences of such Series (or class). Each such resolution shall be incorporated herein by reference upon adoption. Shares of each Series (or class) established pursuant to this Section 6, unless otherwise provided in the resolution establishing such Series, shall have the following relative rights and preferences: (a) Assets Held with Respect to a Particular Series. All consideration received by the Trust for the issue or sale of Shares of a Series, including dividends and distributions paid by, and reinvested in, such Series, together with all assets in which such consideration is invested or reinvested, all 4 income, earnings, profits, and proceeds thereof from whatever source derived, including, without limitation, any proceeds derived from the sale, exchange or liquidation of such assets, and any funds or payments derived from any reinvestment of such proceeds in whatever form the same may be, shall irrevocably be held with respect to that Series for all purposes, subject only to the rights of creditors, and shall be so recorded upon the books of account of the Trust. Such consideration, assets, income, earnings, profits and proceeds thereof, from whatever source derived, including, without limitation, any proceeds derived from the sale, exchange or liquidation of such assets, and any funds or payments derived from any reinvestment of such proceeds, in whatever form the same may be, are herein referred to as "assets held with respect to" that Series. In the event that there are any assets, income, earnings, profits and proceeds thereof, funds or payments which are not readily identifiable as assets held with respect to any particular Series (collectively "General Assets"), the Trustees shall allocate such General Assets to, between or among any one or more of the Series in such manner and on such basis as the Trustees, in their sole discretion, deem fair and equitable, and any General Asset so allocated to a particular Series shall be held with respect to that Series. Each such allocation by the Trustees shall be conclusive and binding upon the Shareholders of all Series for all purposes in absence of manifest error. (b) Liabilities Held with Respect to a Particular Series. The assets of the Trust held with respect to each Series shall be charged with the liabilities of the Trust with respect to such Series and all expenses, costs, charges and reserves attributable to such Series, and any general liabilities of the Trust which are not readily identifiable as being held in respect of a Series shall be allocated and charged by the Trustees to and among any one or more Series in such manner and on such basis as the Trustees in their sole discretion deem fair and equitable. The liabilities, expenses, costs, charges, and reserves so charged to a Series are herein referred to as "liabilities held with respect to" that Series. Each allocation of liabilities, expenses, costs, charges and reserves by the Trustees shall be conclusive and binding upon the holders of all Series for all purposes in absence of manifest error. All Persons who have extended credit which has been allocated to a particular Series, or who have a claim or contract which has been allocated to a Series, shall look exclusively to the assets held with respect to such Series for payment of such credit, claim, or contract. In the absence of an express agreement so limiting the claims of such creditors, claimants and contracting parties, each creditor, claimant and contracting party shall be deemed nevertheless to have agreed to such limitation unless an express provision to the contrary has been incorporated in the written contract or other document establishing the contractual relationship. (c) Dividends, Distributions, Redemptions, and Repurchases. No dividend or distribution including, without limitation, any distribution paid upon termination of the Trust or of any Series (or class) with respect to, or any redemption or repurchase of, the Shares of any Series (or class) shall be effected by the Trust other than from the assets held with respect to such Series, nor shall any Shareholder of any Series otherwise have any right or claim against the assets held with respect to any other Series except to the extent that such Shareholder has such a right or claim hereunder as a Shareholder of such other Series. The Trustees shall have full discretion to determine which items shall be treated as income and which items as capital; and each such determination and allocation shall be conclusive and binding upon the Shareholders in absence of manifest error. 5 (d) Voting. All Shares of the Trust entitled to vote on a matter shall vote without differentiation between the separate Series on a one-vote-per-each dollar (and a fractional vote for each fractional dollar) of the net asset value of each share (including fractional shares) basis; provided however, if a matter to be voted on affects only the interests of not all Series (or class of a Series), then only the Shareholders of such affected Series (or class) shall be entitled to vote on the matter. (e) Equality. All the Shares of each Series shall represent an equal proportionate undivided interest in the assets held with respect to such Series (subject to the liabilities of such Series and such rights and preferences as may have been established and designated with respect to classes of Shares within such Series), and each Share of a Series shall be equal to each other Share of such Series. (f) Fractions. Any fractional Share of a Series shall have proportionately all the rights and obligations of a whole share of such Series, including rights with respect to voting, receipt of dividends and distributions and redemption of Shares. (g) Exchange Privilege. The Trustees shall have the authority to provide that the holders of Shares of any Series shall have the right to exchange such Shares for Shares of one or more other Series in accordance with such requirements and procedures as may be established by the Trustees. (h) Combination of Series. The Trustees shall have the authority, without the approval of the Shareholders of any Series unless otherwise required by applicable law, to combine the assets and liabilities held with respect to any two or more Series into assets and liabilities held with respect to a single Series. (i) Elimination of Series. At any time that there are no Shares outstanding of a Series (or class), the Trustees may abolish such Series (or class). ARTICLE IV. The Board of Trustees Section 1. Number, Election and Tenure. The number of Trustees constituting the Board of Trustees shall be fixed from time to time by a written instrument signed, or by resolution approved at a duly constituted meeting, by a majority of the Board of Trustees, provided, however, that the number of Trustees shall in no event be less than one (1) nor more than fifteen (15). Subject to the requirements of Section 16(a) of the 1940 Act, the Board of Trustees, by action of a majority of the then Trustees at a duly constituted meeting, may fill vacancies in the Board of Trustees and remove Trustees with or without cause. Each Trustee shall serve during the continued lifetime of the Trust until he or she dies, resigns, is declared bankrupt or incompetent by a court of competent jurisdiction, or is removed. Any Trustee may resign at any time by written 6 instrument signed by him and delivered to any officer of the Trust or to a meeting of the Trustees. Such resignation shall be effective upon receipt unless specified to be effective at some other time. Except to the extent expressly provided in a written agreement with the Trust, no Trustee resigning and no Trustee removed shall have any right to any compensation for any period following his or her resignation or removal, or any right to damages or other payment on account of such removal. Any Trustee may be removed at any meeting of Shareholders by a vote of two-thirds of the total combined net asset value of all Shares of the Trust issued and outstanding. A meeting of Shareholders for the purpose of electing or removing one or more Trustees may be called (i) by the Trustees upon their own vote, or (ii) upon the demand of Shareholders owning 10% or more of the Shares of the Trust in the aggregate. Section 2. Effect of Death, Resignation, etc. of a Trustee. The death, declination, resignation, retirement, removal, or incapacity of one or more Trustees, or all of them, shall not operate to annul the Trust or to revoke any existing agency created pursuant to the terms of this Declaration of Trust. Whenever a vacancy in the Board of Trustees shall occur, until such vacancy is filled as provided in Article IV, Section 1, the Trustees in office, regardless of their number, shall have all the powers granted to the Trustees and shall discharge all the duties imposed upon the Trustees by this Declaration of Trust. Section 3. Powers. Subject to the provisions of this Declaration of Trust, the business of the Trust shall be managed by the Board of Trustees, and such Board shall have all powers necessary or convenient to carry out that responsibility including the power to engage in transactions of all kinds on behalf of the Trust. Trustees, in all instances, shall act as principals and are and shall be free from the control of the Shareholders. The Trustees shall have full power and authority to do any and all acts and to make and execute any and all contracts, documents and instruments that they may consider desirable, necessary or appropriate in connection with the administration of the Trust. Without limiting the foregoing, the Trustees may: adopt, amend and repeal By-Laws not inconsistent with this Declaration of Trust providing for the regulation and management of the affairs of the Trust; elect and remove such officers and appoint and terminate such agents as they consider appropriate; appoint from their own number and establish and terminate one or more committees consisting of two or more Trustees who may exercise the powers and authority of the Board of Trustees to the extent that the Trustees determine; employ one or more custodians of the assets of the Trust and may authorize such custodians to employ subcustodians and to deposit all or any part of such assets in a system or systems for the central handling of securities or with a Federal Reserve Bank, retain a transfer agent or a shareholder servicing agent, or both; provide for the issuance and distribution of Shares by the Trust directly or through one or more Principal Underwriters or otherwise; redeem, repurchase and transfer Shares pursuant to applicable law; set record dates for the determination of Shareholders with respect to various matters; declare and pay dividends and distributions to Shareholders of each Series from the assets of such Series; establish from time to time, in accordance with the provisions of Article III, Section 6 hereof, any Series of Shares, each such Series to operate as a separate and distinct investment medium and with separately defined investment objectives and policies and distinct investment purpose; and in general delegate such authority as they consider desirable to any officer of the Trust, to any committee of the Trustees and to any agent or employee of the Trust or to any such custodian, transfer or shareholder servicing agent, Investment Manager or Principal Underwriter. Any determination as to what is in the interests of the Trust made by the Trustees in good faith shall be conclusive. In construing the provisions of this Declaration of Trust, the presumption shall be in favor of a grant of power to the Trustees and unless otherwise specified herein or required by the 1940 Act or other applicable law, any action by the Board of Trustees shall be deemed effective if approved or taken by a majority of the Trustees 7 then in office or a majority of any duly constituted committee of Trustees. Any action required or permitted to be taken at any meeting of the Board of Trustees, or any committee thereof, may be taken without a meeting if all members of the Board of Trustees or committee (as the case may be) consent thereto in writing, and the writing or writings are filed with the minutes of the proceedings of the Board of Trustees, or committee, except as otherwise provided in the 1940 Act. Without limiting the foregoing, the Trust shall have power and authority: (a) To invest and reinvest cash and cash items, to hold cash uninvested, and to subscribe for, invest in, reinvest in, purchase or otherwise acquire, own, hold, pledge, sell, assign, transfer, exchange, distribute, write options on, lend or otherwise deal in or dispose of contracts for the future acquisition or delivery of all types of securities, futures contracts and options thereon, and forward currency contracts of every nature and kind, including, without limitation, all types of bonds, debentures, stocks, preferred stocks, negotiable or non-negotiable instruments, obligations, evidences of indebtedness, certificates of deposit or indebtedness, commercial paper, repurchase agreements, bankers' acceptances, and other securities of any kind, issued, created, guaranteed, or sponsored by any and all Persons, including, without limitation, states, territories, and possessions of the United States and the District of Columbia and any political subdivision, agency, or instrumentality thereof, any foreign government or any political subdivision of the U.S. Government or any foreign government, or any international instrumentality or organization, or by any bank or savings institution, or by any corporation or organization organized under the laws of the United States or of any state, territory, or possession thereof, or by any corporation or organization organized under any foreign law, or in "when issued" contracts for any such securities, futures contracts and options thereon, and forward currency contracts, to change the investments of the assets of the Trust; and to exercise any and all rights, powers, and privileges of ownership or interest in respect of any and all such investments of every kind and description, including, without limitation, the right to consent and otherwise act with respect thereto, with power to designate one or more Persons, to exercise any of said rights, powers, and privileges in respect of any of said instruments; (b) To sell, exchange, lend, pledge, mortgage, hypothecate, lease, or write options with respect to or otherwise deal in any property rights relating to any or all of the assets of the Trust or any Series; (c) To vote or give assent, or exercise any rights of ownership, with respect to stock or other securities or property; and to execute and deliver proxies or powers of attorney to such person or persons as the Trustees shall deem proper, granting to such person or persons such power and discretion with relation to securities or property as the Trustees shall deem proper; 8 (d) To exercise powers and right of subscription or otherwise which in any manner arise out of ownership of securities; (e) To hold any security or property in a form not indicating that it is trust property, whether in bearer, unregistered or other negotiable form, or in its own name or in the name of a custodian or subcustodian or a nominee or nominees or otherwise or to authorize the custodian or a subcustodian or a nominee or nominees to deposit the same in a securities depository, subject in each case to the applicable provisions of the 1940 Act; (f) To consent to, or participate in, any plan for the reorganization, consolidation or merger of any corporation or issuer of any security which is held in the Trust; to consent to any contract, lease, mortgage, purchase or sale of property by such corporation or issuer; and to pay calls or subscriptions with respect to any security held in the Trust; (g) To join with other security holders in acting through a committee, depository, voting trustee or otherwise, and in that connection to deposit any security with, or transfer any security to, any such committee, depository or trustee, and to delegate to them such power and authority with relation to any security (whether or not so deposited or transferred) as the Trustees shall deem proper, and to agree to pay, and to pay, such portion of the expenses and compensation of such committee, depository or trustee as the Trustees shall deem proper; (h) To litigate, compromise, arbitrate, settle or otherwise adjust claims in favor of or against the Trust or a Series, or any matter in controversy, including but not limited to claims for taxes; (i) To enter into joint ventures, general or limited partnerships and any other combinations or associations; (j) To borrow funds or other property in the name of the Trust or Series exclusively for Trust purposes; (k) To endorse or guarantee the payment of any notes or other obligations of any Person; to make contracts of guaranty or suretyship, or otherwise assume liability for payment thereof; (l) To purchase and pay for entirely out of Trust Property such insurance as the Trustees may deem necessary, desirable or appropriate for the conduct of the business, including, without limitation, insurance policies insuring the assets of the Trust or payment of distributions and principal on its portfolio investments, and insurance policies insuring the Shareholders, Trustees, officers, employees, agents, Investment Manager, principal underwriters, or 9 independent contractors of the Trust, individually against all claims and liabilities of every nature arising by reason of holding Shares, holding, being or having held any such office or position, or by reason of any action alleged to have been taken or omitted by any such Person as Trustee, officer, employee, agent, Investment Manager, Principal Underwriter, or independent contractor, including any action taken or omitted that may be determined to constitute negligence, whether or not the Trust would have the power to indemnify such Person against liability; and (m) To adopt, establish and carry out pension, profit-sharing, share bonus, share purchase, savings, thrift and other retirement, incentive and benefit plans, trusts and provisions, including the purchasing of life insurance and annuity contracts as a means of providing such retirement and other benefits, for any or all of the Trustees, officers, employees and agents of the Trust. The Trust shall not be limited to investing in obligations maturing before the possible termination of the Trust or one or more of its Series. The Trust shall not in any way be bound or limited by any present or future law or custom in regard to investment by fiduciaries. The Trust shall not be required to obtain any court order to deal with any assets of the Trust or take any other action hereunder. Section 4. Payment of Expenses by the Trust. Subject to the provisions of Article III, Section 6(b), the Trustees are authorized to pay or cause to be paid out of the principal or income of the Trust or Series, or partly out of the principal and partly out of income, and to charge or allocate the same to, between or among such one or more of the Series that may be established or designated pursuant to Article III, Section 6, all expenses, fees, charges, taxes and liabilities incurred or arising in connection with the Trust or Series, or in connection with the management thereof, including, but not limited to, the Trustees' compensation and such expenses and charges for the services of the Trust's officers, employees, Investment Manager^, Principal Underwriter, auditors, counsel, custodian, transfer agent, Shareholder servicing agent, and such other agents or independent contractors and such other expenses and charges as the Trustees may deem necessary or proper to incur. Section 5. Ownership of Assets of the Trust. Title to all of the assets of the Trust shall at all times be considered as vested in the Trust, except that the Trustees shall have power to cause legal title to any Trust Property to be held by or in the name of one or more of the Trustees, or in the name of the Trust, or in the name of any other Person as nominee, on such terms as the Trustees may determine. Upon the resignation, incompetency, bankruptcy, removal, or death of a Trustee he or she shall automatically cease to have any such title in any of the Trust Property, and the title of such Trustee in the Trust Property shall vest automatically in the remaining Trustees. Such vesting and cessation of title shall be effective whether or not conveyancing documents have been executed and delivered. The Trustees may determine that the Trust or the Trustees, acting for and on behalf of the Trust, shall be deemed to hold beneficial ownership of any income earned on the securities owned by the Trust, whether domestic or foreign. Section 6. Service Contracts. ---------- ----------------- (a) The Trustees may, at any time and from time to time, contract for exclusive or nonexclusive advisory, management and/or administrative services for the Trust or for any Series with any Person; and any such contract may contain such other terms as the Trustees may determine, including without 10 limitation, authority for the Investment Adviser to determine from time to time without prior consultation with the Trustees what investments shall be purchased, held, sold or exchanged and what portion, if any, of the assets of the Trust shall be held uninvested and to make changes in the Trust's investments, and such other responsibilities as may specifically be delegated to such Person. (b) The Trustees may also, at any time and from time to time, contract with any Persons, appointing such Persons exclusive or nonexclusive distributor or Principal Underwriter for the Shares of one or more of the Series or other securities to be issued by the Trust. Every such contract may contain such other terms as the Trustees may determine. (c) The Trustees are also empowered, at any time and from time to time, to contract with any Persons, appointing such Person(s) to serve as custodian(s), transfer agent and/or shareholder servicing agent for the Trust or one or more of its Series. Every such contract shall comply with such terms as may be required by the Trustees. (d) The Trustees are further empowered, at any time and from time to time, to contract with any Persons to provide such other services to the Trust or one or more of the Series, as the Trustees determine to be in the best interests of the Trust and the applicable Series. (e) The fact that: (i) any of the Shareholders, Trustees, or officers of the Trust is a shareholder, director, officer, partner, trustee, employee, Manager, adviser, Principal Underwriter, distributor, or affiliate or agent of or for any Person with which an advisory, management or administration contract, or Principal Underwriter's or distributor's contract, or transfer, shareholder servicing or other type of service contract may be made, or that (ii) any Person with which an advisory, management or administration contract or Principal Underwriter's or distributor's contract, or transfer, shareholder servicing or other type of service contract may be made also has an advisory, management or administration contract, or principal underwriter's or distributor's contract, or transfer, shareholder servicing or other service contract, or has other business or interests with any other Person, shall not affect the validity of any such contract or disqualify any Shareholder, Trustee or officer of the Trust from voting upon or executing the same, or create any liability or accountability to the Trust or its Shareholders, provided approval of each such contract is made pursuant to the applicable requirements of the 1940 Act. ARTICLE V. Shareholders' Voting Powers and Meetings 11 Section 1. Voting Powers. Subject to the provisions of Article III, Sections 5 and 6(d), the Shareholders shall have right to vote only (i) for the election or removal of Trustees as provided in Article IV, Section 1, and (ii) with respect to such additional matters relating to the Trust as may be required by the applicable provisions of the 1940 Act, including Section 16(a) thereof, and (iii) on such other matters as the Trustees may consider necessary or desirable. Each shareholder shall have one vote for each dollar (and a fractional vote for each fractional dollar) of the net asset value of each share (including fractional shares) held by such shareholder on the record date on each matter submitted to a vote at a meeting of shareholders. For purposes of this section, net asset value shall be determined pursuant to Section 3 of Article VIII of the Trustee's Bylaws as of the record date for such meeting set pursuant to Section 5 of such Bylaws. There shall be no cumulative voting in the election of Trustees. Votes may be made in person or by proxy. A proxy purporting to be executed by or on behalf of a Shareholder shall be deemed valid unless challenged at or prior to its exercise and the burden of proving invalidity shall rest on the challenger. Section 2. Voting Power and Meetings. Meetings of the Shareholders may be called by the Trustees for the purposes described in Section 1 of this Article V. A meeting of Shareholders may be held at any place designated by the Trustees. Written notice of any meeting of Shareholders shall be given or caused to be given by the Trustees by delivering personally or mailing such notice not more than ninety (90), nor less than ten (10) days before such meeting, postage prepaid, stating the time and place of the meeting, to each Shareholder at the Shareholder's address as it appears on the records of the Trust. Whenever notice of a meeting is required to be given to a Shareholder under this Declaration of Trust, a written waiver thereof, executed before or after the meeting by such Shareholder or his or her attorney thereunto authorized and filed with the records of the meeting, or actual attendance at the meeting of Shareholders in person or by proxy, shall be deemed equivalent to such notice. Section 3. Quorum and Required Vote. Except as otherwise provided by the Investment Company Act of 1940 or in the Trust's Declaration of Trust, at any meeting of shareholders, the presence in person or by proxy of the holders of record of Shares issued and outstanding and entitled to vote representing more than fifty percent of the total combined net asset value of all Shares issued and outstanding and entitled to vote shall constitute a quorum for the transaction of any business at the meeting. Any meeting of Shareholders may be adjourned from time to time by a majority of the votes properly cast upon the question of adjourning a meeting to another date and time, whether or not a quorum is present, and the meeting may be held as adjourned within a reasonable time after the date set for the original meeting without further notice. Subject to the provisions of Article III, Section 6(d) and the applicable provisions of the 1940 Act, when a quorum is present at any meeting, a majority vote of the combined net asset value of all shares entitled to vote that are present in person or by proxy shall decide any questions, except only a plurality vote shall be necessary to elect trustees. Section 4. Action by Written Consent. Any action taken by Shareholders may be taken without a meeting if all the holders of Shares entitled to vote on the matter are provided with not less than 7 days written notice thereof and written consent to the action is filed with the records of the meetings of Shareholders by the holders of the number of votes that would be required to approve the matter as provided in Article V, Section 3. Such consent shall be treated for all purposes as a vote taken at a meeting of Shareholders. 12 Section 5. Record Dates. For the purpose of determining the Shareholders who are entitled to vote or act at any meeting or any adjournment thereof, the Trustees may fix a time, which shall be not more than ninety (90) nor less than ten (10) days before the date of any meeting of Shareholders, as the record date for determining the Shareholders having the right to notice of and to vote at such meeting and any adjournment thereof, and in such case only Shareholders of record on such record date shall have such right, notwithstanding any transfer of shares on the books of the Trust after the record date. For the purpose of determining the Shareholders who are entitled to receive payment of any dividend or of any other distribution, the Trustees may fix a date, which shall be before the date for the payment of such dividend or distribution, as the record date for determining the Shareholders having the right to receive such dividend or distribution. Nothing in this Section shall be construed as precluding the Trustees from setting different record dates for different Series. ARTICLE VI. Net Asset Value, Distributions, and Redemptions Section 1. Determination of Net Asset Value, Net Income, and Distributions. Subject to Article III, Section 6 hereof, the Trustees, in their absolute discretion, may prescribe and shall set forth in the By-laws or in a duly adopted resolution of the Trustees such bases and time for determining the per Share net asset value of the Shares of any Series and the declaration and payment of dividends and distributions on the Shares of any Series, as they may deem necessary or desirable. Section 2. Redemptions and Repurchases. The Trust shall purchase such Shares as are offered by any Shareholder for redemption, upon receipt by the Trust or a Person designated by the Trust that the Trust redeem such Shares or in accordance with such procedures for redemption as the Trustees may from time to time authorize; and the Trust will pay therefor the net asset value thereof, in accordance with the By-Laws and the applicable provisions of the 1940 Act. Payment for said Shares shall be made by the Trust to the Shareholder within seven days after the date on which the request for redemption is received in proper form. The obligation set forth in this Section 2 is subject to the provision that in the event that any time the New York Stock Exchange (the "Exchange") is closed for other than weekends or holidays, or if permitted by the Rules of the Commission during periods when trading on the Exchange is restricted or during any emergency which makes it impracticable for the Trust to dispose of the investments of the applicable Series or to determine fairly the value of the net assets held with respect to such Series or during any other period permitted by order of the Commission for the protection of investors, such obligations may be suspended or postponed by the Trustees. The redemption price may in any case or cases be paid in cash or wholly or partly in kind in accordance with Rule 18f-1 under the 1940 Act if the Trustees determine that such payment is advisable in the interest of the remaining Shareholders of the Series of which the Shares are being redeemed. Subject to 13 the foregoing, the selection and quantity of securities or other property so paid or delivered as all or part of the redemption price shall be determined by or under authority of the Trustees. In no case shall the Trust be liable for any delay of any corporation or other Person in transferring securities selected for delivery as all or part of any payment in kind. Section 3. Redemptions at the Option of the Trust. The Trust shall have the right, at its option, upon 30 days notice to the affected Shareholder at any time to redeem Shares of any Shareholder at the net asset value thereof as described in Section 1 of this Article VI: (i) if at such time such Shareholder owns Shares of any Series having an aggregate net asset value of less than a minimum value determined from time to time by the Trustees; or (ii) to the extent that such Shareholder owns Shares of a Series equal to or in excess of a maximum percentage of the outstanding Shares of such Series determined from time to time by the Trustees; or (iii) to the extent that such Shareholder owns Shares equal to or in excess of a maximum percentage, determined from time to time by the Trustees, of the outstanding Shares of the Trust. Section 4. Transfer of Shares. The Trust shall transfer shares held of record by any Person to any other Person upon receipt by the Trust or a Person designated by the Trust of a written request therefore in such form and pursuant to such procedures as may be approved by the Trustees. ARTICLE VII. Compensation and Limitation of Liability Section 1. Compensation of Trustees. The Trustees as such shall be entitled to reasonable compensation from the Trust, and they may fix the amount of such compensation from time to time. Nothing herein shall in any way prevent the employment of any Trustee to provide advisory, management, legal, accounting, investment banking or other services to the Trust and to be specially compensated for such services by the Trust. Section 2. Indemnification and Limitation of Liability. The Trustees shall not be responsible or liable in any event for any neglect or wrong-doing of any officer, agent, employee, Manager or Principal Underwriter of the Trust, nor shall any Trustee be responsible for the act or omission of any other Trustee, and, subject to the provisions of the Bylaws, the Trust out of its assets may indemnify and hold harmless each and every Trustee and officer of the Trust from and against any and all claims, demands, costs, losses, expenses, and damages whatsoever arising out of or related to such Trustee's or officer's performance of his or her duties as a Trustee or officer of the Trust; provided that nothing herein contained shall indemnify, hold harmless or protect any Trustee or officer from or against any liability to the Trust or any Shareholder to which he or she would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of his or her office. Every note, bond, contract, instrument, certificate or undertaking and every other act or thing whatsoever issued, executed or done by or on behalf of 14 the Trust or the Trustees or any of them in connection with the Trust shall be conclusively deemed to have been issued, executed or done only in or with respect to their or his or her capacity as Trustees or Trustee, and such Trustees or Trustee shall not be personally liable thereon. Section 3. Trustee's Good Faith Action, Expert Advice, No Bond or Surety. The exercise by the Trustees of their powers hereunder shall be binding upon everyone interested in or dealing with the Trust. A Trustee shall be liable to the Trust and to any Shareholder solely for his or her own willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of the office of Trustee, and shall not be liable for errors of judgment or mistakes of fact or law. The Trustees may take advice of counsel or other experts with respect to the meaning and operation of this Declaration of Trust, and shall be under no liability for any act or omission in accordance with such advice nor for failing to follow such advice. The Trustees shall not be required to give any bond as such, nor any surety if a bond is required. Section 4. Insurance. The Trustees shall be entitled and empowered to the fullest extent permitted by law to purchase with Trust assets insurance for liability and for all expenses reasonably incurred or paid or expected to be paid by a Trustee or officer in connection with any claim, action, suit or proceeding in which he or she becomes involved by virtue of his or her capacity or former capacity with the Trust, whether or not the Trust would have the power to indemnify him or her against such liability under the provisions of this Article. ARTICLE VIII. Miscellaneous Section 1. Liability of Third Persons Dealing with Trustees. No Person dealing with the Trustees shall be bound to make any inquiry concerning the validity of any transaction made or to be made by the Trustees or to see to the application of any payments made or property transferred to the Trust or upon its order. Section 2. Termination of Trust or Series. Unless terminated as provided herein, the Trust shall continue without limitation of time. The Trust may be terminated at any time by the Trustees upon 60 days prior written notice to the Shareholders. Any Series may be terminated at any time by the Trustees upon 60 days prior written notice to the Shareholders of that Series. Upon termination of the Trust (or any Series, as the case may be), after paying or otherwise providing for all charges, taxes, expenses and liabilities held, severally, with respect to each Series (or the applicable Series, as the case may be), whether due or accrued or anticipated as may be determined by the Trustees, the Trust shall, in accordance with such procedures as the Trustees consider appropriate, reduce the remaining assets held, severally, with respect to each Series (or the applicable Series, as the case may be), to distributable form in cash or shares or other securities, and any combination thereof, and 15 distribute the proceeds held with respect to each Series (or the applicable Series, as the case may be), to the Shareholders of that Series, as a Series, ratably according to the number of Shares of that Series held by the several Shareholders on the date of termination. Section 3. Merger and Consolidation. The Trustees may cause (i) the Trust or one or more of its Series to the extent consistent with applicable law to be merged into or consolidated with another Trust, series or Person, (ii) the Shares of the Trust or any Series to be converted into beneficial interests in another business trust (or series thereof), (iii) the Shares to be exchanged for assets or property under or pursuant to any state or federal statute to the extent permitted by law or (iv) a sale of assets of the Trust or one or more of its Series. Such merger or consolidation, Share conversion, Share exchange or sale of assets must be authorized by vote as provided in Article V, Section 3 herein; provided that in all respects not governed by statute or applicable law, the Trustees shall have power to prescribe the procedure necessary or appropriate to accomplish a sale of assets, Share exchange, merger or consolidation including the power to create one or more separate business trusts to which all or any part of the assets, liabilities, profits or losses of the Trust may be transferred and to provide for the conversion of Shares of the Trust or any Series into beneficial interests in such separate business trust or trusts (or series thereof). Section 4. Amendments. This Declaration of Trust may be restated and/or amended at any time by an instrument in writing signed by a majority of the Trustees then holding office. Any such restatement and/or amendment hereto shall be effective immediately upon execution and approval. The Certificate of Trust of the Trust may be restated and/or amended by a similar procedure, and any such restatement and/or amendment shall be effective immediately upon filing with the Office of the Secretary of State of the State of Delaware or upon such future date as may be stated therein. Section 5. Filing of Copies, References, Headings. The original or a copy of this instrument and of each restatement and/or amendment hereto shall be kept at the office of the Trust where it may be inspected by any Shareholder. Anyone dealing with the Trust may rely on a certificate by an officer of the Trust as to whether or not any such restatements and/or amendments have been made and as to any matters in connection with the Trust hereunder; and, with the same effect as if it were the original, may rely on a copy certified by an officer of the Trust to be a copy of this instrument or of any such restatements and/or amendments. In this instrument and in any such restatements and/or amendment, references to this instrument, and all expressions like "herein," "hereof" and "hereunder," shall be deemed to refer to this instrument as amended or affected by any such restatements and/or amendments. Headings are placed herein for convenience of reference only and shall not be taken as a part hereof or control or affect the meaning, construction or effect of this instrument. Whenever the singular number is used herein, the same shall include the plural; and the neuter, masculine and feminine genders shall include each other, as applicable. This instrument may be executed in any number of counterparts each of which shall be deemed an original. Section 6. Applicable Law. This Agreement and Declaration of Trust is created under and is to be governed by and construed and administered according to the laws of the State of Delaware and the Delaware Business Trust Act, as amended from time to time (the "Act"). The Trust shall be a Delaware business trust pursuant to such Act, and without limiting the provisions hereof, the Trust may exercise all powers which are ordinarily exercised by such a business trust. 16 Section 7. Provisions in Conflict with Law or Regulations. ---------- ---------------------------------------------- (a) The provisions of the Declaration of Trust are severable, and if the Trustees shall determine, with the advice of counsel, that any of such provisions is in conflict with the 1940 Act, the regulated investment company provisions of the Internal Revenue Code or with other applicable laws and regulations, the conflicting provision shall be deemed never to have constituted a part of the Declaration of Trust; provided, however, that such determination shall not affect any of the remaining provisions of the Declaration of Trust or render invalid or improper any action taken or omitted prior to such determination. (b) If any provision of the Declaration of Trust shall be held invalid or unenforceable in any jurisdiction, such invalidity or unenforceability shall attach only to such provision in such jurisdiction and shall not in any manner affect such provision in any other jurisdiction or any other provision of the Declaration of Trust in any jurisdiction. Section 8. Business Trust Only. It is the intention of the Trustees to create a business trust pursuant to the Act, and thereby to create only the relationship of trustee and beneficial owners within the meaning of such Act between the Trustees and each Shareholder. It is not the intention of the Trustees to create a general partnership, limited partnership, joint stock association, corporation, bailment, joint venture, or any form of legal relationship other than a business trust pursuant to such Act. Nothing in this Declaration of Trust shall be construed to make the Shareholders, either by themselves or with the Trustees, partners or members of a joint stock association. Section 9. Use of the Name "The Vanguard Group, Inc.". The name "The Vanguard Group, Inc." and any variants thereof and all rights to the use of the name "The Vanguard Group, Inc." or any variants thereof shall be the sole and exclusive property of The Vanguard Group, Inc. ("VGI"). VGI has permitted the use by the Trust of the identifying word "Vanguard" and the use of the name "Vanguard" as part of the name of the Trust and the name of any Series of Shares. Upon the Trust's withdrawal from the Amended and Restated Funds' Service Agreement among the Trust, the other investment companies within the Vanguard Group of Investment Companies and VGI, and upon the written request of VGI, the Trust and any Series of Shares thereof shall cease to use or in any way to refer to itself as related to "The Vanguard Group, Inc." or any variant thereof. IN WITNESS WHEREOF, the Trustees named below do hereby make and enter into this Declaration of Trust as of the 19th day of July 2002. For and on behalf of the Delaware business trusts listed on Appendix A attached hereto.* /s/ John J. Brennan /s/ Burton G. Malkiel - ---------------------------------- ---------------------------------- John J. Brennan Burton G. Malkiel /s/ Charles D. Ellis /s/ Alfred M. Rankin, Jr. - ---------------------------------- ---------------------------------- Charles D. Ellis Alfred M. Rankin, Jr. /s/ Rajiv L. Gupta /s/ J. Lawrence Wilson - ---------------------------------- ---------------------------------- Rajiv L. Gupta J. Lawrence Wilson /s/ JoAnn Heffernan Heisen - ---------------------------------- JoAnn Heffernan Heisen THE PRINCIPAL PLACE OF BUSINESS OF THE TRUST IS 100 Vanguard Boulevard Malvern, PA 19355 * Mr. Malkiel is not signing as a trustee of Vanguard Fenway Funds. Mr. Gupta is not signing as a trustee of Vanguard Fenway Funds, Vanguard Municipal Bond Funds, and the Vanguard California, Florida, Massachusetts, New Jersey, New York, Ohio and Pennsylvania Tax-Exempt Funds. 18 TABLE OF CONTENTS
Page ARTICLE I. Name and Definitions.................................................................................. 1 Section 1. Name................................................................................... 1 Section 2. Definitions............................................................................ 1 (a) The Trust....................................................................................... 1 (b) Trust Property.................................................................................. 1 (c) Trustees........................................................................................ 1 (d) Shares.......................................................................................... 1 (e) Shareholder..................................................................................... 2 (f) Person.......................................................................................... 2 (g) 1940 Act........................................................................................ 2 (h) Commission and Principal Underwriter............................................................ 2 (i) Declaration of Trust............................................................................ 2 (j) By-Laws......................................................................................... 2 (k) Interested Person............................................................................... 2 (l) Investment Adviser.............................................................................. 2 (m) Series.......................................................................................... 2 ARTICLE II. Purpose of Trust..................................................................................... 2 ARTICLE III. Shares.............................................................................................. 3 Section 1. Division of Beneficial Interest........................................................ 3 Section 2. Ownership of Shares.................................................................... 3 Section 3. Investments in the Trust............................................................... 3 Section 4. Status of Shares and Limitation of Personal Liability............................................................................ 4 Section 5. Power of Board of Trustees to Change Provisions Relating to Shares........................................................ 4 Section 6. Establishment and Designation of Shares................................................ 4 (a) Assets Held with Respect to a Particular Series................................................. 4 (b) Liabilities Held with Respect to a Particular Series............................................................................. 5 (c) Dividends, Distributions, Redemptions, and Repurchases................................................................................... 5 (d) Voting.......................................................................................... 6 (e) Equality........................................................................................ 6 (f) Fractions....................................................................................... 6 (g) Exchange Privilege.............................................................................. 6 (h) Combination of Series........................................................................... 6 (i) Elimination of Series........................................................................... 6
ARTICLE IV. The Board of Trustees................................................................................ 6 Section 1. Number, Election and Tenure............................................................ 6 Section 2. Effect of Death, Resignation, etc. of a Trustee......................................................................... 7 Section 3. Powers................................................................................. 7 Section 4. Payment of Expenses by the Trust....................................................... 10 Section 5. Ownership of Assets of the Trust....................................................... 10 Section 6. Service Contracts...................................................................... 10 ARTICLE V. Shareholders' Voting Powers and Meetings.............................................................. 11 Section 1. Voting Powers.......................................................................... 12 Section 2. Voting Power and Meetings.............................................................. 12 Section 3. Quorum and Required Vote............................................................... 12 Section 4. Action by Written Consent.............................................................. 12 Section 5. Record Dates........................................................................... 13 ARTICLE VI. Net Asset Value, Distributions, and Redemptions...................................................... 13 Section 1. Determination of Net Asset Value, Net Income, and Distributions............................................................ 13 Section 2. Redemptions and Repurchases............................................................ 13 Section 3. Redemptions at the Option of the Trust................................................. 14 Section 4. Transfer of Shares..................................................................... 14 ARTICLE VII. Compensation and Limitation of Liability............................................................ 14 Section 1. Compensation of Trustees............................................................... 14 Section 2. Indemnification and Limitation of Liability............................................ 14 Section 3. Trustee's Good Faith Action, Expert Advice, No Bond or Surety............................................................ 15 Section 4. Insurance.............................................................................. 15 ARTICLE VIII. Miscellaneous...................................................................................... 15 Section 1. Liability of Third Persons Dealing with Trustees........................................................................ 15 Section 2. Termination of Trust or Series......................................................... 15 Section 3. Merger and Consolidation............................................................... 16 Section 4. Amendments............................................................................. 16 Section 5. Filing of Copies, References, Headings................................................. 16 Section 6. Applicable Law......................................................................... 16 Section 7. Provisions in Conflict with Law or Regulations......................................... 17 Section 8. Business Trust Only.................................................................... 17 Section 9. Use of the Name "The Vanguard Group, Inc."............................................. 17
EX-99.B 3 valleyforgebylaws.txt BY LAWS BY-LAWS OF VANGUARD VALLEY FORGE FUNDS (Formerly VANGUARD BALANCED INDEX FUNDS) ARTICLE I Fiscal Year and Offices SECTION 1. FISCAL YEAR. Unless otherwise provided by resolution of the Board of Trustees, the fiscal year of the Trust shall begin on the 1st day of January and end on the last day of December. SECTION 2. DELAWARE OFFICE. The Board of Trustees shall establish a registered office in the State of Delaware and shall appoint as the Trust's registered agent for service of process in the State of Delaware an individual resident of the State of Delaware or a Delaware corporation or a foreign corporation authorized to transact business in the State of Delaware; in each case the business office of such registered agent for service of process shall be identical with the registered Delaware office of the Trust. SECTION 3. OTHER OFFICES. The Board of Trustees may at any time establish branch or subordinate offices at any place or places where the Trust intends to do business. ARTICLE II Meetings of Shareholders SECTION 1. PLACE OF MEETING. Meetings of the shareholders for the election of trustees shall be held in such place as shall be fixed by resolution of the Board of Trustees and stated in the notice of the meeting. SECTION 2. ANNUAL MEETINGS. An Annual Meeting of shareholders will not be held unless the Investment Company Act of 1940 requires the election of trustees to be acted upon. SECTION 3. SPECIAL MEETINGS. Special Meetings of the shareholders may be called at any time by the Chairman, or President, or by a majority of the Board of Trustees, and shall be called by the Secretary upon written request of the holders of shares entitled to cast not less than twenty percent of all the votes entitled to be cast at such meeting provided that (a) such request shall state the purposes of such meeting and the matters proposed to be acted on and (b) the shareholders requesting such meeting shall have paid to the Trust the reasonable estimated cost of preparing and mailing the notice thereof, which the Secretary shall determine and specify to such shareholders. No special meeting need be called upon the request of shareholders entitled to cast less than a majority of all votes entitled to be cast at such meeting to consider any matter which is substantially the same as a matter voted on at any meeting of the shareholders held during the preceding twelve months. The foregoing provisions of this section 3 notwithstanding a special meeting of shareholders shall be called upon the request of the holders of at least ten percent of the votes entitled to be cast for the purpose of consideration removal of a trustee from office as provided in section 16(c) of the Investment Company Act of 1940. SECTION 4. NOTICE. Not less than ten, nor more than ninety days before the date of every Annual or Special Shareholders Meeting, the Secretary shall cause to be mailed to each shareholder entitled to vote at such meeting at his (her) address (as it appears on the records of the Trust at the time of mailing) written notice stating the time and place of the meeting and, in the case of a Special Meeting of Shareholders, shall be limited to the purposes stated in the notice. Notice of adjournment of a shareholders meeting to another time or place need not be given, if such time and place are announced at the meeting. SECTION 5. RECORD DATE FOR MEETINGS. Subject to the provisions of the Declaration of Trust, the Board of Trustees may fix in advance a date not more than ninety, nor less than ten days, prior to the date of any annual or special meeting of the shareholders as a record date for the determination of the shareholders entitled to receive notice of, and to vote at any meeting and any adjournment thereof; and in such case such shareholders and only such shareholders as shall be shareholders of record on the date so fixed shall be entitled to receive notice of and to vote at such meeting and any adjournment thereof as the case may be, notwithstanding any transfer of any stock on the books of the Trust after any such record date fixed as aforesaid. SECTION 6. QUORUM. Except as otherwise provided by the Investment Company Act of 1940 or in the Trust's Declaration of Trust, at any meeting of shareholders, the presence in person or by proxy of the holders of record of Shares issued and outstanding and entitled to vote representing more than fifty percent of the total combined net asset value of all Shares issued and outstanding and entitled to vote shall constitute a quorum for the transaction of any business at the meeting. -2- If, however, a quorum shall not be present or represented at any meeting of the shareholders, the holders of a majority of the votes present or in person or by proxy shall have the power to adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present or represented to a date not more than 120 days after the original record date. At such adjourned meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally notified. SECTION 7. VOTING. Each shareholder shall have one vote for each dollar (and a fractional vote for each fractional dollar) of the net asset value of each share (including fractional shares) held by such shareholder on the record date set pursuant to Section 5 on each matter submitted to a vote at a meeting of shareholders. For purposes of this section and Section 6 of this Article II, net asset value shall be determined pursuant to Section 3 Article VIII of these Bylaws as of the record date for such meeting set pursuant to Section 5. There shall be no cumulative voting in the election of trustees. Votes may be made in person or by proxy. At all meetings of the shareholders, a quorum being present, all matters shall be decided by majority of the votes entitled to be cast held by shareholders present in person or by proxy, unless the question is one for which by express provision of the laws of the State of Delaware, the Investment Company Act of 1940, as from time to time amended, or the Declaration of Trust, a different vote is required, in which case such express provision shall control the decision of such question. At all meetings of shareholders, unless the voting is conducted by inspectors, all questions relating to the qualification of voters and the validity of proxies and the acceptance or rejection of votes shall be decided by the Chairman of the meeting. SECTION 8. INSPECTORS. At any election of trustees, the Board of Trustees prior thereto may, or, if they have not so acted, the Chairman of the meeting may appoint one or more inspectors of election who shall first subscribe an oath of affirmation to execute faithfully the duties of inspectors at such election with strict impartiality and according to the best of their ability, and shall after the election make a certificate of the result of the vote taken. SECTION 9. STOCK LEDGER AND LIST OF SHAREHOLDERS. It shall be the duty of the Secretary or Assistant Secretary of the Trust to cause an original or duplicate share ledger to be maintained at the office of the Trust's transfer agent. Such share ledger may be in written form or any other form capable of being converted into written form within a reasonable time for visual inspection. -3- SECTION 10. ACTION WITHOUT MEETING. Any action to be taken by shareholders may be taken without a meeting if (a) all shareholders entitled to vote on the matter consent to the action in writing, and (b) all shareholders entitled to notice of the meeting but not entitled to vote at it sign a written waiver of any right to dissent, and (c) the written consents are filed with the records of the meeting of shareholders. Such consent shall be treated for all purposes as a vote at a meeting. ARTICLE III Trustees SECTION 1. GENERAL POWERS. The business of the Trust shall be managed under the direction of its Board of Trustees, which may exercise all powers of the Trust, except such as are by statute, or the Declaration of Trust, or by these Bylaws conferred upon or reserved to the shareholders. SECTION 2. NUMBER AND TERM OF OFFICE. The number of trustees which shall constitute the whole Board shall be determined from time to time by the Board of Trustees, but shall not be fewer than the minimum number permitted by applicable laws, nor more than fifteen. Each trustee elected shall hold office until his successor is elected and qualified. Trustees need not be shareholders. SECTION 3. ELECTIONS. Provided a quorum is present, the trustees shall be elected by the vote of a plurality of the votes present in person or by proxy, except that any vacancy on the Board of Trustees may be filled by a majority vote of the Board of Trustees, although less than a quorum, subject to the requirements of Section 16(a) of the Investment Company Act of 1940. SECTION 4. PLACE OF MEETING. Meetings of the Board of Trustees, regular or special, may be held at any place as the Board may from time to time determine. SECTION 5. QUORUM. At all meetings of the Board of Trustees, one-third of the entire Board of Trustees shall constitute a quorum for the transaction of business provided that in no case may a quorum be less than two persons. The -4- action of a majority of the trustees present at any meeting at which a quorum is present shall be the action of the Board of Trustees unless the concurrence of a greater proportion is required for such action by the Investment Company Act of 1940, these Bylaws or the Declaration of Trust. If a quorum shall not be present at any meeting of trustees, the trustees present thereat may by a majority vote adjourn the meeting from time to time without notice other than announcement at the meeting, until a quorum shall be present. SECTION 6. REGULAR MEETINGS. Regular meetings of the Board of Trustees may be held without additional notice at such time and place as shall from time to time be determined by the Board of Trustees provided that notice of any change in the time or place of such meetings shall be sent promptly to each trustee not present at the meeting at which such change was made in the manner provided for notice of special meetings. SECTION 7. SPECIAL MEETINGS. Special meetings of the Board of Trustees may be called by the Chairman or President on one day's notice to each trustee; Special meetings shall be called by the Chairman or President or Secretary in like manner and on like notice on the written request of two trustees. SECTION 8. TELEPHONE MEETING. Members of the Board of Trustees or a committee of the Board of Trustees may participate in a meeting by means of a conference telephone or similar communications equipment if all persons participating in the meeting can hear each other at the same time. SECTION 9. INFORMAL ACTIONS. Any action required or permitted to be taken at any meeting of the Board of Trustees or of any committee thereof may be taken without a meeting, if a written consent to such action is signed by all members of the Board or of such committee, as the case may be, and such written consent is filed with the minutes of proceedings of the Board or committee. SECTION 10. COMMITTEES. The Board of Trustees may by resolution passed by a majority of the entire Board appoint from among its members an Executive Committee and other committees composed of two or more trustees, and may delegate to such committees, in the intervals between meetings of the Board of Trustees, any or all of the powers of the Board of Trustees in the management of the business and affairs of the Trust. SECTION 11. ACTION OF COMMITTEES. In the absence of an appropriate resolution of the Board of Trustees, each committee may adopt such rules and regulations governing its proceedings, quorum and manner of acting as it shall -5- deem proper and desirable, provided that the quorum shall not be less than two trustees. The committees shall keep minutes of their proceedings and shall report the same to the Board of Trustees at the meeting next succeeding, and any action by the committee shall be subject to revision and alteration by the Board of Trustees, provided that no rights of third persons shall be affected by any such revision or alteration. In the absence of any member of such committee, the members thereof present at any meeting, whether or not they constitute a quorum, may appoint a member of the Board of Trustees to act in the place of such absent member. SECTION 12. COMPENSATION. Any trustee, whether or not he is a salaried officer or employee of the Trust, may be compensated for his services as trustee or as a member of a committee of trustees, or as chairman of a committee by fixed periodic payments or by fees for attendance at meetings or by both, and in addition may be reimbursed for transportation and other expenses, all in such manner and amounts as the Board of Trustees may from time to time determine. ARTICLE IV Notices SECTION 1. FORM. Notices to shareholders shall be in writing and delivered personally or mailed to the shareholders at their addresses appearing on the books of the Trust. Notices to trustees shall be oral or by telephone or telegram or in writing delivered personally or mailed to the trustees at their addresses appearing on the books of the Trust. Notice by mail shall be deemed to be given at the time when the same shall be mailed. Subject to the provisions of the Investment Company Act of 1940, notice to trustees need not state the purpose of a regular or special meeting. SECTION 2. WAIVER. Whenever any notice of the time, place or purpose of any meeting of shareholders, trustees or a committee is required to be given under the provisions of the Declaration of Trust or these Bylaws, a waiver thereof in writing, signed by the person or persons entitled to such notice and filed with the records of the meeting, whether before or after the holding thereof, or actual attendance at the meeting of shareholders in person or by proxy, or at the meeting of trustees or a committee in person, shall be deemed equivalent to the giving of such notice to such persons. -6- ARTICLE V Officers Section 1. Executive Officers. The officers of the Trust shall be chosen by the Board of Trustees and shall include a Chairman, President, a Secretary and a Treasurer. The Board of Trustees may, from time to time, elect or appoint a Controller, one or more Vice Presidents, Assistant Secretaries and Assistant Treasurers. The Board of Trustees, at its discretion, may also appoint a trustee as Senior Chairman of the Board who shall perform and execute such executive and administrative duties and powers as the Board of Trustees shall from time to time prescribe. The same person may hold two or more offices, except that no person shall be both President and Vice-President and no officer shall execute, acknowledge or verify any instrument in more than one capacity, if such instrument is required by law, the Declaration of Trust or these Bylaws to be executed, acknowledged or verified by two or more officers. SECTION 2. ELECTION. The Board of Trustees shall choose a Chairman, President, a Secretary and a Treasurer. SECTION 3. OTHER OFFICERS. The Board of Trustees from time to time may appoint such other officers and agents as it shall deem advisable, who shall hold their offices for such terms and shall exercise powers and perform such duties as shall be determined from time to time by the Board. The Board of Trustees from time to time may delegate to one or more officers or agents the power to appoint any such subordinate officers or agents and to prescribe their respective rights, terms of office, authorities and duties. SECTION 4. COMPENSATION. The salaries or other compensation of all officers and agents of the Trust shall be fixed by the Board of Trustees, except that the Board of Trustees may delegate to any person or group of persons the power to fix the salary or other compensation of any subordinate officers or agents appointed pursuant to Section 3 of this Article V. SECTION 5. TENURE. The officers of the Trust shall serve at the pleasure of the Board of Trustees. Any officer or agent may be removed by the affirmative vote of a majority of the Board of Trustees whenever, in its judgment, the best interests of the Trust will be served thereby. In addition, any officer or agent appointed pursuant to Section 3 may be removed, either with or without cause, by any officer upon whom such power of removal shall have been conferred by the Board of Trustees. Any vacancy occurring in any office of the Trust by death, resignation, removal or otherwise shall be filled by the Board of Trustees, unless pursuant to Section 3 the power of appointment has been conferred by the Board of Trustees on any other officer. -6- SECTION 6. PRESIDENT AND CHIEF EXECUTIVE OFFICER. The President shall be the Chief Executive Officer of the Trust, unless the Board of Trustees designates the Chairman as Chief Executive Officer. The Chief Executive Officer shall see that all orders and resolutions of the Board are carried into effect. The Chief Executive Officer shall also be the Chief Administrative Officer of the Trust and shall perform such other duties and have such other powers as the Board of Trustees may from time to time prescribe. SECTION 7.CHAIRMAN. The Chairman of the Board shall perform and execute such duties and administrative powers as the Board of Trustees shall from time to time prescribe. SECTION 8. SENIOR CHAIRMAN OF THE BOARD. The Senior Chairman of the Board, if one shall be chosen, shall perform and execute such executive duties and administrative powers as the Board of Trustees shall from time to time prescribe. SECTION 9. VICE-PRESIDENT. The Vice-Presidents, in order of their seniority, shall, in the absence or disability of the Chief Executive Officer, perform the duties and exercise the powers of the Chief Executive Officer and shall perform such other duties as the Board of Trustees or the Chief Executive Officer may from time to time prescribe. SECTION 10. SECRETARY. The Secretary shall attend all meetings of the Board of Trustees and all meetings of the shareholders and record all the proceedings thereof and shall perform like duties for any committee when required. He shall give, or cause to be given, notice of meetings of the shareholders and of the Board of Trustees, shall have charge of the records of the Trust, including the stock books, and shall perform such other duties as may be prescribed by the Board of Trustees or Chief Executive Officer, under whose supervision he shall be. He shall keep in safe custody the seal of the Trust and, when authorized by the Board of Trustees, shall affix and attest the same to any instrument requiring it. The Board of Trustees may give general authority to any other officer to affix the seal of the Trust and to attest the affixing by his signature. SECTION 11. ASSISTANT SECRETARIES. The Assistant Secretaries in order of their seniority, shall, in the absence or disability of the Secretary, perform the duties and exercise the powers of the Secretary and shall perform such other duties as the Board of Trustees shall prescribe. -8- SECTION 12. TREASURER. The Treasurer, unless another officer has been so designated, shall be the Chief Financial Officer of the Trust. He shall have general charge of the finances and books of account of the Trust. Except as otherwise provided by the Board of Trustees, he shall have general supervision of the funds and property of the Trust and of the performance by the custodian of its duties with respect thereto. He shall render to the Board of Trustees, whenever directed by the Board, an account of the financial condition of the Trust and of all his transactions as Treasurer. He shall cause to be prepared annually a full and correct statement of the affairs of the Trust, including a balance sheet and a statement of operations for the preceding fiscal year. He shall perform all the acts incidental to the office of Treasurer, subject to the control of the Board of Trustees. SECTION 13. ASSISTANT TREASURER. The Assistant Treasurer shall in the absence or disability of the Treasurer, perform the duties and exercise the powers of the Treasurer and shall perform such other duties as the Board of Trustees may from time to time prescribe. ARTICLE VI Indemnification and Insurance SECTION 1. AGENTS, PROCEEDINGS AND EXPENSES. For the purpose of this Article, "agent" means any person who is or was a trustee or officer of this Trust and any person who, while a trustee or officer of this Trust, is or was serving at the request of this Trust as a trustee, director, officer, partner, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust or other enterprise; "Trust" includes any domestic or foreign predecessor entity of this Trust in a merger, consolidation, or other transaction in which the predecessor's existence ceased upon consummation of the transaction; "proceeding" means any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative, or investigative; and "expenses" includes without limitation attorney's fees and any expenses of establishing a right to indemnification under this Article. SECTION 2. ACTIONS OTHER THAN BY TRUST. This Trust shall indemnify any person who was or is a party or is threatened to be made a party to any proceeding (other than an action by or in the right of this Trust) by reason of the fact that such person is or was an agent of this Trust, against expenses, judgments, fines, settlements and other amounts actually and reasonably incurred in connection with such proceeding, if it is determined that person acted in -9- good faith and reasonably believed: (a) in the case of conduct in his official capacity as an agent of the Trust, that his conduct was in the Trust's best interests and (b) in all other cases, that his conduct was at least not opposed to the Trust's best interests and (c) in the case of a criminal proceeding, that he had no reasonable cause to believe the conduct of that person was unlawful. The termination of any proceeding by judgment, order or settlement shall not of itself create a presumption that the person did not meet the requisite standard of conduct set forth in this Section. The termination of any proceeding by conviction, or a plea of nolo contendere or its equivalent, or an entry of an order of probation prior to judgment, creates a rebuttable presumption that the person did not meet the requisite standard of conduct set forth in this Section. SECTION 3. ACTIONS BY THE TRUST. This Trust shall indemnify any person who was or is a party or is threatened to be made a party to any proceeding by or in the right of this Trust to procure a judgment in its favor by reason of the fact that that person is or was an agent of this Trust, against expenses actually and reasonably incurred by that person in connection with the defense or settlement of that action if that person acted in good faith, in a manner that person believed to be in the best interests of this Trust and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances. SECTION 4. EXCLUSION OF INDEMNIFICATION. Notwithstanding any provision to the contrary contained herein, there shall be no right to indemnification for any liability arising by reason of willful misfeasance, bad faith, gross negligence, or the reckless disregard of the duties involved in the conduct of the agent's office with this Trust. No indemnification shall be made under Sections 2 or 3 of this Article: (a) In respect of any proceeding as to which that person shall have been adjudged to be liable on the basis that personal benefit was improperly received by him, whether or not the benefit resulted from an action taken in the person's official capacity; or (b) In respect of any proceeding as to which that person shall have been adjudged to be liable in the performance of that person's duty to this Trust, unless and only to the extent that the court in which that -10- action was brought shall determine upon application that in view of all the relevant circumstances of the case, that person is fairly and reasonably entitled to indemnity for the expenses which the court shall determine; however, in such case, indemnification with respect to any proceeding by or in the right of the Trust or in which liability shall have been adjudged by reason of the disabling conduct set forth in the preceding paragraph shall be limited to expenses; or (c) Of amounts paid in settling or otherwise disposing of a proceeding, with or without court approval, or of expenses incurred in defending a proceeding which is settled or otherwise disposed of without court approval, unless the required approval set forth in Section 6 of this Article is obtained. SECTION 5. SUCCESSFUL DEFENSE BY AGENT. To the extent that an agent of this Trust has been successful, on the merits or otherwise, in the defense of any proceeding referred to in Sections 2 or 3 of this Article before the court or other body before whom the proceeding was brought, the agent shall be indemnified against expenses actually and reasonably incurred by the agent in connection therewith, provided that the Board of Trustees, including a majority who are disinterested, non-party trustees, also determines that based upon a review of the facts, the agent was not liable by reason of the disabling conduct referred to in Section 4 of this Article. SECTION 6. REQUIRED APPROVAL. Except as provided in Section 5 of this Article, any indemnification under this Article shall be made by this Trust only if authorized in the specific case on a determination that indemnification of the agent is proper in the circumstances because the agent has met the applicable standard of conduct set forth in Sections 2 or 3 of this Article and is not prohibited from indemnification because of the disabling conduct set forth in Section 4 of this Article, by: (a) A majority vote of a quorum consisting of trustees who are not parties to the proceeding and are not interested persons of the Trust (as defined in the Investment Company Act of 1940); (b) A written opinion by an independent legal counsel; or -11- (c) The shareholders; however, shares held by agents who are parties to the proceeding may not be voted on the subject matter under this Sub-Section. SECTION 7. ADVANCE OF EXPENSES. Expenses incurred in defending any proceeding may be advanced by this Trust before the final disposition of the proceeding if (a) receipt of a written affirmation by the agent of his good faith belief that he has met the standard of conduct necessary for indemnification under this Article and a written undertaking by or on behalf of the agent, such undertaking being an unlimited general obligation to repay the amount of the advance if it is ultimately determined that he has not met those requirements, and (b) a determination that the facts then known to those making the determination would not preclude indemnification under this Article. Determinations and authorizations of payments under this Section must be made in the manner specified in Section 6 of this Article for determining that the indemnification is permissible. SECTION 8. OTHER CONTRACTUAL RIGHTS. Nothing contained in this Article shall affect any right to indemnification to which persons other than Trustees and officers of this Trust or any subsidiary hereof may be entitled by contract or otherwise. SECTION 9. LIMITATIONS. No indemnification or advance shall be made under this Article, except as provided in Sections 5 or 6 in any circumstances where it appears: (a) That it would be inconsistent with a provision of the Agreement and Declaration of Trust of the Trust, a resolution of the shareholders, or an agreement in effect at the time of accrual of the alleged cause of action asserted in the proceeding in which the expenses were incurred or other amounts were paid which prohibits or otherwise limits indemnification; or (b) That it would be inconsistent with any condition expressly imposed by a court in approving a settlement. SECTION 10. INSURANCE. Upon and in the event of a determination by the Board of Trustees of this Trust to purchase such insurance, this Trust shall purchase and maintain insurance on behalf of any agent or employee of this Trust against any liability asserted against or incurred by the agent or employee in such capacity or arising out of the agent's or employee's status as such to the fullest extent permitted by law. -10- SECTION 11. FIDUCIARIES OF EMPLOYEE BENEFIT PLAN. This Article does not apply to any proceeding against any trustee, investment manager or other fiduciary of an employee benefit plan in that person's capacity as such, even though that person may also be an agent of this Trust as defined in Section 1 of this Article. Nothing contained in this Article shall limit any right to indemnification to which such a trustee, investment manager, or other fiduciary may be entitled by contract or otherwise which shall be enforceable to the extent permitted by applicable law other than this Article. ARTICLE VII Shares of Beneficial Interest SECTION 1. CERTIFICATES. A certificate or certificates representing and certifying the class and the full, but not fractional, number of shares of beneficial interest owned by each shareholder in the Trust shall not be issued except as the Board of Trustees may otherwise determine from time to time. Any such certificate issued shall be signed by facsimile signature or otherwise by the Chairman or President or a Vice-President and counter-signed by the Secretary or an Assistant Secretary or the Treasurer or an Assistant Treasurer. SECTION 2. SIGNATURE. In case any officer who has signed any certificate ceases to be an officer of the Trust before the certificate is issued, the certificate may nevertheless be issued by the Trust with the same effect as if the officer had not ceased to be such officer as of the date of its issue. SECTION 3. RECORDING AND TRANSFER WITHOUT CERTIFICATES. The Trust shall have the full power to participate in any program approved by the Board of Trustees providing for the recording and transfer of ownership of the Trust's shares by electronic or other means without the issuance of certificates. SECTION 4. LOST CERTIFICATES. The Board of Trustees may direct a new certificate or certificates to be issued in place of any certificate or certificates theretofore issued by the Trust alleged to have been stolen, lost or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of stock to have been stolen, lost or destroyed, or upon other satisfactory evidence of such theft, loss or destruction and may in its discretion and as a condition precedent to the issuance thereof, require the owner of such stolen, lost or destroyed certificate or certificates, or his legal representative, to give the Trust a bond with sufficient surety, to the Trust to indemnify it against any loss or claim that may be made by reason of the issuance of a new certificate. -13- SECTION 5. TRANSFER OF SHARES. Transfers of shares of beneficial interest of the Trust shall be made on the books of the Trust by the holder of record thereof (in person or by his attorney thereunto duly authorized by a power of attorney duly executed in writing and filed with the Secretary of the Trust) (i) if a certificate or certificates have been issued, upon the surrender of the certificate or certificates, properly endorsed or accompanied by proper instruments of transfer, representing such shares, or (ii) as otherwise prescribed by the Board of Trustees. Every certificate exchanged, surrendered for redemption or otherwise returned to the Trust shall be marked "Canceled" with the date of cancellation. SECTION 6. REGISTERED SHAREHOLDERS. The Trust shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, and to vote as such owner, and to hold liable for calls and assessments a person registered on its books as the owner of shares, and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by applicable law or the Declaration of Trust. SECTION 7. TRANSFER AGENTS AND REGISTRARS. The Board of Trustees may, from time to time, appoint or remove transfer agents and or registrars of the Trust, and they may appoint the same person as both transfer agent and registrar. Upon any such appointment being made, all certificates representing shares of beneficial interest thereafter issued shall be countersigned by such transfer agent and shall not be valid unless so countersigned. SECTION 8. STOCK LEDGER. The Trust shall maintain an original stock ledger containing the names and addresses of all shareholders and the number and class of shares held by each shareholder. Such stock ledger may be in written form or any other form capable of being converted into written form within reasonable time for visual inspection. ARTICLE VIII General Provisions SECTION 1. CUSTODIANSHIP. Except as otherwise provided by resolution of the Board of Trustees, the Trust shall place and at all times maintain in the -14- custody of a custodian (including any sub-custodian for the custodian) all funds, securities and similar investments owned by the Trust. Subject to the approval of the Board of Trustees, the custodian may enter into arrangements with securities depositories, provided such arrangements comply with the provisions of the Investment Company Act of 1940 and the rules and regulations promulgated thereunder. SECTION 2. EXECUTION OF INSTRUMENTS. All deeds, documents, transfers, contracts, agreements and other instruments requiring execution by the Trust shall be signed by the Chairman or President or a Vice President. SECTION 3. NET ASSET VALUE. The net asset value per share shall be determined separately as to each class of the Trust's shares, by dividing the sum of the total market value of the class's investments and other assets, less any liabilities, by the total outstanding shares of such class, subject to the Investment Company Act of 1940 and any other applicable Federal securities law or rule or regulation currently in effect. ARTICLE IX Amendments The Board of Trustees shall have the power to make, alter and repeal the Bylaws of the Trust. -15- EX-99.G 4 bbhcustagmt0807amd1007.txt CUSTODIAN AGREEMENT FOR BROWN BROTHERS HARRIMAN AMENDED AND RESTATED CUSTODIAN AGREEMENT THIS AMENDED AND RESTATED AGREEMENT, dated as of June 25, 2001, between certain open-end management investment companies (each investment company a "Fund") organized under the laws of the State of Delaware and registered with the Securities and Exchange Commission under the Investment Company Act of 1940 (the "1940 Act"), on behalf of certain of their series (each series a "Series"), and BROWN BROTHERS HARRIMAN & CO., a limited partnership formed under the laws of the State of New York (BBH&Co. or the Custodian), W I T N E S S E T H: WHEREAS, each Fund has employed BBH&Co. to act as the Fund's custodian and to provide related services, all as provided herein; WHEREAS, the Securities and Exchange Commission has promulgated amendments to Rule 17f-5 and adopted Rule 17f-7 under the 1940 Act that establish rules regarding the custody of investment company assets held outside the United States; and WHEREAS, BBH&Co. is willing to provide services in connection with such Rules in accordance with the terms of this Amended Custodian Agreement; NOW, THEREFORE, in consideration of the mutual covenants and agreements herein contained, each Fund and BBH&Co. hereby agree, as follows: 1. APPOINTMENT OF CUSTODIAN. The Fund hereby appoints BBH&Co. as the Fund's custodian, and BBH&Co. hereby accepts such appointment. All Investments of the Fund delivered to the Custodian or its agents or Subcustodians shall be dealt with as provided in this Agreement. The duties of the Custodian with respect to the Fund's Investments shall be set forth expressly in this Agreement and any addenda thereto which duties are generally comprised of safekeeping and various administrative duties that will be performed in accordance with Instructions and as reasonably required to effect Instructions. 2. REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE FUND. The Fund hereby represents, warrants and covenants each of the following: 2.1 This Agreement has been, and at the time of delivery of each Instruction such Instruction will have been, duly authorized, executed and delivered by the Fund. This Agreement does not violate any Applicable Law or conflict with or constitute a default under the Fund's prospectus or other organic document, agreement, judgment, order or decree to which the Fund is a party or by which it or its Investments is bound. The Fund is and will be in compliance with all laws and regulations applicable to its operations, investments or activities. 2.2 By providing an Instruction with respect to the first acquisition of an Investment in a jurisdiction other than the United States of America, the Fund shall be deemed to have confirmed to the Custodian that the Fund has (a) assessed and accepted all material Country or Sovereign Risks and accepted responsibility for their occurrence, (b) made all determinations required to be made by the Fund under the 1940 Act, and (iii) appropriately and adequately disclosed to its shareholders, other investors and all persons who have rights in or to such Investments, all material investment risks, including those relating to the custody and settlement infrastructure or the servicing of securities in such jurisdiction. 2.3 The Fund shall safeguard and shall solely be responsible for the safekeeping of any testkeys, identification codes, passwords, other security devices or statements of account with which the Custodian provides it. In furtherance and not limitation of the foregoing, in the event the Fund utilizes any on-line service offered by the Custodian, the Fund and the Custodian shall be fully responsible for the security of each party's connecting terminal, access thereto and the proper and authorized use thereof and the initiation and application of continuing effective safeguards in respect thereof. Additionally, if the Fund uses any on-line or similar communications service made available by the Custodian, the Fund shall be solely responsible for ensuring the security of its access to the service and for the use of the service, and shall only attempt to access the service and the Custodian's computer systems as directed by the Custodian. If the Custodian provides any computer software to the Fund relating to the services described in this Agreement, the Fund will only use the software for the purposes for which the Custodian provided the software to the Fund, and will abide by the license agreement accompanying the software and any other security policies which the Custodian provides to the Fund. 3. REPRESENTATION AND WARRANTY OF BBH&CO. BBH&Co. hereby represents and warrants that this Agreement has been duly authorized, executed and delivered by BBH&Co. and does not and will not violate any Applicable Law or conflict with or constitute a default under BBH&Co.'s limited partnership agreement or any agreement, instrument, judgment, order or decree to which BBH&Co. is a party or by which it is bound. BBH&Co. also warrants that it will comply with all applicable laws and regulations in performance of its duties under this Agreement. 2 4. INSTRUCTIONS. Unless otherwise explicitly indicated herein, the Custodian shall perform its duties pursuant to Instructions. As used herein, the term Instruction shall mean a directive initiated by the Fund, acting directly or through its board of directors or trustees, officers or other Authorized Persons, which directive shall conform to the requirements of this Section 4. 4.1 AUTHORIZED PERSONS. For purposes hereof, an Authorized Person shall be a person or entity authorized to give Instructions for or on behalf of the Fund by written notices to the Custodian or otherwise in accordance with procedures delivered to the Custodian. The Custodian may treat any Authorized Person as having full authority of the Fund to issue Instructions hereunder unless the notice of authorization contains explicit limitations as to said authority. The Custodian shall be entitled to rely upon the authority of Authorized Persons until it receives appropriate written notice from the Fund to the contrary. 4.2 FORM OF INSTRUCTION. Each Instruction shall be transmitted by such secured or authenticated electro-mechanical means as the Custodian shall make available to the Fund from time to time unless the Fund shall elect to transmit such Instruction in accordance with Subsections 4.2.1 through 4.2.3 of this Section. 4.2.1 Fund Designated Secured-Transmission Method. Instructions may be transmitted through a secured or tested electro-mechanical means identified by the Fund or by an Authorized Person entitled to give Instruction and acknowledged and accepted by the Custodian; it being understood that such acknowledgment shall authorize the Custodian to receive and process such means of delivery but shall not represent a judgment by the Custodian as to the reasonableness or security of the method determined by the Authorized Person. 4.2.2 Written Instructions. Instructions may be transmitted in a writing that bears the manual signature of Authorized Persons. 4.2.3 Other Forms of Instruction. Instructions may also be transmitted by another means determined by the Fund or Authorized Persons and acknowledged and accepted by the Custodian (subject to the same limits as to acknowledgements as is contained in Subsection 4.2.1, above) including Instructions given orally or by SWIFT, telex or telefax (whether tested or untested). 3 When an Instruction is given by means established under Subsections 4.2.1 through 4.2.3, it shall be the responsibility of the Custodian to use reasonable care to adhere to any security or other procedures established in writing between the Custodian and the Authorized Person with respect to such means of Instruction, but such Authorized Person shall be solely responsible for determining that the particular means chosen is reasonable under the circumstances. If the Custodian believes that the means chosen are unreasonable, it shall promptly notify an Authorized Person. Oral Instructions shall be binding upon the Custodian only if and when an Authorized Person provides Instructions that conform to the requirements of this Section 4. Any Oral Instructions shall promptly thereafter be confirmed in writing by an Authorized Person (which confirmation may bear the facsimile signature of such Person). With respect to telefax Instructions, the parties agree and acknowledge that receipt of legible Instructions cannot be assured and that the Custodian cannot verify that authorized signatures on telefax Instructions are original or properly affixed. If the Custodian determines that a telefax Instruction is illegible, the Custodian shall promptly contact an Authorized Person and request a legible telefax Instruction. Provided the Custodian has exercised the standard of care required herein with respect to receipt of Proper Instructions including but not limited to any applicable security or authorization procedures, the Custodian shall not be liable for losses or expenses incurred through actions taken in reliance on inaccurately stated or unauthorized telefax Instructions. The provisions of Section 4A of the Uniform Commercial Code shall apply to Funds Transfers performed in accordance with Instructions. In the event that a Funds Transfer Services Agreement is executed between the Fund or an Authorized Person and the Custodian, such an agreement shall comprise a designation of form of a means of delivering Instructions for purposes of this Section 4.2. 4.3 COMPLETENESS AND CONTENTS OF INSTRUCTIONS. The Authorized Person shall be responsible for assuring the adequacy and accuracy of Instructions. Particularly, upon any acquisition or disposition or other dealing in the Fund's Investments and upon any delivery and transfer of any Investment or moneys, the person initiating such Instruction shall give the Custodian an Instruction with appropriate detail, including, without limitation: 4 4.3.1 The transaction date and the date and location of settlement; 4.3.2 The specification of the type of transaction; 4.3.4 A description of the Investments or moneys in question, including, as appropriate, quantity, price per unit, amount of money to be received or delivered and currency information. Where an Instruction is communicated by electronic means, or otherwise where an Instruction contains an identifying number such as a CUSIP, SEDOL or ISIN number, the Custodian shall be entitled to rely on such number as controlling notwithstanding any inconsistency contained in such Instruction, particularly with respect to Investment description. If the Custodian is aware of such an inconsistency in an Instruction, it shall give prompt notice of such inconsistency to an Authorized Person. 4.3.5 The name of the broker or similar entity concerned with execution of the transaction. If the Custodian shall reasonably determine that an Instruction, including a telefax Instruction, is either unclear or incomplete, the Custodian shall give prompt notice of such determination to the Fund, and the Fund shall thereupon amend or otherwise reform such Instruction. In such event, the Custodian shall have no obligation to take any action in response to the Instruction initially delivered until the redelivery of an amended or reformed Instruction 4.4 TIMELINESS OF INSTRUCTIONS. In giving an Instruction, the Fund shall take into consideration delays which may occur due to the involvement of a Subcustodian or agent, differences in time zones, and other factors particular to a given market, exchange or issuer. When the Custodian has established specific timing requirements or deadlines with respect to particular classes of Instruction and the Custodian has notified the Fund of such timing requirements and deadlines, or when an Instruction is received by the Custodian at such a time that it could not reasonably be expected to have acted on such Instruction due to time zone differences or other factors beyond its reasonable control, the execution of any Instruction received by the Custodian after such deadline or at such time (including any modification or revocation of a previous Instruction) shall be at the risk of the Fund. 5 5. SAFEKEEPING OF FUND ASSETS. The Custodian shall hold Investments delivered to it or Subcustodians for the Fund in accordance with the provisions of this Section. The Custodian will identify the Investments on its books as belonging to each individual Series. The Custodian shall not be responsible for (a) the safekeeping of Investments not delivered or that are not caused to be issued to it or its Subcustodians; or, (b) pre-existing faults or defects in Investments that are delivered to the Custodian, or its Subcustodians. The Custodian or Subcustodian shall give prompt notice to the Fund of any pre-existing faults or defects that it is aware of. The Custodian is hereby authorized to hold with itself or a Subcustodian, and to record in one or more accounts, all Investments delivered to and accepted by the Custodian, any Subcustodian or their respective agents pursuant to an Instruction or in consequence of any corporate action. Each such account is a "Securities Account" (as such term is defined in the Uniform Commercial Code as in effect from time to time in the State of New York (the "UCC"). The Custodian shall hold Investments for the account of the Fund and shall segregate Investments from assets belonging to the Custodian and shall cause its Subcustodians to segregate Investments from assets belonging to the Subcustodian in an account held for the Fund or in an account maintained by the Subcustodian generally for non-proprietary assets of the Custodian. The parties acknowledge that the Custodian and Subcustodians each are acting under this Agreement as a "Securities Intermediary" (as such term is used and defined in the UCC). For the purposes of this Agreement, the parties hereto acknowledge and agree that (i) any Investment held by the Custodian or any Subcustodian shall constitute a "Financial Asset" (as such term is used and defined in the UCC), (ii) the Fund may at any time issue one or more "Entitlement Orders" (as such term is used and defined in the UCC) with respect to the Fund's Investments, (iii) upon the Custodian's or Subcustodian's receipt of an Investment for the benefit of the Fund, the Custodian or Subcustodian, as the case may be, shall credit to the Fund a "Security Entitlement" (as such term is used and defined in the UCC), and (iv) the Fund shall have a Security Entitlement with respect to all Investments held by the Custodian or Subcustodian. 6 5.1 USE OF SECURITIES DEPOSITORIES. The Custodian may deposit and maintain Investments in any Securities Depository, either directly or through one or more Subcustodians appointed by the Custodian. Investments held in a Securities Depository shall be held (a) subject to the agreement, rules, statement of terms and conditions or other document or conditions effective between the Securities Depository and the Custodian or the Subcustodian, as the case may be, and (b) in an account for the Fund or in bulk segregation in an account maintained for the non-proprietary assets of the entity holding such Investments in the Depository. If market practice or the rules and regulations of the Securities Depository prevent the Custodian, the Subcustodian or (any agent of either) from holding its client assets in such a separate account, the Custodian, the Subcustodian or other agent shall as appropriate segregate such Investments for the benefit of the Fund or for benefit of clients of the Custodian generally on its own books. 5.2 CERTIFICATED ASSETS. Investments which are certificated may be held in registered or bearer form: (a) in the Custodian's vault; (b) in the vault of a Subcustodian or agent of the Custodian or a Subcustodian; or (c) in an account maintained by the Custodian, Subcustodian or agent at a Securities Depository; all in accordance with customary market practice in the jurisdiction in which any Investments are held. 7 5.3 REGISTERED ASSETS. Investments which are registered may be registered in the name of the Custodian, a Subcustodian, or in the name of the Fund or a nominee for any of the foregoing, and may be held in any manner set forth in paragraph 5.2 above with or without any identification of fiduciary capacity in such registration. 5.4 BOOK ENTRY ASSETS. Investments which are represented by book-entry may be so held in an account maintained by the Book-Entry Agent on behalf of the Custodian, a Subcustodian or another agent of the Custodian, or a Securities Depository. 5.5 REPLACEMENT OF LOST INVESTMENTS. In the event of a loss of Investments for which the Custodian is responsible under the terms of this Agreement, the Custodian shall promptly replace such Investment, or in the event that such replacement cannot be effected, the Custodian shall pay to the Fund the fair market value of such Investment based on the last available price as of the close of business in the relevant market on the date that a claim was first made to the Custodian with respect to such loss. 6. ADMINISTRATIVE DUTIES OF THE CUSTODIAN. The Custodian shall perform the following administrative duties with respect to Investments of the Fund. 6.1 PURCHASE OF INVESTMENTS. Pursuant to Instruction, Investments purchased for the account of the Fund shall be paid for (a) against delivery thereof to the Custodian or a Subcustodian, as the case may be, either directly or through a Clearing Corporation or a Securities Depository (in accordance with the rules of such Securities Depository or such Clearing Corporation), or (b) otherwise in accordance with an Instruction, Applicable Law, generally accepted trade practices, or the terms of the instrument representing such Investment. 6.2 SALE OF INVESTMENTS. Pursuant to Instruction, Investments sold for the account of the Fund shall be delivered (a) against payment therefor in cash, by check or by bank wire transfer, (b) by credit to the account of the Custodian or the applicable Subcustodian, as the case may be, with a Clearing Corporation or a Securities Depository (in accordance with the rules of such Securities Depository or such Clearing Corporation), or (c) otherwise in accordance with an Instruction, Applicable Law, generally accepted trade practices, or the terms of the instrument representing such Investment. 8 6.3 DELIVERY IN CONNECTION WITH BORROWINGS OF THE FUND OR OTHER COLLATERAL AND MARGIN REQUIREMENTS. Pursuant to Instruction, the Custodian may deliver Investments or cash of the Fund in connection with borrowings and other collateral and margin requirements. 6.4 FUTURES AND OPTIONS. If, pursuant to an Instruction, the Custodian shall become a party to an agreement with the Fund and a futures commission merchant regarding margin (Tri-Party Agreement), the Custodian shall (a) receive and retain, to the extent the same are provided to the Custodian, confirmations or other documents evidencing the purchase or sale by the Fund of exchange-traded futures contracts and commodity options, (b) when required by such Tri-Party Agreement, deposit and maintain in an account opened pursuant to such Agreement (Margin Account), segregated either physically or by book-entry in a Securities Depository for the benefit of any futures commission merchant, such Investments as the Fund shall have designated as initial, maintenance or variation "margin" deposits or other collateral intended to secure the Fund's performance of its obligations under the terms of any exchange-traded futures contracts and commodity options; and (c) thereafter pay, release or transfer Investments into or out of the Margin Account in accordance with the provisions of the such Agreement. Alternatively, the Custodian may deliver Investments, in accordance with an Instruction, to a futures commission merchant for purposes of margin requirements in accordance with Rule 17f-6. The Custodian shall in no event be responsible for but shall give prompt notice to the Fund in the event it becomes aware of the acts and omissions of any futures commission merchant to whom Investments are delivered pursuant to this Section; for the sufficiency of Investments held in any Margin Account; or, for the performance of any terms of any exchange-traded futures contracts and commodity options. 6.5 CONTRACTUAL OBLIGATIONS AND SIMILAR INVESTMENTS. From time to time, the Fund's Investments may include Investments that are not ownership interests as may be represented by certificate (whether registered or bearer), by entry in a Securities Depository or by book entry agent, registrar or similar agent for recording ownership interests in the relevant Investment. If the Fund shall at any time acquire such Investments, including without limitation deposit obligations, loan participations, repurchase agreements and derivative arrangements, the Custodian shall (a) receive and retain, to the extent the same are provided to the Custodian, confirmations or other documents evidencing the arrangement; and (b) perform on the Fund's account in accordance with the terms of the applicable arrangement, but only to the extent directed to do so by Instruction. The Custodian shall have no responsibility for agreements running to the Fund as to which it is not a party other than to retain, to the extent the same are provided to the Custodian, documents or copies of documents evidencing the arrangement and, in accordance with Instruction, to include such arrangements in reports made to the Fund. 9 6.6 EXCHANGE OF SECURITIES. Unless otherwise directed by Instruction, the Custodian shall: (a) exchange securities held for the account of the Fund for other securities in connection with any reorganization, recapitalization, conversion, split-up, change of par value of shares or similar event, and (b) deposit any such securities in accordance with the terms of any reorganization or protective plan. 6.7 SURRENDER OF SECURITIES. Unless otherwise directed by Instruction, the Custodian may surrender securities: (a) in temporary form for definitive securities; (b) for transfer into the name of an entity allowable under Section 5.3; and (c) for a different number of certificates or instruments representing the same number of shares or the same principal amount of indebtedness. 6.8 RIGHTS, WARRANTS, ETC. Pursuant to Instruction, the Custodian shall (a) deliver warrants, puts, calls, rights or similar securities to the issuer or trustee thereof, or to any agent of such issuer or trustee, for purposes of exercising such rights or selling such securities, and (b) deposit securities in response to any invitation for the tender thereof. 6.9 MANDATORY CORPORATE ACTIONS. Unless otherwise directed by Instruction, the Custodian shall: (a) comply with the terms of all mandatory or compulsory exchanges, calls, tenders, redemptions or similar rights of securities ownership affecting securities held on the Fund's account and promptly notify the Fund of such action, and (b) collect all stock dividends, rights and other items of like nature with respect to such securities. 6.10 INCOME COLLECTION. Unless otherwise directed by Instruction, the Custodian shall collect any amount due and payable to the Fund with respect to Investments and promptly credit the amount collected to a Principal or Agency Account; provided, however, that the Custodian shall not be responsible for: (a) the collection of amounts due and payable with respect to Investments that are in default, or (b) the collection of cash or share entitlements with respect to Investments that are not registered in the name of the Custodian or its Subcustodians. The Custodian is hereby authorized to endorse and deliver any instrument required to be so endorsed and delivered to effect collection of any amount due and payable to the Fund with respect to Investments. 10 6.11 OWNERSHIP CERTIFICATES AND DISCLOSURE OF THE FUND'S INTEREST. The Custodian is hereby authorized to execute on behalf of the Fund ownership certificates, affidavits or other disclosure required under Applicable Law or established market practice in connection with the receipt of income, capital gains or other payments by the Fund with respect to Investments, or in connection with the sale, purchase or ownership of Investments. 6.12 PROXY MATERIALS. The Custodian shall deliver, or cause to be delivered promptly, to the Fund proxy forms, notices of meeting, and any other notices or announcements materially affecting or relating to Investments received by the Custodian or any nominee. 6.13 TAX RECLAIM SERVICE. The Custodian will apply for a reduction of withholding tax and any refund of any tax paid or tax credits which apply in each applicable market in respect of income payments on Investments for the benefit of the Fund which the Custodian believes may be available to such Fund. Where such reports are available, the Custodian shall periodically report to the Fund concerning the making of applications for a reduction of withholding tax and refund of any tax paid or tax credits which apply in each applicable market in respect of income payments on Investments for the benefit of the Fund. The provision of tax reclaim services by the Custodian is conditional upon the Custodian receiving from the Fund or, where required, the beneficial owner of Investments (a) a declaration of its identity and place of residence and (b) certain other documentation (pro forma copies of which are available from the Custodian). The Custodian shall use reasonable means to advise the Fund of the declarations, documentation and information which the Fund is to provide to the Custodian in order for the Custodian to provide the tax reclaim services described herein. The Fund shall provide to the Custodian such documentation and information as it may require in connection with taxation, and warrants that, when given, this information shall be true and correct in every respect, not misleading in any way, and contain all material information. The Fund undertakes to notify the Custodian immediately if any such information requires updating or amendment. The Custodian shall perform tax reclaim services only with respect to taxation by the revenue authorities of the countries notified to the Fund. 11 The Fund confirms that the Custodian is authorized to deduct from any cash received or credited to an account any taxes or levies required by any revenue or governmental authority for whatever reasons in respect of the accounts. The Custodian and the Fund shall promptly notify the other regarding any change in the Fund's tax status with respect to withholding taxes of which it becomes aware. It is acknowledged that the Custodian does not offer tax advice and that the Fund should consult with its tax adviser as to tax matters. 6.14 OTHER DEALINGS. The Custodian shall otherwise act as directed by Instruction, including without limitation effecting the free payments of moneys or the free delivery of securities, provided that such Instruction shall indicate the purpose of such payment or delivery and that the Custodian shall record the party to whom such payment or delivery is made. The Custodian shall attend to all nondiscretionary details in connection with the sale or purchase or other administration of Investments, except as otherwise directed by an Instruction. In fulfilling the duties set forth in Sections 6.6 through 6.10 above, the Custodian shall provide promptly to the Fund all material information pertaining to a corporate action which the Custodian actually receives. The Custodian shall not be responsible for the completeness or accuracy of such information as long as the Custodian has shown due diligence in attempting to receive complete and accurate information. Any advance credit of cash or shares expected to be received as a result of any corporate action shall be subject to actual collection and may, when the Custodian deems collection unlikely, be reversed by the Custodian. The Custodian shall notify the Fund at least 48 hours prior to any such reversal. The Custodian may at any time or times in its discretion appoint (and may at any time remove) agents (other than Subcustodians) to carry out some or all of the administrative provisions of this Agreement (Agents), provided, however, that the appointment of such agent shall not relieve the Custodian of its administrative obligations under this Agreement. 12 7. CASH ACCOUNTS, DEPOSITS AND MONEY MOVEMENTS. Subject to the terms and conditions set forth in this Section 7, the Fund hereby authorizes the Custodian to open and maintain, with itself or with Subcustodians, cash accounts in United States Dollars, in such other currencies as are the currencies of the countries in which the Fund maintains Investments or in such other currencies as the Fund shall from time to time request by Instruction. 7.1 TYPES OF CASH ACCOUNTS. Cash accounts opened on the books of the Custodian (Principal Accounts) shall be opened in the name of the Fund. Such accounts collectively shall be a deposit obligation of the Custodian and shall be subject to the terms of this Section 7 and the general liability provisions contained in Section 9. Cash accounts opened on the books of a Subcustodian may be opened in the name of the Fund or the Custodian or in the name of the Custodian for its customers generally (Agency Accounts). Such deposits shall be obligations of the Subcustodian and shall be treated as an Investment of the Fund. Accordingly, the Custodian shall be responsible for exercising reasonable care in the administration of such accounts but shall not be liable for their repayment in the event such Subcustodian, by reason of its bankruptcy, insolvency or sovereign risk/force majeure, fails to make repayment unless (a) such Subcustodian is a parent, subsidiary or otherwise affiliated with the Custodian or (b) the Custodian's negligence, bad faith or willful misconduct was the direct cause of the Subcustodian failing to make the repayment or (c) a transaction or other matter between the Custodian and Subcustodian unrelated to the Funds was the cause of the Subcustodian failing to make repayment. Under (a), (b) or (c) the Custodian shall be liable for the repayment. 13 7.2 PAYMENTS AND CREDITS WITH RESPECT TO THE CASH ACCOUNTS. The Custodian shall make payments from or deposits to any of said accounts in the course of carrying out its administrative duties, including but not limited to income collection with respect to the Fund's Investments, and otherwise in accordance with Instructions. The Custodian and its Subcustodians shall be required to credit amounts to the cash accounts only when moneys are actually received in cleared funds in accordance with banking practice in the country and currency of deposit. Any credit made to any Principal or Agency Account before actual receipt of cleared funds shall be provisional and may be reversed by the Custodian in the event such payment is not actually collected. The Custodian shall provide the Fund with at least 48 hours notice prior to any such reversal. Unless otherwise specifically agreed in writing by the Custodian or any Subcustodian, all deposits shall be payable only at the branch of the Custodian or Subcustodian where the deposit is made or carried. 7.3 CURRENCY AND RELATED RISKS. The Fund bears risks of holding or transacting in any currency. The Custodian shall not be liable for any loss or damage arising from the applicability of any law or regulation now or hereafter in effect, or from the occurrence of any event, which may delay or affect the transferability, convertibility or availability of any currency in the country (a) in which such Principal or Agency Accounts are maintained or (b) in which such currency is issued, and in no event shall the Custodian be obligated to make payment of a deposit denominated in a currency during the period during which its transferability, convertibility or availability has been affected by any such law, regulation or event. The Custodian shall notify the Fund in the event it is aware that the Fund is entering into a transaction that is, to its knowledge, illegal under local law. Without limiting the generality of the foregoing, neither the Custodian nor any Subcustodian shall be required to repay any deposit made at a foreign branch of either the Custodian or Subcustodian if such branch cannot repay the deposit due to a cause for which the Custodian would not be responsible in accordance with the terms of Section 9 of this Agreement unless the Custodian or such Subcustodian expressly agrees in writing to repay the deposit under such circumstances. All currency transactions in any account opened pursuant to this Agreement are subject to exchange control regulations of the United States and of the country where such currency is the lawful currency or where the account is maintained. Any taxes, costs, charges or fees imposed on the convertibility of a currency held by the Fund shall be for the account of the Fund unless such taxes, costs, charges or fees were due to an error by the Custodian or Subcustodian. 14 7.4 FOREIGN EXCHANGE TRANSACTIONS. The Custodian shall, subject to the terms of this Section, settle foreign exchange transactions (including contracts, futures, options and options on futures) on behalf and for the account of the Fund with such currency brokers or banking institutions, including Subcustodians, as the Fund may direct pursuant to Instructions. The Custodian may act as principal in any foreign exchange transaction with the Fund in accordance with Section 7.4.2 of this Agreement. The obligations of the Custodian in respect of all foreign exchange transactions (whether or not the Custodian shall act as principal in such transaction) shall be contingent on the free, unencumbered transferability of the currency transacted on the actual settlement date of the transaction. 7.4.1 THIRD PARTY FOREIGN EXCHANGE TRANSACTIONS. The Custodian shall process foreign exchange transactions (including without limitation contracts, futures, options, and options on futures), where any third party acts as principal counterparty to the Fund on the same basis it performs duties as agent for the Fund with respect to any other of the Fund's Investments. Accordingly the Custodian shall only be responsible for delivering or receiving currency on behalf of the Fund in respect of such contracts pursuant to Instructions. The Custodian shall not be responsible for the failure of any counterparty (including any Subcustodian) in such agency transaction to perform its obligations thereunder unless (a) such counterparty is a parent, subsidiary or otherwise affiliated with the Custodian or (b) the Custodian's negligence, bad faith or willful misconduct was the direct cause of the counterparty failing to perform its obligations or (c) a transaction or other matter between the Custodian and the counterparty unrelated to the Funds was the cause of the counterparty's failure to perform. Under (a), (b) or (c) , the Custodian shall be liable. The Custodian (a) shall transmit cash and Instructions to and from the currency broker or banking institution with which a foreign exchange contract or option has been executed pursuant hereto, (b) may make free outgoing payments of cash in the form of Dollars or foreign currency without receiving confirmation of a foreign exchange contract or option or confirmation that the countervalue currency completing the foreign exchange contract has been delivered or received or that the option has been delivered or received, and (c) shall hold all confirmations, certificates and other documents and agreements received by the Custodian and evidencing or relating to such foreign exchange transactions in safekeeping. The Fund accepts full responsibility for its use of third-party foreign exchange dealers and for execution of said foreign exchange contracts and options and understands that the Fund shall be responsible for any and all costs and interest charges which may be incurred by the Fund or the Custodian as a result of the failure or delay of third parties to deliver foreign exchange. The Custodian or Subcustodian shall respectively be responsible for any failure or delay of third parties to deliver foreign exchange when either of those parties respectively is a parent, subsidiary or otherwise affiliated with such third party. 15 7.4.2 FOREIGN EXCHANGE WITH THE CUSTODIAN AS PRINCIPAL. The Custodian may undertake foreign exchange transactions with the Fund as principal as the Custodian and the Fund may agree from time to time. In such event, the foreign exchange transaction will be performed in accordance with the particular agreement of the parties, or in the event a principal foreign exchange transaction is initiated by Instruction in the absence of specific agreement, such transaction will be performed in accordance with the usual commercial terms of the Custodian. 7.5 DELAYS. If no event of Force Majeure shall have occurred and be continuing and in the event that a delay shall have been caused by the negligence, bad faith or willful misconduct of the Custodian in carrying out an Instruction to credit or transfer cash, the Custodian shall be liable to the Fund: (a) with respect to Principal Accounts, for interest to be calculated at the rate customarily paid on such deposit and currency by the Custodian on overnight deposits at the time the delay occurs for the period from the day when the transfer should have been effected until the day it is in fact effected; and, (b) with respect to Agency Accounts, for interest to be calculated at the rate customarily paid on such deposit and currency by the Subcustodian on overnight deposits at the time the delay occurs for the period from the day when the transfer should have been effected until the day it is in fact effected. The Custodian shall not be liable for delays in carrying out such Instructions to transfer cash which are not due to the Custodian's own negligence, bad faith or willful misconduct. The Custodian shall make reasonable attempts where possible to mitigate any such delays. 16 7.6 ADVANCES. If, for any reason in the conduct of its safekeeping duties pursuant to Section 5 hereof or its administration of the Fund's assets pursuant to Section 6 hereof, the Custodian or any Subcustodian advances monies to facilitate settlement or otherwise for benefit of the Fund (whether or not any Principal or Agency Account shall be overdrawn either during, or at the end of, any Business Day), Fund hereby does: 7.6.1 grant to the Custodian a continuing security interest in certain Investments (as mutually agreed from time to time) as security for such Advance, such security interest to be effective only as long as such Advance remain outstanding; and, 7.6.2 agree that the Custodian may secure the resulting Advance by perfecting a security interest in such Investments under Applicable Law. The Custodian shall promptly notify the Fund of any such Advances and the time at which such Advances must be repaid. Such Advances shall be deemed a loan payable on demand, bearing interest at the rate customarily charged by the Custodian on similar loans. Neither the Custodian nor any Subcustodian shall be obligated to advance monies to the Fund, and in the event that such Advance occurs, any transaction giving rise to an Advance shall be for the account and risk of the Fund and shall not be deemed to be a transaction undertaken by the Custodian for its own account and risk. If such Advance shall have been made by a Subcustodian or any other person, the Custodian may assign any rights granted to the Custodian hereunder to such Subcustodian or other person. If the Fund shall fail to repay when due the principal balance of an Advance and accrued and unpaid interest thereon, the Custodian or its assignee, as the case may be, shall be entitled to utilize the available cash balance in the applicable Series Agency or Principal Account and to dispose of any agreed upon Investments to the extent necessary to recover payment of all principal of, and interest on, such Advance in full. The Custodian may assign any rights it has hereunder to a Subcustodian or third party. Any security interest in Investments taken hereunder shall be treated as Financial Assets credited to Securities Accounts under Articles 8 and 9 of the UCC. Accordingly, the Custodian shall have the rights and benefits of a secured creditor that is a Securities Intermediary under such Articles 8 and 9. 17 7.7 INTEGRATED ACCOUNT. For purposes hereof, deposits maintained in all Principal Accounts for each Series of each Fund (whether or not denominated in Dollars) shall collectively constitute a single and indivisible current account with respect to that Series' obligations to the Custodian, or its assignee, and balances in such Principal Accounts shall be available for satisfaction of that Series' obligations under this Section 7. The Custodian shall further have a right of offset against the balances in any Agency Account maintained hereunder to the extent that the aggregate of all Principal Accounts is overdrawn. 8. SUBCUSTODIANS AND SECURITIES DEPOSITORIES. Subject to the provisions hereinafter set forth in this Section 8, the Fund hereby authorizes the Custodian to utilize Securities Depositories to act on behalf of the Fund and to appoint from time to time and to utilize Subcustodians. With respect to securities and funds held by a Subcustodian, either directly or indirectly (including by a Securities Depository or Clearing Corporation), notwithstanding any provisions of this Agreement to the contrary, payment for securities purchased and delivery of securities sold may be made prior to receipt of securities or payment, respectively, and securities or payment may be received in a form, in accordance with (a) governmental regulations, (b) rules of Securities Depositories and clearing agencies, (c) generally accepted trade practice in the applicable local market, (d) the terms and characteristics of the particular Investment, or (e) the terms of Instructions. 8.1 DOMESTIC SUBCUSTODIANS AND SECURITIES DEPOSITORIES. The Custodian may deposit and/or maintain, either directly or through one or more agents appointed by the Custodian, Investments of the Fund in any Securities Depository in the United States, including The Depository Trust Company, provided such Depository meets applicable requirements of the Federal Reserve Bank or of the Securities and Exchange Commission. The Custodian may, at any time and from time to time, appoint any bank as defined in Section 2(a)(5) of the 1940 Act meeting the requirements of a custodian under Section 17(f) of the 1940 Act and the rules and regulations thereunder, to act on behalf of the Fund as a Subcustodian for purposes of holding Investments of the Fund in the United States. 18 8.2 FOREIGN SUBCUSTODIANS AND SECURITIES DEPOSITORIES. Unless instructed otherwise by the Fund, the Custodian may deposit and/or maintain non-U.S. Investments of the Fund in any non-U.S. Securities Depository provided such Securities Depository meets the requirements of an "eligible securities depository" under Rule 17f-7 promulgated under the 1940 Act, or any successor rule or regulation ("Rule 17f-7") or which by order of the Securities and Exchange Commission is exempted therefrom. Prior to the time that securities are placed with such depository, but subject to the provisions of Section 8.2.5 below, the Custodian shall have prepared an analysis of the custody risks associated with maintaining assets with the Securities Depository and shall have established a system to monitor such risks on a continuing basis in accordance with Subsection 8.2.3 of this Section. Additionally, the Custodian may, at any time and from time to time, appoint (a) any bank, trust company or other entity meeting the requirements of an "eligible foreign custodian" under Rule 17f-5 under the 1940 Act or which by order of the Securities and Exchange Commission is exempted therefrom, or (b) any bank as defined in Section 2(a)(5) of the 1940 Act meeting the requirements of a custodian under Section 17(f) of the 1940 Act and the rules and regulations thereunder, to act on behalf of the Fund as a Subcustodian for purposes of holding Investments of the Fund outside the United States. Such appointment of foreign Subcustodians shall be subject to approval of the Fund in accordance with Subsections 8.2.1 and 8.2.2 hereof, and the use of non-U.S. Securities Depositories shall be subject to the terms of Subsections 8.2.3, 8.2.4 and 8.2.5 hereof. An Instruction to open an account in a given country shall comprise authorization of the Custodian to hold assets in such country in accordance with the terms of this Agreement. The Custodian shall not be required to make independent inquiry as to the authorization of the Fund to invest in such country. 19 8.2.1 BOARD APPROVAL OF FOREIGN SUBCUSTODIANS. Unless and except to the extent that the Board has delegated to, and the Custodian has accepted delegation of, review of certain matters concerning the appointment of Subcustodians pursuant to Subsection 8.2.2, the Custodian shall, prior to the appointment of any Subcustodian for purposes of holding Investments of the Fund outside the United States, obtain written confirmation of the approval of the Board of Trustees or Directors of the Fund with respect to (a) the identity of a Subcustodian, and (b) the Subcustodian agreement which shall govern such appointment, such confirmation to be signed by an Authorized Person. Each such duly approved Subcustodian shall be listed on the Global Custody Network listing attached hereto as the same may from time to time be amended. 8.2.2 DELEGATION OF BOARD REVIEW OF SUBCUSTODIANS. From time to time, the Custodian may agree to perform certain reviews of Subcustodians and of Subcustodian Contracts as delegate of the Fund's Board. In such event, the Custodian's duties and obligations with respect to this delegated review will be performed in accordance with the terms of the attached 17f-5 Delegation Schedule to this Agreement. 8.2.3 MONITORING AND RISK ASSESSMENT OF SECURITIES DEPOSITORIES. Prior to the placement of any assets of the Fund with a Securities Depository, the Custodian: (a) shall provide to the Fund or its authorized representative an assessment of the custody risks associated with maintaining assets with such Securities Depository; and (b) shall have established a system to monitor the custody risks associated with maintaining assets with such Securities Depository on a continuing basis and to promptly notify the Fund or its Investment Adviser of any material changes in such risk. In performing its duties under this subsection, the Custodian shall use reasonable care, prudence and diligence and may rely on such reasonable sources of information as may be available including but not limited to: (i) published ratings; (ii) information supplied by a Subcustodian that is a participant in such Securities Depository; (iii) industry surveys or publications; (iv) information supplied by the depository itself, by its auditors (internal or external) or by the relevant Foreign Financial Regulatory Authority. It is acknowledged that information procured through some or all of these sources may not be independently verifiable by the Custodian and that direct access to Securities Depositories is limited in most circumstances. Accordingly, the Custodian shall not be responsible for errors or omissions in its duties hereunder provided that it has performed its monitoring and assessment duties with reasonable care. The risk assessment shall be provided to the Fund or its Investment Adviser by such means as the Custodian shall reasonably establish. Advice of material change in such assessment may be provided by the Custodian in the manner established as customary between the Fund and the Custodian for transmission of material market information. 8.2.4 WITHDRAWAL OF ASSETS FROM ELIGIBLE SECURITIES DEPOSITORY. If the Fund or its authorized representative determines that a custody arrangement with an Eligible Securities Depository no longer meets the requirements of Rule 17f-7(a), the Fund or its Investment Adviser shall Instruct the Custodian to remove the Fund's Assets from the Depository as soon as reasonably practicable. 20 8.2.5 SPECIAL TRANSITIONAL RULE. It is acknowledged that Rule 17f-7 has an effective date of July 1, 2001 and that the Custodian will require a period of time to fully prepare risk assessment information and to establish a risk monitoring system as provided in Subsection 8.2.3. Accordingly, until July 1, 2001, the Custodian shall use reasonable efforts to implement the measures required by Subsection 8.2.3, and shall in the interim provide to the Fund or its Investment Adviser the depository information customarily provided and shall promptly inform the Fund or its Investment Adviser of any material development affecting the custody risks associated with the maintenance of assets with a particular Securities Depository of which it becomes aware in the course of its general duties under this Agreement or from its duties under Subsection 8.2.3 as such duties have been implemented at any given time. 8.3 RESPONSIBILITY FOR SUBCUSTODIANS. Except as provided in the last sentence of this Section 8.3, the Custodian shall be liable to the Fund for any loss or damage to the Fund caused by or resulting from the acts or omissions of any Subcustodian to the extent that such acts or omissions would be deemed to be negligence, gross negligence, willful misconduct or bad faith in accordance with the terms of the relevant subcustodian agreement under the laws, circumstances and practices prevailing in the place where the act or omission occurred. The liability of the Custodian in respect of the countries and subcustodians listed on the attached Subcustodian Liability Appendix to this Agreement, as such Appendix may be amended from time to time, shall be subject to the additional condition that the Custodian actually recovers such loss or damage from the Subcustodian. 8.4 NEW COUNTRIES. The Fund shall be responsible for informing the Custodian sufficiently in advance of a proposed investment which is to be held in a country in which no Subcustodian is authorized to act in order that the Custodian shall, if it deems appropriate to do so, have sufficient time to establish a subcustodial arrangement in accordance herewith. In the event, however, the Custodian is unable to establish such arrangements prior to the time such Investment is to be acquired, the Custodian is authorized to designate at its discretion a local safekeeping agent, and the use of such local safekeeping agent shall be at the sole risk of the Fund, and accordingly the Custodian shall be responsible to the Fund for the actions of such agent if and only to the extent the Custodian shall have recovered from such agent for any damages caused the Fund by such agent. Notwithstanding the above, the Custodian shall be liable to the extent that (a) such local safekeeping agent is a parent, subsidiary or otherwise affiliated with the Custodian or (b) the Custodian's negligence, bad faith or willful misconduct is the direct cause of the local safekeeping agent failing to make the repayment or (c) a transaction or other matter between the Custodian and the local safekeeping agent unrelated to the Funds was the cause of the loss or damage. Under (a), (b) or (c) the Custodian shall be liable. 21 9. RESPONSIBILITY OF THE CUSTODIAN. In performing its duties and obligations hereunder, the Custodian shall use reasonable care under the facts and circumstances prevailing in the market where performance is effected. Subject to the specific provisions of this Section, the Custodian shall be liable for any direct damage incurred by the Fund in consequence of the Custodian's negligence, bad faith or willful misconduct. The Custodian hereby indemnifies the Fund and agrees to hold the Fund harmless from and against all claims and liabilities, including counsel fees and taxes, incurred or assessed against the Fund to the extent that such claim or liability arises from the negligence, gross negligence, bad faith or willful misconduct on the part of the Custodian itself. If a Fund gives written notice of claim to the Custodian, the Custodian shall promptly give a written response to the Fund. Not more than 30 days following the date of such response, unless the Custodian shall not be liable, the Custodian will pay the amount of such claim or reimburse the Fund for any payment made by the Fund in respect thereof. In no event shall the Custodian be liable hereunder for any special, indirect, punitive or consequential damages arising out of, pursuant to or in connection with this Agreement even if the Custodian has been advised of the possibility of such damages. It is agreed that the Custodian shall have no duty to assess the risks inherent in the Fund's Investments or to provide investment advice with respect to such Investments and that the Fund as principal shall bear any risks attendant to particular Investments such as failure of counterparty or issuer. The Custodian shall provide the Fund with its Market Practice Reports in respect of any foreign market where a Series shall place and maintain Investments. In addition, the Custodian shall provide the Fund with access to its Global Updates which address topical "market" events. 22 9.1 FORCE MAJEURE The Custodian shall not be responsible for any failure to perform its duties and correspondingly, shall not be liable for any loss, cost, damage or expense attributable to its failure to perform in consequence of a force majeure event. Force Majeure shall mean any circumstance or event which is beyond the reasonable control of the Custodian, a Subcustodian or any agent of the Custodian or a Subcustodian and which adversely affects the performance by the above parties, including any event caused by, arising out of or involving (a) an act of God, (b) accident, fire, water damage or explosion, (c) any third party computer, system or other equipment failure or malfunction caused by any computer virus or the malfunction or failure of any communications medium, (d) any third party interruption of the power supply or other utility service, (e) any strike or other work stoppage, whether partial or total, (f) any delay or disruption resulting from or reflecting the occurrence of any Sovereign Risk, (g) any disruption of, or suspension of trading in, the securities, commodities or foreign exchange markets, whether or not resulting from or reflecting the occurrence of any Sovereign Risk, (h) any encumbrance on the transferability of a currency or a currency position on the actual settlement date of a foreign exchange transaction, whether or not resulting from or reflecting the occurrence of any Sovereign Risk, or (i) any other cause similarly beyond the reasonable control of the Custodian, provided always that this shall not affect the Custodian's duty to indemnify the Fund for other losses, claims and liabilities for which the Custodian is bound to indemnify the Fund pursuant to Section 9. The Custodian and the Subcustodian shall take reasonable steps to mitigate additional damages. The Custodian shall notify the Fund when it becomes aware of a situation outlined above. The Fund shall not be responsible for temporary delays in the performance of its duties and obligations and correspondingly shall not be liable for any loss, cost, damage or expense attributable to such delay in consequence of a Force Majeure event as described above affecting the Fund's principal place of business operations or administration; provided always that this shall not affect the Fund's duty to indemnify the Custodian for losses, claims and liabilities for which the Fund is bound to indemnify the Custodian pursuant to Section 10. 9.2 Limitations of Performance. The Custodian shall not be responsible under this Agreement for any failure to perform its duties, and shall not be liable hereunder for any loss or damage in association with such failure to perform, for or in consequence of the following causes: 23 9.2.1 COUNTRY RISK. Country Risk shall mean, with respect to the acquisition, ownership, settlement or custody of Investments in a jurisdiction, all risks relating to, or arising in consequence of, systemic and markets factors affecting the acquisition, payment for or ownership of Investments including (a) the prevalence of crime and corruption, (b) the inaccuracy or unreliability of business and financial information, (c) the instability or volatility of banking and financial systems, or the absence or inadequacy of an infrastructure to support such systems, (d) custody and settlement infrastructure of the market in which such Investments are transacted and held, (e) the acts, omissions and operation of any Securities Depository, (f) the risk of the bankruptcy or insolvency of banking agents, counterparties to cash and securities transactions, registrars or transfer agents, and (g) the existence of market conditions which prevent the orderly execution or settlement of transactions or which affect the value of assets. The Custodian shall provide the Fund with its Market Practice Reports in respect of any foreign market where a Series shall place and maintain Investments. Such Market Practice Report may describe some of the Country Risks outlined above. In addition, the Custodian shall provide the Fund with access to its Global Updates which may describe some timely Country Risks outlined above. 9.2.2 SOVEREIGN RISK. Sovereign Risk shall mean, in respect of any jurisdiction, including the United States of America, where Investments are acquired or held hereunder or under a Subcustody Agreement, (a) any act of war, terrorism, riot, insurrection or civil commotion, (b) the imposition of any investment, repatriation or exchange control restrictions by any Governmental Authority, (c) the confiscation, expropriation or nationalization of any Investments by any Governmental Authority, whether de facto or de jure, (d) any devaluation or revaluation of the currency, (e) the imposition of taxes, levies or other charges affecting Investments, (f) any change in the Applicable Law, or (g) any other economic or political risk incurred or experienced. The Custodian shall provide the Fund with its Market Practice Reports in respect of any foreign market where a Series shall place and maintain Investments. Such Market Practice Report may describe some of the Sovereign Risks outlined above. In addition, the Custodian shall provide the Fund with access to its Global Updates which may describe some timely Sovereign Risks outlined above. 9.3. LIMITATIONS ON LIABILITY. The Custodian shall not be liable for any loss, claim, damage or other liability arising from the following causes: 9.3.1 FAILURE OF THIRD PARTIES. The failure of any third party including: (a) any issuer of Investments or book-entry or other agent of an issuer; (b) any counterparty with respect to any Investment, including any issuer of exchange-traded or other futures, option, derivative or commodities contract; (c) failure of an Investment Advisor, Foreign Custody Manager or other agent of the Fund; or (d) failure of other third parties similarly beyond the control or choice of the Custodian unless: (a) any such third party is a parent, subsidiary or otherwise affiliated with the Custodian or (b) the Custodian's negligence, bad faith or willful misconduct was the direct cause of the failure of the third party or (c) a transaction or other matter between the Custodian and the third party unrelated to the Funds was the cause of the failure of the third party. Under (a), (b) or (c) the Custodian shall be liable for the failure of such third party. 9.3.2 INFORMATION SOURCES. The Custodian may rely upon information received from issuers of Investments or agents of such issuers, information received from Subcustodians and from other commercially reasonable sources such as commercial data bases and the like, but shall not be responsible for specific inaccuracies in such information, provided that the Custodian has relied upon such information in good faith, or for the failure of any commercially reasonable information provider. 9.3.3 RELIANCE ON INSTRUCTION. Action by the Custodian or the Subcustodian in accordance with an Instruction, even when such action conflicts with, or is contrary to any provision of, the Fund's declaration of trust, certificate of incorporation or by-laws, Applicable Law, or actions by the trustees, directors or shareholders of the Fund. If the Custodian or Subcustodian is aware of any of the above, it shall promptly contact an officer of the Fund. 24 9.3.4 RESTRICTED SECURITIES. The limitations inherent in the rights, transferability or similar investment characteristics of a given Investment of the Fund. 10. INDEMNIFICATION. The Fund hereby indemnifies the Custodian and each Subcustodian, and their respective agents, nominees and the partners, employees, officers and directors, and agrees to hold each of them harmless from and against all claims and liabilities, including counsel fees and taxes, incurred or assessed against any of them in connection with the performance of this Agreement and any Instruction except to the extent that such claim or liability is the result of the negligence, bad faith or willful misconduct of the Custodian or Subcustodian. If a Subcustodian or any other person indemnified under the preceding sentence, gives written notice of claim to the Custodian, the Custodian shall promptly give written notice to the Fund. Not more than thirty days following the date of such notice, unless the Custodian shall be liable under Section 8 hereof in respect of such claim, the Fund will pay the amount of such claim or reimburse the Custodian for any payment made by the Custodian in respect thereof. 11. REPORTS AND RECORDS. The Custodian shall: 11.1 create and maintain records relating to the performance of its obligations under this Agreement; 11.2 make available to the Fund, its auditors, agents and employees, upon reasonable request and during normal business hours of the Custodian, all records maintained by the Custodian pursuant to Section 11.1 above, subject, however, to all reasonable security requirements of the Custodian then applicable to the records of its custody customers generally; and 11.3 make available to the Fund all Electronic Reports; it being understood that the Custodian shall not be liable hereunder for the inaccuracy or incompleteness thereof or for errors in any information included therein except to the extent that such inaccuracy, incompleteness or errors are the result of the Custodian's negligence, bad faith or willful misconduct. 25 All such reports and records shall, to the extent applicable, be maintained and preserved in conformity with the 1940 Act and the rules and regulations thereunder. The Fund shall examine all records, howsoever produced or transmitted, promptly upon receipt thereof and notify the Custodian promptly of any discrepancy or error therein. Unless the Fund delivers written notice of any such discrepancy or error within a reasonable time after its receipt thereof, such records shall be deemed to be true and accurate. It is understood that the Custodian now obtains and will in the future obtain information on the value of assets from outside sources which may be utilized in certain reports made available to the Fund. The Custodian deems such sources to be reliable but it is acknowledged and agreed that the Custodian does not verify nor represent nor warrant as to the accuracy or completeness of such information and accordingly shall be without liability in selecting and using such sources and furnishing such information as long as the Custodian has shown due diligence in attempting to receive complete and accurate information. 12. MISCELLANEOUS. 12.1 PROXIES, ETC. The Fund will promptly execute and deliver, upon request, such proxies, powers of attorney or other instruments as may be necessary or desirable for the Custodian to provide, or to cause any Subcustodian to provide, custody services. 12.2 ENTIRE AGREEMENT. Except as specifically provided herein, this Agreement constitutes the entire agreement between the Fund and the Custodian with respect to the subject matter hereof. Accordingly, this Agreement supersedes any custody agreement or other oral or written agreements heretofore in effect between the Fund and the Custodian with respect to the custody of the Fund's Investments. 12.3 WAIVER AND AMENDMENT. No provision of this Agreement may be waived, amended or modified, and no addendum to this Agreement shall be or become effective, or be waived, amended or modified, except by an instrument in writing executed by the party against which enforcement of such waiver, amendment or modification is sought; provided, however, that an Instruction shall, whether or not such Instruction shall constitute a waiver, amendment or modification for purposes hereof, be deemed to have been accepted by the Custodian when it commences actions pursuant thereto or in accordance therewith. 26 12.4 GOVERNING LAW AND JURISDICTION. THIS AGREEMENT SHALL BE CONSTRUED IN ACCORDANCE WITH, AND BE GOVERNED BY THE LAWS OF, THE STATE OF NEW YORK, WITHOUT GIVING EFFECT TO THE CONFLICTS OF LAW OF SUCH STATE. 12.5 NOTICES. Notices and other writings contemplated by this Agreement, other than Instructions, shall be delivered (a) by hand, (b) by first class registered or certified mail, postage prepaid, return receipt requested, (c) by a nationally recognized overnight courier or (d) by facsimile transmission, provided that any notice or other writing sent by facsimile transmission shall also be mailed, postage prepaid, to the party to whom such notice is addressed. All such notices shall be addressed, as follows: If to the Fund: Vanguard Group P.O. Box 2600 Valley Forge, PA 19482 Attn: Assistant Treasurer Telephone: (610) 669-6106 Facsimile (610) 669-6112 If to the Custodian: Brown Brothers Harriman & Co. 40 Water Street Boston, Massachusetts 02109 Attn: Manager, Investor Services Department Telephone: (617) 772-1818 Facsimile: (617) 772-2263, or such other address as the Fund or the Custodian may have designated in writing to the other. 27 12.6 HEADINGS. Paragraph headings included herein are for convenience of reference only and shall not modify, define, expand or limit any of the terms or provisions hereof. 12.7 COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which shall be deemed an original. This Agreement shall become effective when one or more counterparts have been signed and delivered by the Fund and the Custodian. 12.8 CONFIDENTIALITY. The parties hereto agree that each shall treat confidentially the terms and conditions of this Agreement and all information provided by each party to the other regarding its business and operations. All confidential information provided by a party hereto shall be used by any other party hereto solely for the purpose of rendering or obtaining services pursuant to this Agreement and, except as may be required in carrying out this Agreement, shall not be disclosed to any third party without the prior consent of such providing party. The foregoing shall not be applicable to any information that is publicly available when provided or thereafter becomes publicly available other than through a breach of this Agreement, or that is required to be disclosed by or to any bank examiner of the Custodian or any Subcustodian, any Regulatory Authority, any auditor of the parties hereto, or by judicial or administrative process or otherwise by Applicable Law. 12.9 COUNSEL. In fulfilling its duties hereunder, the Custodian shall be entitled to receive and act upon the advice of (i) counsel regularly retained by the Custodian in respect of such matters, (ii) counsel for the Fund or (iii) such counsel as the Fund and the Custodian may agree upon, with respect to all matters, and the Custodian shall be without liability for any action reasonably taken or omitted pursuant to such advice (except to the extent that such action was due to the Custodian's negligence, bad faith or willful misconduct). 28 13. DEFINITIONS. The following defined terms will have the respective meanings set forth below. 13.1 advance shall mean any extension of credit by or through the Custodian or by or through any Subcustodian and shall include amounts paid to third parties for the account of the Fund or in discharge of any expense, tax or other item payable by the Fund. 13.2 AGENCY ACCOUNT shall mean any deposit account opened on the books of a Subcustodian or other banking institution in accordance with Section 7.1. 13.3 AGENT shall have the meaning set forth in the last paragraph of Section 6. 13.4 APPLICABLE LAW shall mean with respect to each jurisdiction, all (a) laws, statutes, treaties, regulations, guidelines (or their equivalents); (b) orders, interpretations, licenses and permits; and (c) judgments, decrees, injunctions, writs, orders and similar actions by a court of competent jurisdiction; compliance with which is required or customarily observed in such jurisdiction. 13.5 AUTHORIZED PERSON shall mean any person or entity authorized to give Instructions on behalf of the Fund in accordance with Section 4.1. 13.6 BOOK-ENTRY AGENT shall mean an entity acting as agent for the issuer of Investments for purposes of recording ownership or similar entitlement to Investments, including without limitation a transfer agent or registrar. 13.7 CLEARING CORPORATION shall mean any entity or system established for purposes of providing securities settlement and movement and associated functions for a given market. 13.8 DELEGATION AGREEMENT shall mean any separate agreement entered into between the Custodian and the Fund or its authorized representative with respect to certain matters concerning the appointment and administration of Subcustodians delegated to the Custodian pursuant to Rule 17f-5 under the 1940 Act. 13.9 FOREIGN CUSTODY MANAGER shall mean the Fund's foreign custody manager appointed pursuant to Rule 17f-5 under the 1940 Act. 13.10 FOREIGN FINANCIAL REGULATORY AUTHORITY shall have the meaning given by Section 2(a)(50) of the 1940 Act. 13.11 FUNDS TRANSFER SERVICES AGREEMENT shall mean any separate agreement entered into between the Custodian and the Fund or its authorized representative with respect to certain matters concerning the processing of payment orders from Principal Accounts of the Fund. 13.12 INSTRUCTION(S) shall have the meaning assigned in Section 4. 13.13 INVESTMENT ADVISOR shall mean any investment advisor as defined in Section 202(a)(11) of the Investment Advisors Act of 1940. 13.14 INVESTMENTS shall mean any investment asset of the Fund, including without limitation securities, bonds, notes, and debentures as well as receivables, derivatives, contractual rights or entitlements and other intangible assets. 29 13.15 MARGIN ACCOUNT shall have the meaning set forth in Section 6.4 hereof. 13.16 PRINCIPAL ACCOUNT shall mean deposit accounts of the Fund carried on the books of BBH&Co. as principal in accordance with Section 7. 13.17 SAFEKEEPING ACCOUNT shall mean an account established on the books of the Custodian or any Subcustodian for purposes of segregating the interests of the Fund (or clients of the Custodian or Subcustodian) from the assets of the Custodian or any Subcustodian. 13.18 SECURITIES DEPOSITORY shall mean a central or book entry system or agency established under Applicable Law for purposes of recording the ownership and/or entitlement to investment securities for a given market that, if a foreign Securities Depository, meets the requirements of an "Eligible Securities Depository" as defined in Rule 17f-7 under the 1940 Act. 13.19 SUBCUSTODIAN shall mean each foreign bank appointed by the Custodian pursuant to Section 8, but shall not include Securities Depositories. 13.20 TRI-PARTY AGREEMENT shall have the meaning set forth in Section 6.4 hereof. 13.21 1940 Act shall mean the Investment Company Act of 1940. 14. COMPENSATION. The Fund agrees to pay to the Custodian for its services under this Agreement such amount as may be agreed upon in writing from time to time ("Fee Schedule"). 15. SEVERAL OBLIGATIONS OF THE FUNDS: With respect to any obligations of the Funds and their related accounts arising hereunder, the Custodian shall look for payment or satisfaction of any such obligation solely to the assets and property of the Fund and such accounts to which such obligation relates as though each investment company had separately contracted with the Custodian by separate written instrument with respect to each Fund and its accounts. The Custodian and each Subcustodian realize that the Fund is comprised of one or more Series. The Custodian and each Subcustodian agree that it will honor and abide by any and all Instructions or notices which the Custodian or Subcustodian may receive from time to time from the Fund with respect to designating, marking, allocating or otherwise attributing securities to or for the benefit of any one Series. 30 16. TERMINATION. This Agreement may be terminated by either party in accordance with the provisions of this Section. The provisions of this Agreement and any other rights or obligations incurred or accrued by any party hereto prior to termination of this Agreement shall survive any termination of this Agreement. This Agreement may be terminated as to one or more Funds (but less than all the Funds) by delivery of an amended List of Funds deleting all such Funds, in which case termination as to the deleted Funds shall take effect sixty days after the date of such delivery. The execution and delivery of an amended List of Funds which deletes one or more Funds, shall constitute a termination hereof only with respect to such deleted Funds, shall be governed by the provisions of Section 16.2 as to the identification of a successor custodian and the delivery of Investments of the Fund so deleted to such successor custodian, and shall not affect the obligations of the Custodian hereunder with respect to the other Funds set forth in the List of Funds, as amended from time to time. 16.1 Notice and Effect. This Agreement may be terminated by either party by written notice effective no sooner than sixty days following the date that notice to such effect shall be delivered to other party at its address set forth in paragraph 12.5 hereof. 16.2 SUCCESSOR CUSTODIAN. In the event of the appointment of a successor custodian, it is agreed that the Investments of the Fund held by the Custodian or any Subcustodian shall be delivered to the successor custodian in accordance with reasonable Instructions. The Custodian agrees to cooperate with the Fund in the execution of documents and performance of other actions necessary or desirable in order to facilitate the succession of the new custodian. If no successor custodian shall be appointed, the Custodian shall in like manner transfer the Fund's Investments in accordance with Instructions. 31 16.3 DELAYED SUCCESSION. If no Instruction has been given as of the effective date of termination, Custodian may at any time on or after such termination date and upon ten days written notice to the Fund either (a) deliver the Investments of the Fund held hereunder to the Fund at the address designated for receipt of notices hereunder; or (b) deliver any investments held hereunder to a bank or trust company having a capitalization of $2M USD equivalent and operating under the Applicable law of the jurisdiction where such Investments are located, such delivery to be at the risk of the Fund. In the event that Investments or moneys of the Fund remain in the custody of the Custodian or its Subcustodians after the date of termination owing to the failure of the Fund to issue Instructions with respect to their disposition or owing to the fact that such disposition could not be accomplished in accordance with such Instructions despite diligent efforts of the Custodian, the Custodian shall be entitled to compensation for its services with respect to such Investments and moneys during such period as the Custodian or its Subcustodians retain possession of such items and the provisions of this Agreement shall remain in full force and effect until disposition in accordance with this Section is accomplished. 32 IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to be duly executed as of the date first above written. By: /s/ Robert Snowden Assistant Treasurer On behalf of the Funds included on the List of Funds attached hereto BROWN BROTHERS HARRIMAN & CO. By: /s/ Stokley P. Towles Partner 33 LIST OF FUNDS SCHEDULE TO THE CUSTODIAN AGREEMENT BETWEEN CERTAIN OPEN-END MANAGEMENT INVESTMENT COMPANIES ("FUNDS") and BROWN BROTHERS HARRIMAN & CO. The following is a list of Funds and their Series for which the Custodian serves under an Amended Custodian Agreement dated as of June 25, 2001 (the "Agreement"): The following series of Vanguard International Equity Index Funds: Vanguard Emerging Markets Stock Index Fund Vanguard European Stock Index Fund Vanguard Pacific Stock Index Fund The following series of Vanguard Horizon Funds: Vanguard Global Asset Allocation Fund Vanguard Global Equity Fund The following series of Vanguard Tax-Managed Funds Vanguard Tax-Managed International Fund The following series of Vanguard Trustees' Equity Fund: Vanguard International Value Fund Vanguard Variable Insurance Funds-International Portfolio IN WITNESS WHEREOF, each of the parties hereto has caused this Schedule to be executed in its name and on behalf of such Funds. FUNDS BROWN BROTHERS HARRIMAN & CO. By: /s/ Robert Snowden By: /s/ Stokley P. Towles Name: Robert Snowden Name: Stokley P. Towles Title: Assistant Treasurer Title: Partner 34 17f-5 DELEGATION SCHEDULE By the terms of this Delegation Schedule between certain open-end management investment companies (each investment company, a "Fund") organized under the laws of the State of Delaware and registered with the Securities and Exchange Commission under the Investment Company Act of 1940 (the "1940 Act"), on behalf of certain of their series (each series a "Series"), each Fund hereby appoints BROWN BROTHERS HARRIMAN & CO., a New York limited partnership with an office in Boston, Massachusetts (the "Delegate") as its delegate to perform certain functions with respect to the custody of Fund Assets outside the United States. 1. Maintenance of Fund Assets Abroad. The Fund, acting through its Board or its duly authorized representative, hereby instructs Delegate pursuant to the terms of the Custodian Agreement to place and maintain the Fund's Assets in countries outside the United States in accordance with Instructions received from the Fund or the Fund's investment advisor. Such instruction shall represent a Proper Instruction under the terms of the Custodian Agreement. The Fund acknowledges that - (a) the Delegate shall perform services hereunder only with respect to the countries where it accepts Delegation as Foreign Custody Manager as indicated on the BBH Global Custody Network listing; (b) depending on conditions in the particular country, advance notice may be required before the Delegate shall be able to perform its duties hereunder in or with respect to such country (such advance notice to be reasonable in light of the specific facts and circumstances attendant to performance of duties in such country); and (c) nothing in this Delegation Schedule shall require the Delegate to provide delegated or custodial services in any country, and there may from time to time be countries as to which the Delegate determines it will not provide delegation services; such countries shall be indicated on the BBH Global Custody Network listing. 2. Delegation. Pursuant to the provisions of Rule 17f-5 under the 1940 Act as amended, the Board hereby delegates to the Delegate, and the Delegate hereby accepts such delegation and agrees to perform, only those duties set forth in this Delegation Schedule concerning the safekeeping of the Fund's Assets in each of the countries as to which it acts as the Board's delegate. The Delegate is hereby authorized to take such actions on behalf of or in the name of the Fund as are reasonably required to discharge its duties under this Delegation Schedule, including, without limitation, to cause the Fund's Assets to be placed with a particular Eligible Foreign Custodian in accordance herewith. The Fund confirms to the Delegate that the Fund or its investment adviser has considered the Sovereign Risk and prevailing Country Risk as part of its continuing investment decision process, including such factors as may be reasonably related to the systemic risk of maintaining the Fund's Assets in a particular country, including, but not limited to, financial infrastructure, prevailing custody and settlement systems and practices (including the use of any Compulsory Securities Depository), and the laws relating to the safekeeping and recovery of the Fund's Assets held in custody pursuant to the terms of the Custodian Agreement. 3. Selection of Eligible Foreign Custodian and Contract Administration. The Delegate shall perform the following duties with respect to the selection of Eligible Foreign Custodians and administration of certain contracts governing the Fund's foreign custodial arrangements: (a) Selection of Eligible Foreign Custodian. The Delegate shall place and maintain the Fund's Assets with an Eligible Foreign Custodian; provided that the Delegate shall have determined that the Fund's Assets will be subject to reasonable care based on the standards applicable to custodians in the relevant market after considering all factors relevant to the safekeeping of such assets including, without limitation: (i) The Eligible Foreign Custodian's practices, procedures, and internal controls, including, but not limited to, the physical protections available for certificated securities (if applicable), the controls and procedures for dealing with any Eligible Securities Depository, the method of keeping custodial records, and the security and data protection practices; (ii) Whether the Eligible Foreign Custodian has the requisite financial strength to provide reasonable care for the Fund's Assets; (iii) The Eligible Foreign Custodian's general reputation and standing; and (iv) Whether the Fund will have jurisdiction over and be able to enforce judgments against the Eligible Foreign Custodian, such as by virtue of the existence of any offices of such Eligible Foreign Custodian in the United States or such Eligible Foreign Custodian's appointment of an agent for service of process in the United States or consent to jurisdiction in the United States. 2 The Delegate shall be required to make the foregoing determination to the best of its knowledge and belief based only on information reasonably available to it. (b) Contract Administration. The Delegate shall cause that the foreign custody arrangements with an Eligible Foreign Custodian shall be governed by a written contract that the Delegate has determined will provide reasonable care for Fund assets based on the standards applicable to custodians in the relevant market. Each such contract shall, except as set forth in the last paragraph of this subsection (b), include provisions that provide: (i) For indemnification or insurance arrangements (or any combination of the foregoing) such that the Fund will be adequately protected against the risk of loss of Assets held in accordance with such contract; (ii) That the Fund's Assets will not be subject to any right, charge, security interest, lien or claim of any kind in favor of the Eligible Foreign Custodian or its creditors, except a claim of payment for their safe custody or administration or, in the case of cash deposits, liens or rights in favor of creditors of such Custodian arising under bankruptcy, insolvency or similar laws; (iii) That beneficial ownership of the Fund's Assets will be freely transferable without the payment of money or value other than for safe custody or administration; (iv) That adequate records will be maintained identifying the Fund's Assets as belonging to the Fund or as being held by a third party for the benefit of the Fund; (v) That the Fund's independent public accountants will be given access to those records described in (iv) above or confirmation of the contents of such records; and (vi) That the Fund will receive sufficient and timely periodic reports with respect to the safekeeping of the Fund's Assets, including, but not limited to, notification of any transfer to or from the Fund's account or a third party account containing the Fund's Assets. Such contract may contain, in lieu of any or all of the provisions specified in this Section 3 (b), such other provisions that the Delegate determines will provide, in their entirety, the same or a greater level of care and protection for the Fund's Assets as the specified provisions, in their entirety. 3 (c) Limitation to Delegated Selection. Notwithstanding anything in this Delegation Schedule to the contrary, the duties under this Section 3 shall apply only to Eligible Foreign Custodians selected by the Delegate and shall not apply to Securities Depositories or to any Eligible Foreign Custodian that the Delegate is directed to use pursuant to Section 7. 4. Monitoring. The Delegate shall establish a system to monitor at reasonable intervals (but at least annually) the appropriateness of maintaining the Fund's Assets with each Eligible Foreign Custodian that has been selected by the Delegate pursuant to Section 3 of this Delegation Schedule. The Delegate shall monitor the continuing appropriateness of placement of the Fund's Assets in accordance with the criteria established under Section 3(a) of this Delegation Schedule. The Delegate shall monitor the continuing appropriateness of the contract governing the Fund's arrangements in accordance with the criteria established under Section 3(b) of this Delegation Schedule. 5. Reporting. At least annually and more frequently as mutually agreed between the parties, the Delegate shall provide to the Fund's Board written reports specifying placement of the Fund's Assets with each Eligible Foreign Custodian selected by the Delegate pursuant to Section 3 of this Delegation Schedule and shall promptly report as to any material changes to such foreign custody arrangements. Delegate will prepare such a report with respect to any Eligible Foreign Custodian that the Delegate has been instructed to use pursuant to Section 7 only to the extent specifically agreed with respect to the particular situation. Upon request by the Fund, the Delegate will identify the name, address and principal place of business of any Eligible Foreign Custodian of the Fund's Investments and the name and address of the governmental agency or other regulatory authority that supervises or regulates such Eligible Foreign Custodian. 6. Withdrawal of Fund's Assets. If the Delegate determines that an arrangement with a specific Eligible Foreign Custodian selected by the Delegate under Section 3 of this Delegation Schedule no longer meets the requirements of said Section, Delegate shall withdraw the Fund's Assets from the non-complying arrangement as soon as reasonably practicable; provided, however, that if in the reasonable judgment of the Delegate, such withdrawal would require liquidation of any of the Fund's Assets or would materially impair the liquidity, value or other investment characteristics of the Fund's Assets, it shall be the duty of the Delegate to provide information regarding the particular circumstances and to act only in accordance with Proper Instructions of an Authorized Person with respect to such liquidation or other withdrawal. 4 7. Direction as to Eligible Foreign Custodian. Notwithstanding this Delegation Schedule, the Fund, acting through its Board or its other authorized representative, may direct the Delegate to place and maintain the Fund's Assets with a particular Eligible Foreign Custodian, including without limitation with respect to investment in countries as to which the Custodian will not provide delegation services. In such event, the Delegate will notify the Fund that the Delegate will not provide delegation services in that country. In addition, the Delegate shall be entitled to rely on any such instruction as a Proper Instruction under the terms of the Custodian Agreement and shall have no duties under this Delegation Schedule with respect to such arrangement save those that it may undertake specifically in writing with respect to each particular instance. 8. Standard of Care. In carrying out its duties under this Delegation Schedule, the Delegate agrees to exercise reasonable care, prudence and diligence such as a person having responsibility for safekeeping the Fund's Assets would exercise. 9. Representations. The Delegate hereby represents and warrants that it is a U.S. Bank and that this Delegation Schedule has been duly authorized, executed and delivered by the Delegate and is a legal, valid and binding agreement of the Delegate. The Fund hereby represents and warrants that its Board of Trustees has determined that it is reasonable to rely on the Delegate to perform the delegated responsibilities provided for herein and that this Delegation Schedule has been duly authorized, executed and delivered by the Fund and is a legal, valid and binding agreement of the Fund. 10. Effectiveness; termination. This Delegation Schedule shall be effective as of the date on which this Delegation Schedule shall have been accepted by the Delegate, as indicated by the date set forth below the Delegate's signature. This Delegation Schedule may be terminated at any time, without penalty, by written notice from the terminating party to the non-terminating party. Such termination shall be effective on the 60th day following the date on which the non-terminating party shall receive the foregoing notice. The foregoing to the contrary notwithstanding, this Delegation Schedule shall be deemed to have been terminated concurrently with the termination of the Custodian Agreement. 5 11. Notices. Notices and other communications under this Delegation Schedule are to be made in accordance with the arrangements designated for such purpose under the Custodian Agreement unless otherwise indicated in a writing referencing this Delegation Schedule and executed by both parties. 12. Definitions. Capitalized terms in this Delegation Schedule have the following meanings: a. Compulsory Securities Depository - shall mean a Securities Depository the use of which is mandatory (i) under applicable law or regulation; (ii) because securities cannot be withdrawn from the depository; or, (iii) because maintaining securities outside the Securities Depository is not consistent with prevailing custodial practices. b. Country Risk - shall have meaning set forth in Section 9.2.1 of the Custodian Agreement. c. Eligible Foreign Custodian - shall have the meaning set forth in Rule 17f-5(a)(1) under the 1940 Act and shall also include a U.S. Bank. d. Eligible Securities Depository - shall have the meaning set forth in Rule 17f-7(b)(1) under the 1940 Act. e. Fund's Assets - shall mean any of the Fund's investments (including foreign currencies) for which the primary market is outside the United States, and such cash and cash equivalents as are reasonably necessary to effect the Fund's transactions in such investments. 6 f. Proper Instructions - shall have the meaning set forth in the Custodian Agreement. g. Sovereign Risk - shall have the meaning set forth in Section 9.2.2 of the Custodian Agreement. h. U.S. Bank - shall have the meaning set forth in Rule 17f-5(a) (7) under the 1940 Act. 13. Governing Law and Jurisdiction. This Delegation Schedule shall be construed in accordance with the laws of the State of New York. 14. Fees. Delegate shall perform its functions under this Delegation Schedule for the compensation determined under the Custodian Agreement. 15. Integration. This Delegation Schedule sets forth all of the Delegate's duties with respect to the selection and monitoring of Eligible Foreign Custodians, the administration of contracts with Eligible Foreign Custodians, the withdrawal of assets from Eligible Foreign Custodians and the issuance of reports in connection with such duties. The terms of the Custodian Agreement shall apply generally as to matters not expressly covered in this Delegation Schedule, including dealings with the Eligible Foreign Custodians in the course of discharge of the Delegate's obligations under the Custodian Agreement. 7 NOW THEREFORE, the parties have caused this Delegation Schedule to be executed by its duly authorized representatives, effective as of the date written below. BROWN BROTHERS HARRIMAN & CO. ON BEHALF OF THE FUNDS INCLUDED IN THE LIST OF FUNDS ATTACHED TO THE AMENDED AND RESTATED CUSTODIAN AGREEMENT By: /s/ Stokley P. Towles By: /s/ Robert D. Snowden Name: Stokley P. Towles Name: Robert D. Snowden Title: Partner Title: Assistant Treasurer Date: June 25, 2001 Date: June 25, 2001 8 BROWN BROTHERS HARRIMAN - GLOBAL CUSTODY NETWORK VANGUARD GLOBAL CUSTODY NETWORK LISTING COUNTRY SUBCUSTODIAN DEPOSITORIES - ------- ------------ ------------ ARGENTINA CITIBANK NA, BUENOS AIRES CVSA Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 AUSTRALIA NATIONAL AUSTRALIA BANK LTD. (NAB) Austraclear National Australia Bank Agt. 5/1/85 CHESS Agreement Amendment 2/13/92 RBA Omnibus Amendment 11/22/93 AUSTRIA BANK AUSTRIA AG OeKB Creditanstalt Bankverein Agreement 12/18/89 Omnibus Amendment 1/17/94 BAHRAIN HSBC BANK MIDDLE EAST, BAHRAIN FOR None HONGKONG & SHANGHAI BANKING CORP. LTD. (HSBC) Hongkong & Shanghai Banking Corp. Agt. 4/19/91 Omnibus Supplement 12/29/93 Schedule 5/14/96 BBME Supplement 5/14/96 Side Letter Agreement dated 7/28/97 BANGLADESH STANDARD CHARTERED BANK (SCB), DHAKA None Standard Chartered Bank Agreement 2/18/92 Omnibus Amendment 6/13/94 Appendix 4/8/96 BELGIUM BANK BRUSSELS LAMBERT (BBL) CIK Banque Bruxelles Lambert Agt. 11/15/90 Omnibus Amendment 3/1/94 BERMUDA BANK OF N.T. BUTTERFIELD & SON LTD. None The Bank of N.T. Butterfield & Son Ltd. Agreement 5/27/97 BOTSWANA STANBIC BANK BOTSWANA LTD FOR STANDARD None BANK OF SOUTH AFRICA (SBSA) Standard Bank of South Africa Agreement 3/11/94 Subsidiary Amendment 9/29/97 BRAZIL BANKBOSTON NA, SAO PAULO CBLC The First National Bank of Boston Agreement 1/5/88 Omnibus Amendment 2/22/94 Amendment 7/29/96 BULGARIA ING BANK NV, SOFIA BNB ING Bank N.V. Agreement 9/15/97 CANADA ROYAL BANK OF CANADA (RBC) Bank of Canada The Royal Bank of Canada Agreement 2/23/96 Page 1 of 7 COUNTRY SUBCUSTODIAN DEPOSITORIES - ------- ------------ ------------ CHILE CITIBANK NA, SANTIAGO DCV Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 CHINA STANDARD CHARTERED BANK (SCB), SHENZHEN SSCC Standard Chartered Bank Agreement 2/18/92 Omnibus Amendment 6/13/94 Appendix 4/8/96 CHINA STANDARD CHARTERED BANK (SCB), SHANGHAI SSCCRC Standard Chartered Bank Agreement 2/18/92 Omnibus Amendment 6/13/94 Appendix 4/8/96 COLOMBIA CITITRUST COLOMBIA SA, SOCIEDAD DCV FIDUCIARIA FOR CITIBANK NA Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 Citibank, N.A./Cititrust Colombia Agreement 12/2/91 Citibank, N.A. Subsidiary Amendment 10/19/95 CROATIA BANK AUSTRIA CREDITANSTALT CROATIA DD SDA FOR BANK AUSTRIA AG CNB Creditanstalt Bankverein Agreement Ministry of Finance 12/18/89 Omnibus Amendment 1/17/94 Creditanstalt AG / Bank Austria Creditanstalt Croatia d.d. Agt. 9/1/98 CYPRUS CYPRUS POPULAR BANK LTD. None (aka Laiki Bank) Cyprus Popular Bank Ltd. Agt. 2/18/98 ***BBH'S RESPONSIBILITY FOR THIS SUBCUSTODIAN IS CONDITIONED ON THE ABILITY OF BBH TO RECOVER FROM THE SUBCUSTODIAN. IN ADDITION, BBH DOES NOT ACCEPT DELEGATION IN THIS MARKET.*** CZECH REPUBLIC CITIBANK AS FOR CITIBANK NA CNB-TKD System Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 Citibank NA / Citibank AS Agreement 6/24/96 DENMARK DANSKE BANK VP Den Danske Bank Agreement 1/1/89 Omnibus Amendment 12/1/93 ECUADOR CITIBANK NA, QUITO DECEVALE Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 Citibank, Quito Side Letter 7/3/95 EGYPT CITIBANK NA, CAIRO MCSD Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 FINLAND MERITA BANK PLC FCSD Union Bank of Finland Agreement 2/27/89 Omnibus Amendment 4/6/94 FRANCE CREDIT AGRICOLE INDOSUEZ (CAI) BdF Banque Indosuez Agreement 7/19/90 Omnibus Amendment 3/10/94 Page 2 of 7 COUNTRY SUBCUSTODIAN DEPOSITORIES - ------- ------------ ------------ GERMANY DRESDNER BANK CBF Dresdner Bank Agreement 10/6/95 GHANA MERCHANT BANK (GHANA) LIMITED FOR None STANDARD BANK OF SOUTH AFRICA (SBSA) Standard Bank of South Africa Agreement 3/11/94 ***BBH'S RESPONSIBILITY FOR THIS SUBCUSTODIAN IS CONDITIONED ON THE ABILITY OF BBH TO RECOVER FROM THE SUBCUSTODIAN. IN ADDITION, BBH DOES NOT ACCEPT DELEGATION IN THIS MARKET.*** GREECE CITIBANK NA, ATHENS CSD Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 HONG KONG HONGKONG & SHANGHAI BANKING CMU CORPORATION LTD. Hongkong & Shanghai Banking Corp. Agt. 4/19/91 Omnibus Supplement 12/29/93 Schedule 5/14/96 HUNGARY CITIBANK BUDAPEST RT. FOR CITIBANK NA KELER Ltd. Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 Citibank, N.A. Subsidiary Amendment 10/19/95 Citibank, N.A. / Citibank Budapest Agreement 6/23/92 Citibank, N.A. / Citibank Budapest Amendment 9/29/92 INDIA DEUTSCHE BANK AG, MUMBAI NSDL Deutsche Bank Agreement 8/21/96 Deutsche Bank Agreement 2/19/96 INDONESIA CITIBANK NA, JAKARTA PT KSEI Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 IRELAND ALLIED IRISH BANKS PLC (AIB) CREST Allied Irish Banks Agreement 1/10/89 Omnibus Amendment 4/8/94 ISRAEL BANK HAPOALIM BM TASECH Bank Hapoalim Agreement 8/27/92 ITALY INTESA BCI SPA Monte Titoli S.P.A. Banca Commerciale Italiana Agreement 5/8/89 Agreement Amendment 10/8/93 Omnibus Amendment 12/14/93 JAPAN BANK OF TOKYO - MITSUBISHI, LTD. (BTM) BoJ Bank of Tokyo - Mitsubishi Agreement 6/17/96 Page 3 of 7 COUNTRY SUBCUSTODIAN DEPOSITORIES - ------- ------------ ------------ JORDAN HSBC BANK MIDDLE EAST, JORDAN FOR None HONGKONG & SHANGHAI BANKING CORP. (HSBC) Hongkong & Shanghai Banking Corp. Agt. 4/19/91 Omnibus Supplement 12/29/93 Schedule 5/14/96 BBME Supplement 5/14/96 Side letter Agreement dated 7/28/97 KENYA STANBIC BANK KENYA LIMITED FOR STANDARD None BANK OF SOUTH AFRICA (SBSA) Standard Bank of South Africa Agreement 3/11/94 Subsidiary Amendment 9/29/97 KOREA CITIBANK NA, SEOUL KSD Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 Citibank, Seoul Agreement Supplement 10/28/94 LEBANON HSBC BANK MIDDLE EAST, LEBANON FOR Midclear HONGKONG & SHANGHAI BANKING CORP. (HSBC) Hongkong & Shanghai Banking Corp. Agt. 4/19/91 Omnibus Supplement 12/29/93 Schedule 5/14/96 BBME Supplement 5/14/96 Side letter Agreement dated 7/28/97 LUXEMBOURG KREDIETBANK LUXEMBOURG (KBL) CBL Kredietbank Luxembourg Agt. 4/7/98 MALAYSIA HSBC BANK MALAYSIA BERHAD (HBMB) BNM FOR HONGKONG SHANGHAI BANKING CORP. (HSBC) Hongkong & Shanghai Banking Corp. Agt. 4/19/91 Omnibus Supplement 12/29/93 Schedule 5/14/96 Malaysia Subsidiary Supplement 5/23/94 Side letter Agreement dated 7/28/97 MAURITIUS HONGKONG & SHANGHAI BANKING CORP. LTD. CDS (HSBC), MAURITIUS Hongkong & Shanghai Banking Corp. Agt. 4/19/91 Omnibus Supplement 12/29/93 Schedule 5/14/96 MEXICO CITIBANK MEXICO SA FOR CITIBANK NA Banxico Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 Citibank Mexico, S.A. Amendment 2/28/95 MOROCCO CITIBANK MAGHREB, CASABLANCA FOR MCLR Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 Side Letter Agreement pending NAMIBIA STANDARD BANK NAMIBIA FOR STANDARD BANK None OF SOUTH AFRICA (SBSA) Standard Bank of South Africa Agreement 3/11/94 Subsidiary Amendment 10/3/96 NETHERLANDS FORTIS BANK NECIGEF MeesPierson NV Agreement 6/4/99 Page 4 of 7 COUNTRY SUBCUSTODIAN DEPOSITORIES - ------- ------------ ------------ NEW ZEALAND NATIONAL AUSTRALIA BANK LTD. (NAB), NZCSD AUCKLAND National Australia Bank Agt. 5/1/85 Agreement Amendment 2/13/92 Omnibus Amendment 11/22/93 New Zealand Addendum 3/7/89 NORWAY DEN NORSKE BANK VPS Den norske Bank Agreement 11/16/94 OMAN HSBC BANK MIDDLE EAST, OMAN FOR MDSRC HONGKONG & SHANGHAI BANKING CORP. LTD. (HSBC) Hongkong & Shanghai Banking Corp. Agt. 4/19/91 Omnibus Supplement 12/29/93 Schedule 5/14/96 BBME Supplement 5/14/96 Side letter Agreement dated 7/28/97 PAKISTAN STANDARD CHARTERED BANK (SCB), KARACHI CDC Standard Chartered Bank Agreement 2/18/92 Omnibus Amendment 6/13/94 Appendix 4/8/96 PERU CITIBANK NA, LIMA CAVALI Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 PHILIPPINES CITIBANK NA, MANILA PCD Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 POLAND BANK HANDLOWY W WARSZA WIE SA (BHW) CRBS FOR CITIBANK NA Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 Citibank Subsidiary Amendment 10/30/95 Citibank, N.A. / Citibank Poland S.A. Agt. 11/6/92 PORTUGAL BANCO COMERCIAL PORTUGUES SA (BCP) CVM Banco Comercial Portugues 5/18/98 ROMANIA ING BANK NV, BUCHAREST BSE ING Bank N.V. Agreement 9/29/97 NBR SNCDD RUSSIA CREDIT SUISSE FIRST BOSTON AO (CSFB AO) VTB FOR CREDIT SUISSE, ZURICH Credit Suisse First Boston Agreement 8/18/99 Credit Suisse, Zurich Agreement 4/30/96 ***REQUIRES SIGNED AMENDMENT TO THE CUSTODIAN AGREEMENT PRIOR TO INVESTMENT.*** RUSSIA CITIBANK T/O FOR CITIBANK NA VTB Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 Citibank, N.A. Subsidiary Amendment 10/19/95 Citibank N.A. / Citibank T/O Agt. 6/16/97 Side Letter Agt. 8/18/97 ***REQUIRES SIGNED AMENDMENT TO THE CUSTODIAN AGREEMENT PRIOR TO INVESTMENT.*** Page 5 of 7 COUNTRY SUBCUSTODIAN DEPOSITORIES - ------- ------------ ------------ SINGAPORE HONGKONG & SHANGHAI BANKING CORP. LTD. CDP (HSBC), SINGAPORE Hongkong & Shanghai Banking Corp. Agt. 4/19/91 Omnibus Supplement 12/29/93 Schedule 5/14/96 SLOVAKIA ING BANK NV, BRATISLAVA NBS ING Bank N.V. Agreement 9/1/98 SLOVENIA BANK AUSTRIA CREDITANSTALT DD LJUBLJANA KDD Creditanstalt Bankverein Agreement 12/18/89 Omnibus Amendment 1/17/94 Master Subcustodian Agreement 4/17/98 Amendment dated 4/17/98 Amendment dated 10/14/98 SOUTH AFRICA STANDARD BANK OF SOUTH AFRICA (SBSA) CDL Standard Bank of South Africa Agreement 3/11/94 SPAIN BANCO SANTANDER CENTRAL HISPANO SA Banco de Espana (BSCH) Banco de Santander Agreement 12/14/88 SRI LANKA HONGKONG & SHANGHAI BANKING CORP. LTD. CDS (HSBC), COLOMBO Hongkong & Shanghai Banking Corp. Agt. 4/19/91 Omnibus Supplement 12/29/93 Schedule 5/14/96 SWAZILAND STANDARD BANK SWAZILAND LTD FOR None STANDARD BANK OF SOUTH AFRICA (SBSA) Standard Bank of South Africa Agreement 3/11/94 Subsidiary Amendment 9/29/97 SWEDEN SKANDINAVISKA ENSKILDA BANKEN (SEB) VPC Skandinaviska Enskilden Banken Agreement 2/20/89 Omnibus Amendment 12/3/93 SWITZERLAND UBS AG SIS Union Bank of Switzerland Agreement 12/20/88 Omnibus Amendment 11/29/94 TAIWAN STANDARD CHARTERED BANK (SCB), TAIPEI TSCD Standard Chartered Bank Agreement 2/18/92 Omnibus Amendment 6/13/94 Appendix 4/8/96 THAILAND HONGKONG & SHANGHAI BANKING CORP. LTD. TSDC (HSBC), BANGKOK Hongkong & Shanghai Banking Corp. Agt. 4/19/91 Omnibus Supplement 12/29/93 Schedule 5/14/96 TRANSNATIONAL BROWN BROTHERS HARRIMAN & CO. (BBH&CO.) CBL TURKEY CITIBANK NA, ISTANBUL CBT Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 Page 6 of 7 COUNTRY SUBCUSTODIAN DEPOSITORIES - ------- ------------ ------------ UNITED KINGDOM HSBC BANK PLC CMO Midland Bank Agreement 8/8/90 Omnibus Amendment 12/15/93 URUGUAY BANKBOSTON NA, MONTEVIDEO None The First National Bank of Boston Agreement 1/5/88 Omnibus Amendment 2/22/94 Amendment 7/29/96 Uruguay Amendment 10/18/96 VENEZUELA CITIBANK NA, CARACAS CVV Citibank, N.A., New York Agt. 7/16/81 New York Agreement Amendment 8/31/90 New York Agreement Amendment 7/26/96 ZAMBIA STANBIC BANK ZAMBIA LTD FOR STANDARD BoZ BANK OF SOUTH AFRICA (SBSA) Standard Bank of South Africa Agreement 3/11/94 Subsidiary Amendment 10/3/96 ZIMBABWE STANBIC BANK ZIMBABWE LTD FOR STANDARD None BANK OF SOUTH AFRICA (SBSA) Standard Bank of South Africa Agreement 3/11/94 Subsidiary Amendment 10/3/96 Page 7 of 7 BROWN BROTHERS HARRIMAN - GLOBAL CUSTODY NETWORK VANGUARD SUBCUSTODIAN LIABILITY APPENDIX COUNTRY SUBCUSTODIAN DEPOSITORIES - ------- ------------ ------------ CYPRUS THE CYPRUS POPULAR BANK LTD. None (aka Laiki Bank) Cyprus Popular Bank Ltd. Agt. 2/18/98 GHANA MERCHANT BANK (GHANA) LIMITED FOR None STANDARD BANK OF SOUTH AFRICA (SBSA) Standard Bank of South Africa Agreement 3/11/94 AMENDMENT TO THE AMENDED AND RESTATED CUSTODIAN AGREEMENT AMENDMENT entered into as of this 16th day of August, 2007 to the Amended and Restated Custodian Agreement between certain open-ended management investment companies (each investment company a "Fund") on behalf of certain of their series and BROWN BROTHERS HARRIMAN & CO. (the "Custodian") dated as of June 25, 2001 (the "Agreement"). In consideration of the Custodian's offering subcustodial services to the Fund in Russia, the Fund and the Custodian agree that the Agreement is hereby amended as follows: 1. SECTION 5. SAFEKEEPING OF FUND ASSETS is amended by the addition of the following phrase at the end of said Section: "The Custodian's responsibility for safekeeping equity securities of Russian issuers ("Russian Equities") hereunder shall be limited to the safekeeping of relevant share extracts from the share registration books maintained by the entities providing share registration services to issuers of Russian Equities (each a "Registrar") indicating an investor's ownership of such securities (each a "Share Extract")." . 2. SECTION 5.1 USE OF SECURITIES DEPOSITORIES is amended by the addition of the following at the end of said Section: "With respect to Russia, the Fund hereby expressly acknowledges that a Subcustodian for Russian securities may from time to time delegate any of its duties and responsibilities to any securities depository, clearing agency, share registration agent or sub-subcustodian (collectively, "Russian Agent") in Russia, including without limitation Rosvneshtorgbank (also called Vneshtorgbank RF) ("VTB"). The Fund acknowledges that the rights of the Subcustodian against any such Russian Agent may consist only of a contractual claim against the Russian Agent. Notwithstanding any provision of this Agreement to the contrary, neither the Custodian nor the Subcustodian shall be responsible or liable to the Fund or its shareholders for the acts or omissions of any such Russian Agent In the event of a loss of securities or cash held on behalf of a Fund through any Russian Agent, the Custodian shall not be responsible to the Fund or its shareholders unless and to the extent it in fact recovers from the Subcustodian." 3. SECTION 5.4 BOOK ENTRY ASSETS, is amended by the addition of the following at the end of said Section: "With respect to Russian Equities, the Custodian shall instruct a Subcustodian to endeavor to assure that registration thereof shall be reflected on the books of the issuer's Registrar, subject to the following conditions, but shall in no event be liable for losses or costs incurred as a result of delays or failures in the registration process, including without limitation the inability to obtain or enforce relevant Share Extracts, unless such losses or costs are a consequence of the Custodian's negligence, bad faith or willful misconduct Such registration may be in the name of a nominee of a Subcustodian In the event registration is in the name of a Fund, the Fund hereby acknowledges that only the Custodian or Subcustodian may give instructions to the Registrar to transfer or engage in other transactions involving the Russian Equities so registered. A Subcustodian may from time to time enter into contracts with Registrars with respect to the registration of Russian Equities ("Registrar Contracts"). Such Registrar Contracts shall provide for (i) regular (but in no event less than quarterly ) share confirmations by the Subcustodian, (ii) registrations within set timeframes, (iii) use of a Subcustodian's nominee name, (iv) direct access by auditors of the Subcustodian or its clients to share registers, and (v) specification of the Registrar's responsibilities and liabilities. It is hereby acknowledged and agreed that the Custodian does not represent or warrant that such Registrar Contracts are enforceable. If the Fund instructs the Custodian to settle a purchase of a Russian Equity, the Custodian will instruct a Subcustodian to endeavor on a best efforts basis to reregister the Russian Equity and obtain a Share Extract in a timely manner. After completion of reregistration of a Russian Equity in respect of which a Subcustodian has entered into a Registrar Contract, the Custodian shall instruct the Subcustodian to monitor such registrar on a best efforts basis and to notify the Custodian upon the Subcustodian obtaining knowledge of the occurrence of any of the following events ("Registrar Events"): (i) a Registrar has eliminated a shareholder from the register or has altered registration records and that shareholder alleges that such elimination or alteration was unlawful; (ii) a Registrar has refused to register securities in the name of a particular purchaser and the purchaser or seller has alleged that the registrar's refusal to so register was unlawful; (iii) a Registrar holds for its own account shares of an issuer for which it serves as registrar, (iv) if a Registrar Contract is in effect with a Registrar, the Registrar notifies the Subcustodian that it will no longer be able materially to comply with the terms of the Registrar Contract; or (v) if a Registrar Contract is in effect with a Registrar, the Registrar has materially breached such Contract. The Custodian shall inform the Fund of the occurrence of a Registrar Event provided the Custodian has in fact received actual notice thereof from the Subcustodian. It shall be the sole responsibility of the Fund to contact the Custodian prior to executing any transaction in a Russian Equity to determine whether a Registrar Contract exists in respect of such issuer. If the Fund instructs the Custodian by Proper Instruction to settle a purchase of a Russian Equity in respect of which the Subcustodian has not entered into a Registrar Contract, then the Custodian shall instruct the Subcustodian to endeavor to settle such transaction in accordance with the Proper Instruction and with the provisions of Section 6.1 of this Agreement, notwithstanding the absence of any such Registrar Contract and without the Custodian being required to notify the Fund that no such Registrar Contract is then in effect, and it being understood that neither the Custodian nor the Subcustodian shall be required to follow the procedure set forth in the second preceding paragraph." 4. SECTION 6. ADMINISTRATIVE DUTIES OF THE CUSTODIAN is amended by the addition of the following at the end of said Section: "With respect to Russia, the Fund hereby expressly acknowledges the nominee concept of account ownership is not recognized in Russia. Although the account with the Subcustodian will be opened in the name of BBH&Co. in the name of the Fund and on the Fund's behalf as custodian, the Fund may not be considered the beneficial owner of the assets in that account under Russian law. The Fund hereby expressly acknowledges that an unincorporated entity may not be recognized as a legal entity in Russia In addition, only recognized legal entities may grant a power of attorney to a custodian in Russia. Accordingly, market participants (i.e. registrars) (i) may not recognize an unincorporated entity as a valid legal entity in Russia, (ii) may require documentation in support of legal status that does not exist based upon an unincorporated entity legal structure under applicable law, or (iii) may refuse to accept the supporting documentation that an unincorporated entity provides. In addition and based upon entity status and/or an inability to produce requested or adequate documentation in support of legal status, third parties in Russia (i) may refuse to accept a power of attorney given by us to Subcustodian for the purpose of exercising voting and other rights on our behalf in connection with Russian securities undergoing corporate actions, and (ii) may not pay or may delay receipt of entitlements to our account." 5. SECTION 6.1 PURCHASE OF INVESTMENTS is amended by the addition of the following at the end of said Section: "Without limiting the generality of the foregoing, the following provisions shall apply with respect to settlement of purchases of securities in Russia. Unless otherwise instructed by Proper Instructions acceptable to the Custodian, the Custodian shall only authorize a Subcustodian to make payment for purchases of Russian Equities upon receipt of the relevant Share Extract in respect of the Portfolio's purchases. With respect to securities other than Russian Equities, settlement of purchases shall be made in accordance with securities processing or settlement practices which the Custodian in its discretion determines to be a market practice. The Custodian shall only be responsible for securities purchased upon actual receipt of such securities at the premises of its Subcustodian, provided that the Custodian's responsibility for securities represented by Share Extracts shall be limited to the safekeeping of the relevant Share Extract upon actual receipt of such Share Extract at the premises of the Subcustodian" 6. SECTION 6.2 SALE OF INVESTMENTS amended by the addition of the following at the end of said Section: "Without limiting the generality of the foregoing, the following provisions shall apply with respect to settlement of sales of securities in Russia Unless otherwise expressly instructed by Proper Instructions acceptable to the Custodian, settlement of sales of securities shall be made in accordance with securities processing or settlement practices which the Custodian in its discretion determines to be a market practice. The Fund hereby expressly acknowledges that such market practice might require delivery of securities prior to receipt of payment and that the Fund bears the risk of payment in instances where delivery of securities is made prior to receipt of payment therefor in accordance with Proper Instructions received by the Custodian or pursuant to the Custodian's determination in its discretion that such delivery is in accordance with market practice. The Custodian shall not be responsible for any securities delivered from the premises of the Subcustodian from the time they leave such premises." 7. SECTION 6.13 TAXES is amended by the insertion of the following at the end of said Section: "It is agreed that the Fund shall be responsible for preparation and filing of tax returns, reports and other documents on any activities it undertakes in Russia which are required under applicable law to be filed by the Fund with any relevant governmental or other authority in Russia and for the payment of any taxes, levies, duties or similar liability the Fund is required under applicable law to pay to any relevant governmental authority in Russia in respect of property held or sold in Russia or of payments or distributions received in respect thereof in Russian 8. A NEW SECTION 16.15 RISK ACKNOWLEDGMENT is added after the end of the said Section 16.14: "The Fund hereby acknowledges and represents to the Custodian that it has undertaken its own review of the risks associated with investment in Russia and has concluded that such investment is appropriate for the Fund and in no way conflicts with the Fund's constitutive documents, investment objective, duties to its shareholders or with any regulatory requirements applicable to the Fund." MISCELLANEOUS a) Other than as amended hereby, all terms and provisions of the Agreement are hereby ratified and affirmed as of the date hereof and are hereby extended to give effect to the terms hereof. b) By signing below where indicated, each of the Custodian and the Fund hereby ratifies and affirms each of the respective representations and warranties set forth in the Agreement and confirms that each such respective representation and warranty remains true and correct as of the date hereof. c) Upon receipt by the Custodian of a fully executed copy of this Amendment, this Amendment shall be deemed to be executed as an instrument under seal and governed by such laws as provided in the Agreement. This Amendment may be executed in original counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same Amendment. This Amendment together with the Agreement represents the entire agreement and understanding of the parties hereto. IN WITNESS WHEREOF, the parties have executed this Amendment as of the date first set forth above. The undersigned acknowledges that (I/we) have received a copy of this document
BROWN BROTHERS HARRIMAN & CO. VANGUARD INTERNATIONAL EQUITY INDEX FUNDS BY: /s/ Meade Reynolds BY: /s/ Thomas J Higgins - --------------------------------------------------- ---------------------------------------------------- - --------------------------------------------------- ---------------------------------------------------- On behalf of the series included on Schedule A attached hereto Title: Treasurer ----------------------------------------------------
Schedule A Vanguard Emerging Markets Stock Index Fund Vanguard FTSE All-World ex US-Index Fund Page 1 of 1 LIST OF FUNDS AMENDED SCHEDULE TO THE CUSTODIAN AGREEMENT BETWEEN CERTAIN OPEN-END MANAGEMENT INVESTMENT COMPANIES ("FUNDS") and BROWN BROTHERS HARRIMAN & CO. The following is a list of Funds and their Series for which the Custodian serves under an Amended Custodian Agreement dated as of June 25, 2001 (the "Agreement"): The following series of Vanguard Horizon Funds: Vanguard Global Equity Fund The following series of Vanguard International Equity Index Funds: Vanguard Emerging Markets Stock Index Fund Vanguard European Stock Index Fund Vanguard FTSE All-World ex-US Index Fund Vanguard Pacific Stock Index Fund The following series of Vanguard Montgomery Funds: Vanguard Market Neutral Fund The following series of Vanguard Tax-Managed Funds Vanguard Tax-Managed International Fund The following series of Vanguard Trustees' Equity Fund: Vanguard International Value Fund The following series of Vanguard Valley Forge Funds: Vanguard Managed Payout Real Growth Fund Vanguard Managed Payout Moderate Growth Fund Vanguard Managed Payout Capital Preservation Fund The following series of Vanguard Variable Insurance Funds: International Portfolio The following series of Vanguard World Funds: Vanguard Consumer Discretionary Index Fund Vanguard Consumer Staples Index Fund Vanguard Energy Index Fund Vanguard Financials Index Fund Vanguard Health Care Index Fund Vanguard Industrials Index Fund Vanguard Information Technology Index Fund Vanguard Materials Index Fund Vanguard Mega Cap 300 Index Fund Vanguard Mega Cap 300 Growth Index Fund Vanguard Mega Cap 300 Value Index Fund Vanguard Telecommunication Services Index Fund Vanguard Utilities Index Fund IN WITNESS WHEREOF, each of the parties hereto has caused this Schedule to be executed in its name and on behalf of such Funds on October 10, 2007. ----------------- FUNDS BROWN BROTHERS HARRIMAN & CO. By: /s/Thomas J. Higgins By: /s/James R. Kent - ------------------------ --------------------- Name: Thomas J. Higgins Name: James R. Kent Title: Treasurer Title: Managing Director EX-99.N 5 multiclassver24.txt RULE 18F-3 PLAN FOR VGI VANGUARD FUNDS MULTIPLE CLASS PLAN I. INTRODUCTION This Multiple Class Plan (the "Plan") describes six separate classes of shares that may be offered by investment company members of The Vanguard Group (collectively the "Funds," individually a "Fund"). The Plan explains the separate arrangements for each class, how expenses are allocated to each class, and the conversion features of each class. Each Fund may offer any one or more of the specified classes. The Plan has been approved by the Board of Directors of The Vanguard Group ("Vanguard"). In addition, the Plan has been adopted by a majority of the Board of Trustees of each Fund, including a majority of the Trustees who are not interested persons of each Fund. The classes of shares offered by each Fund are designated in Schedule A hereto, as such Schedule may be amended from time to time. II. SHARE CLASSES A Fund may offer any one or more of the following share classes: Investor Shares Admiral Shares Signal Shares Institutional Shares Institutional Plus Shares ETF Shares III. DISTRIBUTION, AVAILABILITY AND ELIGIBILITY Distribution arrangements for all classes are described below. Vanguard retains sole discretion in determining share class availability, and whether Fund shares shall be offered either directly or through certain financial intermediaries, or on certain financial intermediary platforms. Eligibility requirements for purchasing shares of each class will differ, as follows: A. INVESTOR SHARES Investor Shares generally will be available to investors who are not permitted to purchase other classes of shares, subject to the eligibility requirements specified in Schedule B hereto, as such Schedule may be amended from time to time. It is expected that the minimum investment amount for Investor Shares will be substantially lower than the amount required for any other class of shares. B. ADMIRAL SHARES Admiral Shares generally will be available to individual and other investors who meet the eligibility requirements specified in Schedule B hereto, as such Schedule may be amended from time to time. These eligibility requirements may include, but are not limited to the following factors: (i) the total amount invested the Fund; (ii) the length of time that the Fund account has been maintained; (iii) whether the investor has registered for on-line access to the Fund account through Vanguard's web site; or (iv) any other factors deemed appropriate by a Fund's Board of Trustees. C. SIGNAL SHARES Signal Shares generally will be available to institutional and other investors who meet the eligibility requirements specified in Schedule B hereto, as such Schedule may be amended from time to time. It is expected that Signal Shares will be offered to Vanguard's institutional clients according to eligibility criteria that may include, but are not limited to the following factors: (i) the total amount invested in the Fund; (ii) nature and extent of client's relationship with Fund, including services provided by the Fund to the client's account; and (iii) any other factors deemed appropriate by the Fund's Board of Trustees. D. INSTITUTIONAL SHARES Institutional Shares generally will be available to institutional and other investors who meet the eligibility requirements specified in Schedule B hereto, as such Schedule may be amended from time to time. It is expected that the minimum investment amount per account for Institutional Shares will be substantially higher than the amounts required for Investor Shares, Admiral Shares or Signal Shares. E. INSTITUTIONAL PLUS SHARES Institutional Plus Shares generally will be available to institutional and other investors who meet the eligibility requirements specified in Schedule B hereto, as such Schedule may be amended from time to time. It is expected that the minimum investment amount for Institutional Plus Shares will be substantially higher than the amount required for any other class of the Fund's shares. 2 F. ETF SHARES The Fund will sell ETF Shares to investors that are (or who purchase through) Authorized DTC Participants, and who pay for their ETF shares by depositing a prescribed basket of securities rather than paying cash. An Authorized DTC Participant is an institution, usually a broker-dealer, that is a participant in the Depository Trust Company (DTC) and that has executed a Participant Agreement with the Fund's distributor. Additional eligibility requirements may be specified in Schedule B hereto, as such Schedule may be amended from time to time. Investors who are not Authorized Participants may buy and sell ETF shares through various exchanges and market centers. IV. SERVICE ARRANGEMENTS All share classes will receive a range of services provided by Vanguard on a per account basis. These "account-based" services may include transaction processing and shareholder recordkeeping, as well as the mailing of updated prospectuses, shareholder reports, tax statements, confirmation statements, quarterly portfolio summaries, and other items. It is expected that the aggregate amount of account-based services provided to Investor Shares will materially exceed the amount of such services provided to any other class, due to the existence of many more accounts holding Investor Shares. In addition to this difference in the volume of services provided, arrangements will differ among the classes as follows: A. INVESTOR SHARES Investor Shares generally will receive the most basic level of service from Vanguard. Investor Shares generally will be serviced through a pool of Vanguard client service representatives. Investor Shares shareholders may receive VISTA recordkeeping services from Vanguard. B. ADMIRAL SHARES Admiral Shares will receive a different level of service from Vanguard as compared to Investor Shares, including but not limited to special client service representatives who are assigned to service Admiral Shares through a dedicated phone service center. In addition, holders of Admiral Shares may from time to time receive special mailings and unique additional services from Vanguard. Investors who receive VISTA or similar retirement plan recordkeeping services from Vanguard generally may not own Admiral Shares. C. SIGNAL SHARES Signal Shares will receive a level of service from Vanguard that differs from the service provided to the holders of shares of other 3 classes. Such services may include informational newsletters and other similar materials devoted to investment topics of interest and which have been developed exclusively for Signal shareholders. Such newsletters or other materials may be mailed on a periodic basis. These newsletters or other materials may also be available to Signal shareholders through separate electronic venues including a dedicated web site. In addition, special client service representatives may be assigned to service Signal Shares through a dedicated phone service center. Signal Shares' shareholders generally will be permitted to transact with Vanguard through the National Securities Clearing Corporation's FundSERV system and other special servicing platforms for institutional investors. Signal shareholders may receive VISTA recordkeeping services from Vanguard. D. INSTITUTIONAL SHARES Institutional Shares will receive from Vanguard a level of service that differs from the service provided to the holders of shares of other classes. Such services may include special client service representatives who will be assigned to service Institutional Shares. Most holders of Institutional Shares periodically will receive special investment updates from Vanguard's investment staff. Holders of Institutional Shares also may receive unique additional services from Vanguard, and generally will be permitted to transact with Vanguard through the National Securities Clearing Corporation's FundSERV system and other special servicing platforms for institutional investors. Investors who receive VISTA or similar retirement plan recordkeeping services from Vanguard generally may not own Institutional Shares. E. INSTITUTIONAL PLUS SHARES Institutional Plus Shares generally will receive a very high level of service from Vanguard as compared to any other share classes. Special client service representatives will be assigned to service Institutional Plus Shares, and most holders of such shares periodically, but more than the holders of all other shares, will receive special updates from Vanguard's investment staff. Holders of Institutional Plus Shares may receive unique additional services from Vanguard, and generally will be permitted to transact with Vanguard through the National Securities Clearing Corporation's FundSERV system and other special servicing platforms for institutional investors. Investors who receive VISTA or similar retirement plan recordkeeping services from Vanguard generally may not own Institutional Plus Shares F. ETF SHARES A Fund is expected to maintain only one shareholder of record for ETF Shares--DTC or its nominee. Special client service representatives will be assigned to the DTC account, and all transactions on this account will be handled electronically. Due to the nature and purpose of the DTC account, ETF Shares will not receive any special updates from Vanguard's investment staff. 4 V. CONVERSION FEATURES A. VOLUNTARY CONVERSIONS 1. CONVERSION INTO INVESTOR SHARES. An investor may convert Admiral Shares, Signal Shares, or Institutional Shares into Investor Shares (if available), provided that following the conversion the investor: (i) meets the then applicable eligibility requirements for Investor Shares; and (ii) receives services consistent with Investor Shares. Any such conversion will occur at the respective net asset values of the share classes next calculated after Vanguard's receipt of the investor's request in good order. 2. CONVERSION INTO ADMIRAL SHARES. An investor may convert Investor Shares or Institutional Shares into Admiral Shares (if available), provided that following the conversion the investor: (i) meets the then applicable eligibility requirements for Admiral Shares; and (ii) receives services consistent with Admiral Shares. Any such conversion will occur at the respective net asset values of the share classes next calculated after Vanguard's receipt of the investor's request in good order. 3. CONVERSION INTO SIGNAL SHARES. An investor may convert Investor Shares or Institutional Shares into Signal Shares (if available), provided that following the conversion the investor: (i) meets the then applicable eligibility requirements for Signal Shares; and (ii) receives services consistent with Signal Shares. Any such conversion will occur at the respective net asset values of the share classes next calculated after Vanguard's receipt of the investor's request in good order. 4. CONVERSION INTO INSTITUTIONAL SHARES. An investor may convert Investor Shares, Admiral Shares, or Signal Shares into Institutional Shares (if available), provided that following the conversion the investor: (i) meets the then applicable eligibility requirements for Institutional Shares; and (ii) receives services consistent with Institutional Shares. Any such conversion will occur at the respective net asset values of the share classes next calculated after Vanguard's receipt of the investor's request in good order. 5. CONVERSION INTO INSTITUTIONAL PLUS SHARES. An investor may convert Investor Shares, Admiral Shares, Signal Shares, or Institutional Shares into Institutional Plus Shares (if available), 5 provided that following the conversion the investor: (i) meets the then applicable eligibility requirements for Institutional Plus Shares; and (ii) receives services consistent with Institutional Plus Shares. Any such conversion will occur at the respective net asset values of the share classes next calculated after Vanguard's receipt of the investor's request in good order. 6. Conversion into ETF Shares. Except as otherwise provided, an investor may convert Investor Shares, Admiral Shares, Signal Shares or Institutional Shares into ETF Shares (if available), provided that: (i) the shares to be converted are not held through an employee benefit plan; and (ii) following the conversion, the investor will hold ETF Shares through a brokerage account. Any such conversion will occur at the respective net asset values of the share classes next calculated after Vanguard's receipt of the investor's request in good order. Vanguard or the Fund may charge an administrative fee to process conversion transactions. None of the Funds that are series of Vanguard Bond Index Funds (see Schedule A) shall permit holders of Investor Shares, Admiral Shares, Signal Shares or Institutional Shares to convert those shares into ETF Shares. B. AUTOMATIC CONVERSIONS 1. AUTOMATIC CONVERSION INTO ADMIRAL SHARES. Vanguard may automatically convert Investor Shares into Admiral Shares (if available), provided that following the conversion the investor: (i) meets the then applicable eligibility requirements for Admiral Shares; and (ii) receives services consistent with Admiral Shares. Any such conversion will occur at the respective net asset values of the share classes next calculated after Vanguard's conversion without the imposition of any charge. Such automatic conversions may occur on a periodic, or one-time basis. Automatic conversions may occur at different times due to the differing mechanisms through which an account is funded or meets the required investment minimum. Automatic conversions do not apply to certain types of accounts, or to accounts that are eligible for Admiral Shares as a result of tenure in the Fund. 2. AUTOMATIC CONVERSION INTO SIGNAL SHARES, INSTITUTIONAL SHARES OR INSTITUTIONAL PLUS SHARES. Vanguard will not conduct automatic conversions of any share class into either Signal Shares, Institutional Shares, or Institutional Plus Shares. Shareholders may convert eligible shares into either Signal Shares, Institutional Shares, or Institutional Plus Shares only through either a self-directed conversion, or with the assistance of Vanguard representatives. Notwithstanding this rule, once a Fund offers Signal Shares, Admiral Shares of that Fund held by institutional clients may be automatically converted into Signal Shares to align the share class investor eligibility requirements. C. INVOLUNTARY CONVERSIONS AND CASH OUTS 6 1. CASH OUTS. If an investor in any class of shares no longer meets the eligibility requirements for such shares, the Fund may cash out the investor's remaining account balance. Any such cash out will be preceded by written notice to the investor and will be subject to the Fund's normal redemption fees, if any. 2. CONVERSION OF ADMIRAL SHARES. If an investor no longer meets the eligibility requirements for Admiral Shares, the Fund may convert the investor's Admiral Shares into Investor Shares (if available). Any such conversion will be preceded by written notice to the investor, and will occur at the respective net asset values of the share classes without the imposition of any sales load, fee, or other charge. 3. CONVERSION OF SIGNAL SHARES. If an investor no longer meets the eligibility requirements for Signal Shares, the Fund may convert the investor's Signal Shares into Investor Shares (if available). Any such conversion will be preceded by written notice to the investor, and will occur at the respective net asset values of the share classes without the imposition of any sales load, fee, or other charge. 4. CONVERSION OF INSTITUTIONAL SHARES. If an investor no longer meets the eligibility requirements for Institutional Shares, the Fund may convert the investor, according to the investor's ability to satisfy then current eligibility requirements, into Admiral Shares, Signal Shares, or Investor Shares. Any such conversion will be preceded by written notice to the investor, and will occur at the respective net asset values of the share classes without the imposition of any sales load, fee, or other charge. 5. CONVERSION OF INSTITUTIONAL PLUS SHARES. If an investor no longer meets the eligibility requirements for Institutional Plus Shares, the Fund may convert the investor's Institutional Plus Shares into Institutional Shares. Any such conversion will be preceded by written notice to the investor, and will occur at the respective net asset values of the share classes without the imposition of any sales load, fee, or other charge. VI. EXPENSE ALLOCATION AMONG CLASSES A. BACKGROUND Vanguard is a jointly-owned subsidiary of the Funds. Vanguard provides the Funds, on an at-cost basis, virtually all of their corporate management, administrative and distribution services. Vanguard also may provide investment advisory services on an at-cost basis to the Funds. Vanguard was established and operates pursuant to 7 a Funds' Service Agreement between itself and the Funds (the "Agreement"), and pursuant to certain exemptive orders granted by the U.S. Securities and Exchange Commission ("Exemptive Orders"). Vanguard's direct and indirect expenses of providing corporate management, administrative and distribution services to the Funds are allocated among such funds in accordance with methods specified in the Agreement. B. CLASS SPECIFIC EXPENSES 1. EXPENSES FOR ACCOUNT-BASED SERVICES. Expenses associated with Vanguard's provision of account-based services to the Funds will be allocated among the share classes of each Fund on the basis of the amount incurred by each such class as follows: (a) ACCOUNT MAINTENANCE EXPENSES. Expenses associated with the maintenance of investor accounts will be proportionately allocated among each Fund's share classes based upon a monthly determination of the costs to service each class of shares. Factors considered in this determination are (i) the percentage of total shareholder accounts represented by each class; (ii) the percentage of total account transactions performed by Vanguard for each class; and (iii) the percentage of new accounts opened for each class. (b) EXPENSES OF SPECIAL SERVICING ARRANGEMENTS. Expenses relating to any special servicing arrangements for a specific class will be proportionally allocated among each eligible Fund's share classes primarily based on their percentage of total shareholder accounts receiving the special servicing arrangements. (c) LITERATURE PRODUCTION AND MAILING EXPENSES. Expenses associated with shareholder reports, proxy materials and other literature will be allocated among each Fund's share classes based upon the number of such items produced and mailed for each class. 2. OTHER CLASS SPECIFIC EXPENSES. Expenses for the primary benefit of a particular share class will be allocated to that share class. Such expenses would include any legal fees attributable to a particular class. C. FUND-WIDE EXPENSES 1. MARKETING AND DISTRIBUTION EXPENSES. Expenses associated with Vanguard's marketing and distribution activities will be allocated among the Funds and their separate share classes according to the 8 "Vanguard Modified Formula," with each share class treated as if it were a separate Fund. The Vanguard Modified Formula, which is set forth in the Agreement and in certain of the SEC Exemptive Orders, has been deemed an appropriate allocation methodology by each Fund's Board of Trustees under paragraph (c)(1)(v) of Rule 18f-3 under the Investment Company Act of 1940. 2. ASSET MANAGEMENT EXPENSES. Expenses associated with management of a Fund's assets (including all advisory, tax preparation and custody fees) will be allocated among the Fund's share classes on the basis of their relative net assets. 3. OTHER FUND EXPENSES. Any other Fund expenses not described above will be allocated among the share classes on the basis of their relative net assets. VII. ALLOCATION OF INCOME, GAINS AND LOSSES Income, gains and losses will be allocated among each Fund's share classes on the basis of their relative net assets. As a result of differences in allocated expenses, it is expected that the net income of, and dividends payable to, each class of shares will vary. Dividends and distributions paid to each class of shares will be calculated in the same manner, on the same day and at the same time. VIII. VOTING AND OTHER RIGHTS Each share class will have: (i) exclusive voting rights on any matter submitted to shareholders that relates solely to its service or distribution arrangements; and (ii) separate voting rights on any matter submitted to shareholders in which the interests of one class differ from the interests of the other class; and (iii) in all other respects the same rights, obligations and privileges as each other, except as described in the Plan. IX. AMENDMENTS All material amendments to the Plan must be approved by a majority of the Board of Trustees of each Fund, including a majority of the Trustees who are not interested persons of the Fund. In addition, any material amendment to the Plan must be approved by the Board of Directors of Vanguard. Original Board Approval: July 21, 2000 Last Approved by Board: September 21, 2007 9 A-5 SCHEDULE A to VANGUARD FUNDS MULTIPLE CLASS PLAN
- ------------------------------------------------------------------------------------------------------------- Vanguard Fund Share Classes Authorized - ------------------------------------------------------------------------------------------------------------- Vanguard Admiral Funds o Admiral Treasury Money Market Fund Investor Vanguard Valley Forge Funds o Vanguard Balanced Index Fund Investor, Admiral, Signal, Institutional o Vanguard Managed Payout Real Growth Fund Investor o Vanguard Managed Payout Moderate Growth Fund Investor o Vanguard Managed Capital Preservation Fund Investor Vanguard Bond Index Funds o Short-Term Bond Index Fund Investor, Admiral, Signal, ETF o Intermediate-Term Bond Index Fund Investor, Admiral, Signal, Institutional, ETF o Long-Term Bond Index Fund Investor, Institutional, ETF o Total Bond Market Index Fund Investor, Admiral, Signal, Institutional, ETF o Inflation-Protected Securities Fund Investor, Admiral, Institutional Vanguard California Tax-Exempt Funds o Tax-Exempt Money Market Fund Investor o Intermediate-Term Tax-Exempt Fund Investor, Admiral o Long-Term Tax-Exempt Fund Investor, Admiral Vanguard Chester Funds o PRIMECAP Fund Investor, Admiral o Vanguard Target Retirement Income Fund Investor o Vanguard Target Retirement 2005 Fund Investor o Vanguard Target Retirement 2010 Fund Investor o Vanguard Target Retirement 2015 Fund Investor o Vanguard Target Retirement 2020 Fund Investor o Vanguard Target Retirement 2025 Fund Investor o Vanguard Target Retirement 2030 Fund Investor o Vanguard Target Retirement 2035 Fund Investor o Vanguard Target Retirement 2040 Fund Investor o Vanguard Target Retirement 2045 Fund Investor o Vanguard Target Retirement 2050 Fund Investor Vanguard Convertible Securities Fund Investor Vanguard Explorer Fund Investor, Admiral
A-1
- ------------------------------------------------------------------------------------------------------------- Vanguard Fund Share Classes Authorized - ------------------------------------------------------------------------------------------------------------- Vanguard Fenway Funds o Equity Income Fund Investor, Admiral o Growth Equity Fund Investor o PRIMECAP Core Fund Investor Vanguard Fixed Income Securities Funds o Short-Term Treasury Fund Investor, Admiral o Short-Term Federal Fund Investor, Admiral o Short-Term Investment-Grade Fund Investor, Admiral, Institutional o Intermediate-Term Treasury Fund Investor, Admiral o Intermediate-Term Investment-Grade Fund Investor, Admiral o GNMA Fund Investor, Admiral o Long-Term Treasury Fund Investor, Admiral o Long-Term Investment-Grade Fund Investor, Admiral o High-Yield Corporate Fund Investor, Admiral, Vanguard Florida Tax-Exempt Fund Investor, Admiral Vanguard Horizon Funds o Capital Opportunity Fund Investor, Admiral o Global Equity Fund Investor o Strategic Equity Fund Investor o Strategic Small-Cap Equity Fund Investor Vanguard Index Funds o 500 Index Fund Investor, Admiral, Signal o Extended Market Index Fund Investor, Admiral, Signal, Institutional, ETF o Growth Index Fund Investor, Admiral, Signal, Institutional, ETF o Large-Cap Index Fund Investor, Admiral, Signal, Institutional, ETF o Mid-Cap Growth Index Fund Investor, ETF o Mid-Cap Index Fund Investor, Admiral, Signal, Institutional, ETF o Mid-Cap Value Index Fund Investor, ETF o Small-Cap Growth Index Fund Investor, Institutional, ETF o Small-Cap Index Fund Investor, Admiral, Signal, Institutional, ETF o Small-Cap Value Index Fund Investor, Institutional, ETF o Total Stock Market Index Fund Investor, Admiral, Signal, Institutional, ETF o Value Index Fund Investor, Admiral, Signal, Institutional, ETF Vanguard International Equity Index Funds o Emerging Markets Stock Index Fund Investor, Admiral, Signal, Institutional, ETF o European Stock Index Fund Investor, Admiral, Signal, Institutional, ETF o FTSE All-World ex US Index Fund Investor, Institutional, ETF o Pacific Stock Index Fund Investor, Admiral, Signal, Institutional, ETF
A-2
- ------------------------------------------------------------------------------------------------------------- Vanguard Fund Share Classes Authorized - ------------------------------------------------------------------------------------------------------------- Vanguard Malvern Funds o Asset Allocation Fund Investor, Admiral o Capital Value Fund Investor o U.S. Value Fund Investor Vanguard Massachusetts Tax-Exempt Fund Investor Vanguard Money Market Funds o Prime Money Market Fund Investor, Institutional o Federal Money Market Fund Investor Vanguard Morgan Growth Fund Investor, Admiral Vanguard Montgomery Funds o Vanguard Market Neutral Fund Investor, Institutional Vanguard Municipal Bond Funds o Tax-Exempt Money Market Fund Investor o Short-Term Tax-Exempt Fund Investor, Admiral o Limited-Term Tax-Exempt Fund Investor, Admiral o Intermediate-Term Tax-Exempt Fund Investor, Admiral o Insured Long-Term Tax-Exempt Fund Investor, Admiral o Long-Term Tax-Exempt Fund Investor, Admiral o High-Yield Tax-Exempt Fund Investor, Admiral Vanguard New Jersey Tax-Free Funds o Tax-Exempt Money Market Fund Investor o Long-Term Tax-Exempt Fund Investor, Admiral Vanguard New York Tax-Free Funds o Tax-Exempt Money Market Fund Investor o Long-Term Tax-Exempt Fund Investor, Admiral Vanguard Ohio Tax-Free Funds o Tax-Exempt Money Market Fund Investor o Long-Term Tax-Exempt Fund Investor Vanguard Pennsylvania Tax- Free Funds o Tax-Exempt Money Market Fund Investor o Long-Term Tax-Exempt Fund Investor, Admiral Vanguard Quantitative Funds o Growth and Income Fund Investor, Admiral
A-3
- ------------------------------------------------------------------------------------------------------------- Vanguard Fund Share Classes Authorized - ------------------------------------------------------------------------------------------------------------- Vanguard Specialized Funds o Energy Fund Investor, Admiral o Precious Metals Fund Investor o Health Care Fund Investor, Admiral o Dividend Growth Fund Investor o REIT Index Fund Investor, Admiral, Institutional, ETF o Dividend Appreciation Index Fund Investor, ETF Vanguard Tax-Managed Funds o Tax-Managed Balanced Fund Investor o Tax-Managed Capital Appreciation Fund Investor, Admiral, Institutional o Tax-Managed Growth and Income Fund Investor, Admiral, Institutional o Tax-Managed International Fund Investor, Institutional Vanguard Europe Pacific ETF ETF o Tax-Managed Small-Cap Fund Investor, Institutional Vanguard Treasury Funds o Treasury Money Market Fund Investor Vanguard Trustees' Equity Fund o International Value Fund Investor o Diversified Equity Fund Investor Vanguard Wellesley Income Fund Investor, Admiral Vanguard Wellington Fund Investor, Admiral Vanguard Whitehall Funds o Selected Value Fund Investor o Mid-Cap Growth Fund Investor o International Explorer Fund Investor o High Dividend Yield Index Fund Investor, ETF Vanguard Windsor Funds o Windsor Fund Investor, Admiral o Windsor II Investor, Admiral
A-4
- ------------------------------------------------------------------------------------------------------------- Vanguard Fund Share Classes Authorized - ------------------------------------------------------------------------------------------------------------- Vanguard World Funds o Extended Duration Treasury Index Fund Institutional, Institutional Plus, ETF o FTSE Social Index Fund Investor, Institutional o International Growth Fund Investor, Admiral o Mega Cap 300 Index Fund Investor, Institutional, ETF o Mega Cap 300 Growth Index Fund Investor, Institutional, ETF o Mega Cap 300 Value Index Fund Investor, Institutional, ETF o U.S. Growth Fund Investor, Admiral o Consumer Discretionary Index Fund Admiral, ETF o Consumer Staples Index Fund Admiral, ETF o Energy Index Fund Admiral, ETF o Financials Index Fund Admiral, ETF o Health Care Index Fund Admiral, ETF o Industrials Index Fund Admiral, ETF o Information Technology Index Fund Admiral, ETF o Materials Index Fund Admiral, ETF o Telecommunication Services Index Fund Admiral, ETF o Utilities Index Fund Admiral, ETF Vanguard Variable Insurance Funds o Balanced Portfolio Investor o Diversified Value Portfolio Investor o Equity Income Portfolio Investor o Equity Index Portfolio Investor o Growth Portfolio Investor o Total Bond Market Index Portfolio Investor o High Yield Bond Portfolio Investor o International Portfolio Investor o Mid-Cap Index Portfolio Investor o Money Market Portfolio Investor o REIT Index Portfolio Investor o Short-Term Investment Grade Portfolio Investor o Small Company Growth Portfolio Investor o Capital Growth Portfolio Investor o Total Stock Market Index Portfolio Investor
Original Board Approval: July 21, 2000 Last Approved by Board: September 21, 2007 A-5 SCHEDULE B to VANGUARD FUNDS MULTIPLE CLASS PLAN Vanguard has policies and procedures designed to ensure consistency and compliance with the offering of multiple classes of shares within this Multiple Class Plan's eligibility requirements. These policies are reviewed and monitored on an ongoing basis in conjunction with Vanguard's Compliance Department. INVESTOR SHARES - ELIGIBILITY REQUIREMENTS Investor Shares generally require a minimum initial investment and ongoing account balance of $3,000. Particular Vanguard Funds may, from time to time, establish higher or lower minimum amounts for Investor Shares. Vanguard also reserves the right to establish higher or lower minimum amounts for certain investors or a group of investors. ADMIRAL SHARES - ELIGIBILITY REQUIREMENTS Admiral Shares generally are intended for clients who meet the required minimum initial investment and ongoing account balance of $100,000. Particular Vanguard Funds may, from time to time, establish higher or lower minimum amounts for Admiral Shares. Vanguard reserves the right to establish higher or lower minimum amounts for certain investors or a group of investors. Admiral Share class eligibility also is subject to the following rules: o Account Tenure: The minimum amount for Admiral Shares is $50,000 if the investor has maintained an account in the applicable Fund for 10 years, subject to administrative policies developed by Vanguard to exclude costly accounts. For these purposes, a Fund may, in appropriate cases, count periods during which an investor maintained an account in the Fund through a financial intermediary. To take advantage of the tenure rule, an investor generally must be registered for on-line access to their Fund account through Vanguard.com, or otherwise transact with Vanguard on a similarly cost-effective basis. o Certain Retirement Plans: Admiral Shares generally are not available to 403(b)(7) custodial accounts and SIMPLE IRAs held directly with Vanguard; as well as other Vanguard Retirement Plans receiving special administrative services from Vanguard. o Financial Intermediaries -Admiral Shares are not available to financial intermediaries who would meet eligibility requirements by aggregating the holdings of underlying investors within an omnibus account. However, a financial intermediary may hold Admiral Shares in an omnibus account if: B-1 (1) each underlying investor in the omnibus account individually meets the $100,000 minimum amount or the tenure rule described above; and (2) the financial intermediary agrees to monitor ongoing compliance of the underlying investor accounts with the $100,000 minimum amount or the tenure rule described above; or (3) a sub-accounting arrangement between Vanguard and the financial intermediary for the omnibus account allows Vanguard to monitor compliance with the eligibility requirements established by Vanguard. o VISTA - Admiral Shares are not available to participants in employee benefit plans that use Vanguard's VISTA system for plan recordkeeping. o Asset Allocation Fund -- Admiral Shares of Asset Allocation Fund are not available to certain institutional clients who receive no special recordkeeping services from Vanguard. o Account Aggregation -- Vanguard clients may hold Admiral Shares by aggregating up to three separate accounts within the same Vanguard Fund, provided that the total balance of the aggregated accounts in the Fund is at least $1 million. For purposes of this rule, Vanguard management is authorized to permit aggregation of a greater number of accounts in the case of clients whose aggregate assets within the Vanguard Funds are expected to generate substantial economies in the servicing of their accounts. The aggregation rule does not apply to clients receiving special recordkeeping or sub-accounting services from Vanguard, nor does it apply to nondiscretionary omnibus accounts maintained by financial intermediaries. o Accumulation Period -- Accounts funded through regular contributions (e.g. employer sponsored participant contribution plans), whose assets are expected to quickly achieve eligibility levels, may qualify for Admiral Shares upon account creation, rather than undergoing the conversion process shortly after account set-up if Vanguard management determines that the account will become eligible for Admiral Shares within a limited period of time (generally 90 days). SIGNAL SHARES - ELIGIBILITY REQUIREMENTS Signal Shares generally are intended for institutional clients who meet the eligibility requirements set forth by Vanguard's institutional client service departments. Institutional clients generally must maintain a minimum balance of B-2 no less than $1 million in the Fund. Eligibility criteria are subject to the discretion of Vanguard management, and Vanguard reserves the right to establish higher or lower minimum amounts for certain investors or a group of investors and to change such requirements at any time. Signal Share class eligibility also is subject to the following rules: o Previously held Admiral Shares. Admiral Shares held by institutional clients prior to the effective date of Signal Shares will be converted at the discretion of Vanguard management into Signal Shares. o Institutional intermediary clients. Institutional clients that are financial intermediaries generally may hold Signal Shares only if the total amount invested across all accounts held by the intermediary in the Fund is at least $5 million. Signal Shares generally are not available to financial intermediaries that serve as retail fund supermarkets. o Institutional clients whose accounts are not recordkept by Vanguard. Institutional clients, including but not limited to financial intermediary and defined benefit and contribution plan clients, endowments, and foundations whose accounts are not recordkept by Vanguard may hold Signal Shares if the total amount aggregated among all accounts held by such client and invested in a single Fund is at least $1 million. Such institutional clients must disclose to Vanguard on behalf of their accounts the following: (1) that each account has a common decision-maker; and (2) the total balance in each account held by the client in the Fund. o Institutional clients whose accounts are recordkept by Vanguard. Institutional clients whose accounts are recordkept by Vanguard may hold Signal Shares if they meet eligibility criteria established by Vanguard management. These eligibility criteria include, but are not limited to the following factors, which may be changed at any time and without prior notice: (1) the total amount invested in the Fund must be greater than $15 million; (2) the amount of the client's underlying account balances in the Fund; and (3) the extent to which the client uses Fund and Vanguard account services. For purposes of this analysis, Vanguard management may consider clients whose aggregate assets within the Vanguard Funds are expected to generate substantial economies in the servicing of their accounts. o Accumulation Period. Accounts funded through regular contributions (e.g. employer sponsored participant contribution plans), whose assets are expected to quickly achieve eligibility levels, may qualify for Signal Shares upon account creation, rather than undergoing the conversion process shortly after account set-up if Vanguard management determines that the account will become eligible for Signal Shares within a limited period of time (generally 90 days). The accumulation period eligibility is subject to the discretion of Vanguard management. B-3 INSTITUTIONAL SHARES - ELIGIBILITY REQUIREMENTS Institutional Shares generally require a minimum initial investment and ongoing account balance of $5,000,000. However, Vanguard also reserves the right to establish higher or lower minimum amounts for certain investors or a group of investors. Institutional Share class eligibility also is subject to the following special rules: o Vanguard Short-Term Investment Grade Fund - $50,000,000 minimum amount for Institutional Shares o Vanguard Long-Term Bond Index Fund -- $25,000,000 minimum amount for Institutional Shares o Vanguard Intermediate-Term Bond Index Fund -- $25,000,000 minimum amount for Institutional Shares o Individual clients. Individual clients may hold Institutional Shares by aggregating up to 3 accounts held by the same client (same tax I.D. number) in a single Fund. o Institutional intermediary clients. Institutional clients that are financial intermediaries generally may hold Institutional Shares for the benefit of their underlying clients provided that each underlying client account invests at least $5 million (or such higher minimum required by the individual fund) in the Fund. o Institutional clients whose accounts are not recordkept by Vanguard. Institutional clients, including but not limited to financial intermediary and defined benefit and contribution plan clients, endowments, and foundations whose accounts are not recordkept by Vanguard may hold Institutional Shares if the total amount aggregated among all accounts held by such client and invested in the Fund is at least $5 million (or such higher minimum required by the individual fund). Such institutional clients must disclose to Vanguard on behalf of their accounts the following: (1) that each account has a common decision-maker; and (2) the total balance in each account held by the client in the Fund. o Institutional clients whose accounts are recordkept by Vanguard - Institutional Shares are not available to institutional clients whose accounts are recordkept by Vanguard unless Vanguard management determines that the client's aggregate assets within a Fund as well as the extent to which the client uses Fund and Vanguard account services will likely generate substantial economies in the servicing of their accounts. o Investment by Vanguard Target Retirement Collective Trust. A Vanguard Target Retirement Trust that is a collective trust exempt from B-4 regulation under the Investment Company Act and that seeks to achieve its investment objective by investing in underlying Vanguard Funds (a "TRT") may hold Institutional Shares of an underlying Fund whether or not its investment meets the minimum investment threshold specified above. o Accumulation Period -- Accounts funded through regular contributions (e.g. employer sponsored participant contribution plans), whose assets are expected to quickly achieve eligibility levels, may qualify for Institutional Shares upon account creation, rather than undergoing the conversion process shortly after account set-up if Vanguard management determines that the account will become eligible for Institutional Shares within a limited period of time (generally 90 days). The accumulation period eligibility is subject to the discretion of Vanguard management. INSTITUTIONAL PLUS SHARES - ELIGIBILITY REQUIREMENTS Institutional Plus Shares generally require a minimum initial investment and ongoing account balance of $100,000,000. However, Vanguard also reserves the right to establish higher or lower minimum amounts for certain investors or a group of investors. Institutional Plus Share class eligibility also is subject to the following special rules: o Financial Intermediaries - Institutional Plus Shares are not available to financial intermediaries who would meet the eligibility requirements by aggregating the holdings of underlying investors. However, a financial intermediary may hold Institutional Plus Shares in an omnibus account if: (1) each underlying investor in the omnibus account individually meets the investment minimum amount described above; and (2) the financial intermediary agrees to monitor ongoing compliance of the underlying investor accounts with the investment minimum amount; or (3) a sub-accounting arrangement between Vanguard and the financial intermediary for the omnibus account allows Vanguard to monitor compliance with the eligibility requirements established by Vanguard. o VISTA - Institutional Plus Shares are not available to participants in employee benefit plans that utilize Vanguard's VISTA system for plan recordkeeping, unless Vanguard management determines that a plan sponsor's aggregate assets within the Vanguard Funds will likely generate substantial economies in the servicing of their accounts. o Account Aggregation - Vanguard clients may hold Institutional Plus Shares by aggregating up to three separate accounts within the same Vanguard Fund, provided that the total balance of the aggregated accounts in the Fund meets the minimum investment for the Fund's Institutional Plus Shares. For purposes of this rule, Vanguard B-5 management is authorized to permit aggregation of a greater number of accounts in the case of clients whose aggregate assets within the Vanguard Funds are expected to generate substantial economies in the servicing of their accounts. The aggregation rule does not apply to clients receiving special recordkeeping or sub-accounting services from Vanguard, nor does it apply to nondiscretionary omnibus accounts maintained by financial intermediaries. o Accumulation Period - Accounts funded through regular contributions e.g. employer sponsored participant contribution plans), whose assets are expected to quickly achieve eligibility levels, may qualify for Institutional Plus Shares upon account creation, rather than undergoing the conversion process shortly after account set-up if Vanguard management determines that the account will become eligible for Institutional Plus Shares within a limited period of time (generally 90 days). o Asset Allocation Models - Vanguard clients with defined asset allocation models whose assets meet eligibility requirements may qualify for Institutional Plus Shares if such models comply with policies and procedures that have been approved by Vanguard management. ETF Shares - Eligibility Requirements The eligibility requirements for ETF Shares will be set forth in the Fund's Registration Statement. To be eligible to purchase ETF Shares directly from a Fund, an investor must be (or must purchase through) an Authorized DTC Participant, as defined in Paragraph III.D of the Multiple Class Plan. Investors purchasing ETF Shares from a Fund must purchase a minimum number of shares, known as a Creation Unit. The number of ETF Shares in a Creation Unit may vary from Fund to Fund, and will be set forth in the relevant prospectus. The value of a Fund's Creation Unit will vary with the net asset value of the Fund's ETF Shares, but is expected to be several million dollars. An eligible investor generally must purchase a Creation Unit by depositing a prescribed basket of securities with the Fund, rather than paying cash. Original Board Approval: July 21, 2000 Last Approved by Board: September 21, 2007 71024.24 EX-99.H 6 serviceagreement.txt FORM OF SPECIAL SERVICE AGREEMENT VANGUARD MANAGED PAYOUT FUNDS FORM OF SPECIAL SERVICE AGREEMENT AGREEMENT, made as of this 11th day of December, 2007, between VANGUARD VALLEY FORGE FUNDS, a Delaware statutory trust (the "Trust"), and THE VANGUARD GROUP, INC., a Pennsylvania corporation ("Vanguard"). WHEREAS, the Trust is an open-end management investment company registered under the Investment Company Act of 1940 that offers the following series: o Vanguard Managed Payout Growth Focus Fund o Vanguard Managed Payout Distribution Focus Fund o Vanguard Managed Payout Growth and Distribution Fund (each a "Fund"); WHEREAS, each Fund employs a "fund of funds" investment strategy by investing in other registered investment companies managed or administered by Vanguard; WHEREAS, Vanguard provides management, administrative, transfer agency, dividend disbursing, investment advisory and other services to the Funds and certain other registered investment companies pursuant to a written agreement, which agreement may be amended from time to time, the current version being the Fourth Amended and Restated Funds' Service Agreement, dated June 15, 2001 (the "Funds' Service Agreement"); WHEREAS, the Trust wishes to retain Vanguard to render to the Funds the services described in the preceding paragraph on slightly different terms than provided for in the Funds' Service Agreement, and Vanguard is willing to render such services on those terms; and WHEREAS, more than two-thirds of the registered investment companies that are parties to the Funds' Service Agreement have agreed that Vanguard may enter this Agreement with the Trust. NOW, THEREFORE, in consideration of the premises and mutual promises hereinafter set forth, the parties hereto agree as follows: 1. In consideration for the services provided to the Funds by Vanguard pursuant to the Funds' Service Agreement, Vanguard shall be entitled to receive from the Funds the out-of-pocket, incremental costs Vanguard incurs in providing such services. 2. Notwithstanding anything in the Funds' Service Agreement to the contrary, a Fund: (a) shall not be obligated or permitted to make a capital contribution or to acquire shares of Vanguard pursuant to Part I of the Funds' Service Agreement, except to the extent that the Fund's assets are not invested in shares of other Vanguard funds; (b) shall not be allocated, or obligated to pay, any portion of the expenses of Vanguard pursuant to Section 3.2 of the Funds' Service Agreement, except as set forth in Section 1 of this Agreement or as otherwise determined by the Board of Directors of Vanguard pursuant to Section 3.2(A)(4) of the Fund Services' Agreement; and (c) may have the expenses the Fund would otherwise bear pursuant to Section 1 of this Agreement and Section 2.1 of the Funds' Service Agreement reduced or eliminated by the savings that accrue to the benefit of the Vanguard funds by virtue of the operation of the Fund. 3. Except as provided above, the parties agree that each Fund shall be subject to all the provisions of the Funds' Service Agreement. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date first set forth herein. VANGUARD VALLEY FORGE FUNDS By ----------------------------------- John J. Brennan Chairman and Chief Executive Officer THE VANGUARD GROUP, INC. By ----------------------------------- John J. Brennan Chairman and Chief Executive Officer COVER 7 filename7.txt [SHIP][VANGUARD LOGO] P.O. Box 2600 Valley Forge, PA 19482-2600 610-669-6893 edward_delk@vanguard.com November 30, 2007 Christian Sandoe, Esq. U.S. Securities & Exchange Commission VIA ELECTRONIC FILING 100 F Street, N.E. Washington, DC 20549 RE: Vanguard Valley Forge Funds Dear Mr. Sandoe, This letter describes certain changes we made to the prospectus for the Managed Payout Funds. These changes are in addition to the changes we made in response to your comments of November 9 and 13, 2007 on Post-Effective Amendment No. 32 of the registration statement of the above-referenced registrant, which was filed on September 27, 2007. The outside front cover of the Fund's Prospectus and Statement of Additional Information will include the pre-effective language required by Rule 481(b)(2). 1. Fund Names and Investment Objectives. We have revised the Funds' names to be more reflective of their respective investment objectives. We also simplified the wording of the Funds' investment objectives. 2. Primary Investment Strategies. We have revised the Primary Investment Strategies section of each Fund Profile as follows: a. The introductory paragraph has been simplified but also revised to reflect the degree of flexibility the Funds have in the allocation of their assets. b. The description of "Stocks" reflects a change in the underlying stock index funds that are likely to be used to create stock exposure. The description was also revised to include the Vanguard REIT Index, which was formerly listed under the heading "Real Estate Investments". c. A new heading called "Other Investments" has been added to cover two previously-listed investment categories (Commodity-Linked Investments and Market Neutral Investments)(1) as well as a new investment category. The new investment category is called "Investments in a Prospective Absolute Return Fund." The text that follows describes, - -------------------------- (1) The disclosure under Commodity-Linked Investments and Market Neutral Investments is unchanged from the original version except for the deletion of the following text that formerly appeared at the end of the fourth sentence under Market Neutral Investments: "to the extent consistent with the advisors' individual investment decisions to create exposure to specific risk factors." Christian Sandoe, Esq. November 30, 2007 Page 2 among other things, the fact that it is possible, but not yet decided, that Vanguard may establish and manage a private investment fund ("absolute return fund") that uses multiple absolute return investment strategies. The text also describes the fact that it is possible, but not yet decided, that the Managed Payout Funds may in the future invest in the absolute return fund. The text goes on to describe the absolute return fund in further detail. If the absolute return fund is established and approved for investment by the Managed Payout Funds, each Fund expects to adhere to a policy (which can be changed only by the board of trustees) that it will not invest more than 40% of its assets in the absolute return fund under any circumstances.(2) 3. Primary Risks. We have revised the Primary Risks section of each Fund Profile as follows: a. Risks relating to the managed distribution policy have been added. b. The risks previously described under the heading "Asset allocation strategy risk" have been merged into the more appropriate heading "Manager risk." The risks described under "Manager risk" have been updated for clarity. c. "Stock risk" has been expanded to include the risk that previously appeared under the heading "Real estate investment risk" (now called "REIT stock risk"). "Inflation-linked investment risk" has been moved but is unchanged except for the inclusion of the word "primarily." d. "Commodity-linked investment risk" has been moved and expanded to cover more fully the risks of derivatives. e. "Market neutral investment risk" has been moved and remains unchanged except to the extent needed to make "short sale risk" more general and thus applicable (by reference) to the absolute return fund. f. A new category of risks has been added to address the prospective absolute return fund. 4. Fees and Expenses. We have revised the fees and expenses table in each Fund Profile to update the expense ratios and add footnote disclosure. We also added a "Plain Talk About Acquired Fund Short Sale Dividend Expenses." - --------------------- (2) See Cornish & Carey Commercial, Inc., SEC No-Action Letter (pub. avail. June 21, 1996). Christian Sandoe, Esq. November 30, 2007 Page 3 5. Additional Information. We expanded the description of distributions , and added a description of the potential for additional distributions beyond the twelve scheduled monthly distributions per calendar year, under the heading "Additional Information." We also provided certain missing information. 6. Part 4 of the Prospectus. We have revised part 4 of the prospectus to conform to the changes described above in part 2 of the prospectus. We also added a "Plain Talk About Absolute Return Investing." Tandy Requirements As required by the SEC, each Fund acknowledges that: o The Fund is responsible for the adequacy and accuracy of the disclosure in the filing. o Staff comments or changes in response to staff comments in the filings reviewed by the staff do not foreclose the Commission from taking any action with respect to the filing. o The Fund may not assert staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States. Please contact me at (610) 669-6893 with any questions or comments regarding the above. Sincerely, Edward C. Delk Principal November 30, 2007 U.S. Securities and Exchange Commission 100 F Street, N.E. Washington, DC 20549 RE: VANGUARD VALLEY FORGE FUNDS--461(A) REQUEST FOR ACCELERATION OF EFFECTIVENESS FILE NO. 333-48863 ---------------------------------------------------------------- Commissioners: Pursuant to Rule 461(a) under the Securities Act of 1933, Vanguard Valley Forge Funds (the "Trust") and its distributor, Vanguard Marketing Corporation, respectfully request that the effectiveness of the Trust's registration statement on Form N-1A be accelerated to Tuesday, December 11, 2007. Post-Effective Amendment No.34 to the registration statement has been filed today, November 30, 2007. Sincerely, VANGUARD VALLEY FORGE FUNDS - ---------------------------------- Name: John J. Brennan (Heidi Stam)* Title: President VANGUARD MARKETING CORPORATION, Distributor - ---------------------------------- Name: Michael Kimmel Title: Secretary cc: Christian Sandoe, Esq. U.S. Securities and Exchange Commission -----END PRIVACY-ENHANCED MESSAGE-----