UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT
OF
REGISTERED MANAGEMENT INVESTMENT COMPANIES

Investment Company Act file number: 811-07803

 

 

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

Date of fiscal year end: August 31

Date of reporting period: September 1, 2015 – February 29, 2016

Item 1: Reports to Shareholders

Semiannual Report | February 29, 2016

Vanguard Explorer Value^™ Fund

 

Vanguard’s Principles for Investing Success

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

Goals. Create clear, appropriate investment goals.

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

Discipline. Maintain perspective and long-term discipline.

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

We believe there is no wiser course for any investor.

 

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

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

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

 

Your Fund’s Total Returns

 

 

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Chairman’s Letter

Dear Shareholder,

Vanguard Explorer Value Fund returned –5.40% for the six months ended February 29, 2016. Smaller-capitalization stocks continued to underperform large-caps. Within the small-cap arena, growth stocks posted considerably lower returns than their value counterparts.

The fund’s return, although negative, was slightly better than that of its benchmark, the Russell 2500 Value Index. The average return of small-cap value funds was even lower, by more than 1.5 percentage points.

Of the nine sectors represented in the fund, seven lost ground and only two gained. Holdings among financial, industrial, and consumer discretionary firms were notable detractors, while information technology companies and utilities did best.

Stocks mostly slumped over the fiscal half year
U.S. stocks returned about –3% for the period. Results were negative in four of the six months. Only October’s return of about 8% prevented an even weaker performance for the half year.

Fears that China’s economic slowdown would spread globally weighed on results. Oil and commodity prices, which declined through most of the period before showing some resiliency in February, also concerned investors.

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In December, the Federal Reserve increased its target for short-term interest rates to 0.25%–0.5%. Central banks in Europe and Asia, in contrast, boosted stimulus efforts to battle weak growth and low inflation.

International stocks returned about –9%, a result that would have been less severe if not for the U.S. dollar’s strength against many foreign currencies. European stocks were among the worst performers.

Bonds registered gains as investors cut their risk
The broad U.S. taxable bond market returned 2.20% over the six months. Most of the gains came in January and February as investors sought safe-haven assets amid stock market turmoil. The yield of the 10-year U.S. Treasury note closed at 1.74% in February, down from 2.18% six months earlier. (Bond prices and yields move in opposite directions.)

The Fed’s target rate, which stayed anchored at 0%–0.25% until the small rise in December, kept a lid on returns for money market funds and savings accounts.

International bond markets (as measured by the Barclays Global Aggregate Index ex USD) returned 3.13%. Bonds globally have been buoyed by negative interest rates. In December the European Central Bank cut a key rate further into negative territory, and in late January the Bank of Japan adopted a negative-rate policy.

 

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Your fund lost some ground in a downbeat environment
The fund’s three advisors, Frontier Capital Management, Cardinal Capital Management, and Sterling Capital Management, use different but complementary approaches to find smaller companies that they expect will outperform small-cap value stocks over the long term.

In a rocky period for stocks, the Explorer Value Fund’s total return was underwater. But a combination of the advisors’ sector allocations and stock picking prevented the fund from losing as much as its benchmark index.

The fund’s largest sector, financials, returned about –5%, trailing the index by about 2 percentage points. The fund’s real estate investment trust (REIT) portfolio hurt relative performance as the specter of higher rates raised concerns about REITs’ future debt financing costs.

The fund outperformed thanks to selections in information technology (+4%), notably among electronic equipment specialists, and in health care, where the fund’s holdings recorded losses (–8%) but the index’s stocks did worse (–16%).

 

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Relative results also were aided by an underweight position in the troubled energy segment, which returned –38% in the benchmark index. Sinking oil and natural gas prices continued to stress the sector. The fund’s relative performance also benefited from holding energy stocks that didn’t do as badly as the sector overall.

One beneficiary of tumbling energy prices has been the utilities sector. Lower energy costs help utility companies’ bottom line, and the fund’s energy holdings returned 18%. However, the fund had a smaller weighting in the sector than the index did, hurting relative performance.

The continuing decline in commodity prices hit the fund’s industrial and materials holdings, while investor pessimism contributed to a decline among consumer-related stocks.

For more about the advisors’ strategies and the fund’s positioning during the six months, see the Advisors’ Report that follows this letter.

Doing what’s best for clients: That’s how we were built
It’s hard for me to believe, but this year will be my 30th with Vanguard. I knew little about the company when I started in June 1986, but I soon learned what makes Vanguard unique.

Simply put, we’re built differently.

We don’t have stockholders or outside owners. Instead, Vanguard is owned by its funds, which in turn are owned by you—Vanguard clients.

 

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This structure matters because it ensures that our interests are completely aligned with those of our clients. We never have to weigh what’s best for clients against what’s best for the company’s owners; their interests are one and the same. Our client-owned structure is what allows us to run our funds at cost, and it’s why Vanguard’s expense ratios remain among the lowest in the industry.

At the same time, we continually dedicate resources to enhance Vanguard’s service and investment capabilities. We aspire to provide the highest possible quality at the lowest possible price. That was true 30 years ago, it’s true today, and it will remain our focus for decades to come. After all, we’re built to put the long-term interests of our clients first.

As always, thank you for investing with Vanguard.

Sincerely,

F. William McNabb III
Chairman and Chief Executive Officer
March 11, 2016

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Advisors’ Report

For the half year ended February 29, 2016, Vanguard Explorer Value Fund returned –5.40%. Your fund is managed by three independent advisors, a strategy that enhances the fund’s diversification by providing exposure to distinct yet complementary investment approaches. It is not uncommon for different advisors to have different views about individual securities or the broader investment environment.

The advisors, the amount and percentage of fund assets each manages, and brief descriptions of their investment strategies are presented in the table below. The advisors have also prepared a discussion of the investment environment that existed during the half year and of how their portfolio positioning reflects this assessment. (Please note that the Frontier and Sterling discussions refer to industry sectors as defined by Russell classifications, rather than by the Global Industry Classification Standard used elsewhere in this report.) These comments were prepared on March 15, 2016.

Frontier Capital Management Co., LLC

Portfolio Managers:

Thomas W. Duncan, Jr.,
Senior Vice President

William A. Teichner, CFA,
Senior Vice President

Our portion of the fund benefited from both stock and sector selection, with our strongest holdings in financial services and information technology.

 

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The portfolio’s ten best contributors were spread across four sectors and included four technology holdings, three financial companies, two utilities, and one producer durables position.

The top contributor was Ingram Micro, a major distributor of technology-related products. In February, the company agreed to be acquired by China-based Tianjin Tianhai Investment Co. The all-cash transaction values Ingram at $38.90 per share, a 31% premium to its price before the deal. Ingram jumped to $36 on the announcement and should rise further upon completion of the transaction.

The portfolio’s ten largest detractors were spread over six sectors and included three holdings from materials and processing, three from producer durables, and one each from energy, consumer discretionary, financial services, and technology.

One of the biggest detractors was Boise Cascade, a manufacturer of plywood and engineered wood products and a distributor of building materials. The company’s financial results have been hurt by declining profits in its plywood business because of rising competition from Brazilian imports related to the strong U.S. dollar and weak domestic demand in Brazil. We believe that the stock is attractive based on its longer-term earnings potential and expect that over time the company will increase its revenues and improve its profitability as the U.S. housing market continues to recover.

During the period we bought 11 new stocks across five sectors and sold nine others across four sectors. The net effect was an increase in producer durables, consumer discretionary, and materials and processing companies and a reduction in technology and energy holdings. As is typical for us, the changes were related to company-specific reasons rather than top-down positioning.

Cardinal Capital Management, L.L.C.

Portfolio Managers:

Eugene Fox III, Managing Partner

Robert B. Kirkpatrick, CFA,
Managing Partner

Rachel D. Matthews, Partner

During the period, domestic economic data was mixed but much better than in many other developed countries. GDP grew moderately and employment growth picked up after a weak third quarter, but industrial production fell because of the impact of the strong U.S. dollar and sustained weakness in commodity prices. Although the unemployment rate approached historical levels of full employment, wage growth remained tepid. Nonetheless, the Federal Reserve finally took its first well-telegraphed step to normalize interest rates by raising the federal funds rate 25 basis points.

Within our portion of the fund, stock selection in the financial sector and the absence of investments in utilities were the primary detractors from relative

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performance. Specifically, the stock price of PacWest Bancorp, a West Coast bank, declined because of a change in investors’ expectations for further rate increases and the perception that the bank’s high interest margins may be more susceptible to pressure than the margins of its less profitable peers. Shares of Howard Hughes Corp., a real estate owner and developer, fell as a result of its exposure in Houston, which has been hurt by the decline in the price of oil.

Offsetting this performance somewhat was strong stock selection in the energy and consumer discretionary sectors. The stock price of World Fuel Services increased, amid the energy sector’s significant decline; the fuel logistics supplier is more leveraged to the volatility of oil prices than the absolute level. In consumer discretionary, the share price of theme park operator Six Flags Entertainment rose sharply after the company provided more details on its international licensing agreements and aggressively repurchased its shares.

Looking forward, we expect U.S. economic growth to remain moderate, inflation benign, and the dollar strong. The price of oil is likely to remain low, as supply still exceeds demand. Economic uncertainty remains outside the United States, primarily because major economic regions have different monetary policies, as well as sensitivity to low oil prices and the strong U.S. dollar. However, the renewed slowdown in the global growth environment, weakness in emerging markets, and current foreign

central bank policies have made additional rate increases less likely. The merger and acquisition market should remain strong as long as reasonably priced capital is available because growth is scarce, and value can be created through consolidation.

Sterling Capital Management LLC

Portfolio Managers:

Eduardo A. Brea, CFA,
Managing Director

Timothy P. Beyer, CFA,
Managing Director

Investors lurched toward “risk off” positioning, as economically sensitive sectors underperformed defensive and yield-oriented equities during the period. Corporate credit yields widened. Our portfolio was affected equally by sector and stock selection.

We continue to find better values in more cyclical areas of the market. Stock selection was meaningfully positive in the producer durables sector. Mistras Group (+49%) and Itron (+33%) took aggressive action to address their cost structures that trumped weak end markets and preserved earnings power. Axiall, which produces chlor-alkali, was another noteworthy holding; it received an unsolicited cash and stock offer from Westlake Chemical at a 100% premium to its absurdly low trading price in early January, confirming its significant value. We believe its intrinsic value to be significantly higher still.

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Banks also performed poorly during the period. Low interest rates undermine earnings power for lenders. We believe our intrinsic value targets will be realized through higher interest rates or consolidation in the industry, which is picking up in earnest among smaller-capitalization banks. Negative outliers included Popular (–9%) and Bancorp (–35%). Bancorp is struggling because high regulatory costs are depressing results. Those costs are transitory, however, and its prepaid debit card franchise is quite valuable.

Finally, the consumer discretionary sector was a mixed bag, with gains by Regis (+32%) and Interpublic (+19%) more than offset by the performance of retail-oriented stocks such as Elizabeth Arden (–43%), Ascena Retail Group (–30%), and Crocs (–34%). Hertz Global Holdings (–53%) continues to frustrate value investors. Despite significant consolidation in the car rental business, industry pricing power has been soft. Other investor concerns include ride-sharing services such as Uber and strong new-car sales, which can reduce the value for used fleet vehicles for rental companies such as Hertz. We remain convinced, however, that activist pressure and the spin-off of the company’s materials-handling subsidiary will result in significant upside for the stock.

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Explorer Value Fund

Fund Profile
As of February 29, 2016

 

 

 

 

Investment Focus

1 The expense ratio shown is from the prospectus dated December 22, 2015, and represents estimated costs for the current fiscal year. For the six months ended February 29, 2016, the annualized expense ratio was 0.58%.

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Explorer Value Fund

Performance Summary

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

Fiscal-Year Total Returns (%): March 30, 2010, Through February 29, 2016

Average Annual Total Returns: Periods Ended December 31, 2015
This table presents returns through the latest calendar quarter—rather than through the end of the fiscal period. Securities and Exchange Commission rules require that we provide this information.

 

See Financial Highlights for dividend and capital gains information.

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Explorer Value Fund

Financial Statements (unaudited)

Statement of Net Assets
As of February 29, 2016

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

 

 

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Explorer Value Fund

 

 

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Explorer Value Fund

 

 

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Explorer Value Fund

 

• See Note A in Notes to Financial Statements.
* Non-income-producing security.
^ Includes partial security positions on loan to broker-dealers. The total value of securities on loan is $705,000.
1 The fund invests a portion of its cash reserves in equity markets through the use of index futures contracts. After giving effect to futures investments, the fund’s effective common stock and temporary cash investment positions represent 96.5% and 3.4%, respectively, of net assets.
2 Affiliated money market fund available only to Vanguard funds and certain trusts and accounts managed by Vanguard. Rate shown is the 7-day yield.
3 Includes $782,000 of collateral received for securities on loan.
4 The issuer was placed under federal conservatorship in September 2008; since that time, its daily operations have been managed by the Federal Housing Finance Agency and it receives capital from the U.S. Treasury, as needed to maintain a positive net worth, in exchange for senior preferred stock.
5 Securities with a value of $400,000 have been segregated as initial margin for open futures contracts.
See accompanying Notes, which are an integral part of the Financial Statements.

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Explorer Value Fund

Statement of Operations

 

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

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Explorer Value Fund

Statement of Changes in Net Assets

 

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

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Explorer Value Fund

Financial Highlights

The expense ratio, net income ratio, and turnover rate for the current period have been annualized.
1 Total returns do not include account service fees that may have applied in the periods shown. Fund prospectuses provide information about any applicable account service fees.
2 Includes performance-based investment advisory fee increases (decreases) of 0.01%, (0.02%), (0.02%), 0.04%, 0.03%, and 0.01%.

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

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Explorer Value Fund

Notes to Financial Statements

Vanguard Explorer Value Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund.

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

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

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

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

During the six months ended February 29, 2016, the fund’s average investments in long and short futures contracts represented 3% and 0% of net assets, respectively, based on the average of aggregate settlement values at each quarter-end during the period.

3. Federal Income Taxes: The fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Management has analyzed the fund’s tax positions taken for all open federal income tax years (August 31, 2012–2015), and for the period ended February 29, 2016, and has concluded that no provision for federal income tax is required in the fund’s financial statements.

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

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Explorer Value Fund

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

6. Credit Facility: The fund and certain other funds managed by The Vanguard Group (“Vanguard”) participate in a $3 billion committed credit facility provided by a syndicate of lenders pursuant to a credit agreement that may be renewed annually; each fund is individually liable for its borrowings, if any, under the credit facility. Borrowings may be utilized for temporary and emergency purposes, and are subject to the fund’s regulatory and contractual borrowing restrictions. The participating funds are charged administrative fees and an annual commitment fee of 0.06% of the undrawn amount of the facility; these fees are allocated to the funds based on a method approved by the fund’s board of trustees and included in Management and Administrative expenses on the fund’s Statement of Operations. Any borrowings under this facility bear interest at a rate equal to the higher of the federal funds rate or LIBOR reference rate plus an agreed-upon spread.

The fund had no borrowings outstanding at February 29, 2016, or at any time during the period then ended.

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

B. The investment advisory firms Frontier Capital Management Co., LLC, Cardinal Capital Management, L.L.C., and Sterling Capital Management LLC each provide investment advisory services to a portion of the fund for a fee calculated at an annual percentage rate of average net assets managed by the advisor. The basic fee of Frontier Capital Management Co., LLC, is subject to quarterly adjustments based on performance relative to the Russell 2000 Value Index for the preceding three years. The basic fee of Cardinal Capital Management, L.L.C., is subject to quarterly adjustments based on performance relative to the Russell Mid-Cap Value Custom Cap-Range Index for periods prior to March 1, 2015, and the new benchmark, Russell 3000

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Explorer Value Fund

Value Custom Index, beginning March 1, 2015, for the preceding three years. The new benchmark will be fully phased in by February 2018. The basic fee of Sterling Capital Management LLC is subject to quarterly adjustments based on performance relative to the Russell 2500 Value Index for the preceding three years.

Vanguard manages the cash reserves of the fund as described below.

For the six months ended February 29, 2016, the aggregate investment advisory fee represented an effective annual basic rate of 0.36% of the fund’s average net assets, before a net increase of $19,000 (0.01%) based on performance.

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

Upon the request of Vanguard, the fund may invest up to 0.40% of its net assets as capital in Vanguard. At February 29, 2016, the fund had contributed to Vanguard capital in the amount of $25,000, representing 0.01% of the fund’s net assets and 0.01% of Vanguard’s capitalization. The fund’s trustees and officers are also directors and employees, respectively, of Vanguard.

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

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

The following table summarizes the market value of the fund’s investments as of February 29, 2016, based on the inputs used to value them:

 

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Explorer Value Fund

E. At February 29, 2016, the aggregate settlement value of open futures contracts and the related unrealized appreciation (depreciation) were:

 

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

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

At February 29, 2016, the cost of investment securities for tax purposes was $262,192,000. Net unrealized appreciation of investment securities for tax purposes was $11,968,000, consisting of unrealized gains of $40,129,000 on securities that had risen in value since their purchase and $28,161,000 in unrealized losses on securities that had fallen in value since their purchase.

G. During the six months ended February 29, 2016, the fund purchased $42,361,000 of investment securities and sold $40,312,000 of investment securities, other than temporary cash investments.

H. Capital shares issued and redeemed were:

 

I. Management has determined that no material events or transactions occurred subsequent to February 29, 2016, that would require recognition or disclosure in these financial statements.

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About Your Fund’s Expenses

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

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

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

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

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

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

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

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

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

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Trustees Approve Advisory Arrangements

The board of trustees of Vanguard Explorer Value Fund has renewed the fund’s investment advisory arrangements with Cardinal Capital Management, L.L.C. (Cardinal), Frontier Capital Management Co., LLC (Frontier), and Sterling Capital Management LLC (Sterling). The board determined that renewing the fund’s advisory arrangements was in the best interests of the fund and its shareholders.

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

Nature, extent, and quality of services
The board reviewed the quality of the fund’s investment management services since its inception in 2010, and took into account the organizational depth and stability of each advisor. The board considered the following:

Cardinal. Founded in 1995, Cardinal is an investment advisor that manages small- and mid-cap value portfolios. Cardinal utilizes fundamental research to analyze a company’s ability to generate free cash flow and deploy that cash flow efficiently, enhancing shareholder value. Cardinal’s analysts engage extensively with company management teams to understand their capital allocation decisions. Cardinal seeks to purchase companies that can generate superior cash flow and make value-creating capital allocation decisions at suppressed valuations. Cardinal has advised a portion of the fund since the fund’s inception.

Frontier. Founded in 1980, Frontier is an investment advisor with a long history of investing in small- and mid-cap stocks. Frontier employs a relative value approach that focuses on identifying companies with solid business models, unrecognized earnings power, and attractive valuations. The portfolio managers are supported by Frontier’s deep team of sector-focused analysts and other small- and mid-cap portfolio managers. Frontier has advised a portion of the fund since the fund’s inception.

Sterling. Founded in 1970, Sterling is an investment advisor that manages fixed income and equity portfolios, with the latter focused on small- and mid-sized companies. Sterling uses a value-oriented strategy that seeks to identify stocks of quality companies selling at large discounts compared with the underlying value of the business. Sterling defines quality companies as those that generate considerable cash flow, offer reinvestment opportunities with attractive returns, and enjoy competitive advantages in their business sector. Sterling has advised a portion of the fund since the fund’s inception.

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

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

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

The board did not consider profitability of Cardinal, Frontier, or Sterling in determining whether to approve the advisory fees, because the firms are independent of Vanguard, and the advisory fees are the result of arm’s-length negotiations.

The benefit of economies of scale
The board concluded that the fund’s shareholders benefit from economies of scale because of breakpoints in the advisory fee schedule for Cardinal, Frontier, and Sterling. The breakpoints reduce the effective rate of the fees as the fund’s assets managed by each advisor increase.

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

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Glossary

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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The People Who Govern Your Fund

The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are a part owner of the fund. Your fund’s trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides services to them on an at-cost basis.

A majority of Vanguard’s board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. The independent board members have distinguished backgrounds in business, academia, and public service. Each of the trustees and executive officers oversees 196 Vanguard funds.

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

 

 

 

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

 

 

 

Semiannual Report | February 29, 2016

Vanguard Russell 1000 Index Funds

Vanguard Russell 1000 Index Fund

Vanguard Russell 1000 Value Index Fund

Vanguard Russell 1000 Growth Index Fund

 

Vanguard’s Principles for Investing Success

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

Goals. Create clear, appropriate investment goals.

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

Discipline. Maintain perspective and long-term discipline.

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

We believe there is no wiser course for any investor.

 

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

 

Your Fund’s Total Returns

Large-Cap Growth Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company.

 

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

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

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Chairman’s Letter

Dear Shareholder,

After posting mostly strong returns in the years since the financial crisis of 2008–2009, the broad U.S. stock market sagged over the six months ended February 29, 2016. Growth stocks were ahead of value stocks, both finished with negative returns, and large-capitalization stocks outperformed mid- and small-caps.

All three funds reviewed in this report successfully tracked their target indexes and surpassed the average returns of their peers. Vanguard Russell 1000 Growth Index Fund returned about –1%, and Vanguard Russell 1000 Value Index Fund finished at about –3%. Vanguard Russell 1000 Index Fund, a blend of growth and value stocks, returned about –2%.

Stocks mostly slumped over the fiscal half year
U.S. stocks returned about –3% for the period. Results were negative in four of the six months. Only October’s return of about 8% prevented an even weaker performance for the half year.

Fears that China’s economic slowdown would spread globally weighed on results. Oil and commodity prices, which declined through most of the period before showing some resilience in February, also concerned investors.

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In December, the Federal Reserve increased its target for short-term interest rates to 0.25%–0.5%. Central banks in Europe and Asia, in contrast, boosted stimulus efforts to battle weak growth and low inflation.

International stocks returned about –9%, a result that would have been less severe if not for the U.S. dollar’s strength against many foreign currencies. European stocks were among the worst performers.

Bonds registered gains as investors cut their risk
The broad U.S. taxable bond market returned 2.20% over the six months. Most of the gains came in January and February as investors sought safe-haven assets amid stock market turmoil.

The yield of the 10-year U.S. Treasury note ended February at 1.74%, down from 2.18% six months earlier. (Bond prices and yields move in opposite directions.)

The Fed’s target rate, which had stayed anchored at 0%–0.25% until the small rise in December, kept a lid on returns for money market funds and savings accounts.

International bond markets (as measured by the Barclays Global Aggregate Index ex USD) returned 3.13%. Bonds globally have been buoyed by negative interest rates. In December the European Central Bank cut a key rate further into negative territory, and in late January the Bank of Japan adopted a negative-rate policy.

 

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Utilities led the field; energy stocks lagged
The three Russell 1000 Index Funds provide exposure to the largest companies in the U.S. stock market. Investors may choose to invest broadly in the large-cap segment of the market through the Russell 1000 Index Fund, which represents more than 90% of the market’s total value. Or they may focus on the growth or value segment through one of the other funds.

Although stocks of all capitalizations declined over the six months, large-caps fared noticeably better than mid- and small-caps. When markets are volatile, investors tend to gravitate more toward larger companies, which generally provide more predictable earnings, steadier returns, and higher yields.

In a similar vein, the industry sectors viewed as defensive tend to be more attractive to investors during periods of uncertainty or volatility. When the economic picture and the financial markets are unsettled, companies that meet consumers’ primary needs are likely to be more resilient. That was certainly the case over the recent six-month period, as utilities and consumer staples outpaced the other industry sectors.

Utilities stocks were the top performers for all three funds, with returns in the neighborhood of 12%. These companies generally deliver relatively large dividends and reliable results as they provide essentials such as electricity, natural gas, water, telephone service, and wireless

The fund expense ratios shown are from the prospectus dated December 22, 2015, and represent estimated costs for the current fiscal year. For the six months ended February 29, 2016, the funds’ annualized expense ratios were: for the Russell 1000 Index Fund, 0.11% for ETF Shares and 0.07% for Institutional Shares; for the Russell 1000 Value Index Fund, 0.11% for ETF Shares and 0.07% for Institutional Shares; and for the Russell 1000 Growth Index Fund, 0.10% for ETF Shares and 0.07% for Institutional Shares. Peer-group expense ratios are derived from data provided by Lipper, a Thomson Reuters Company, and capture information through year-end 2015.

Peer groups: For the Russell 1000 Index Fund, Large-Cap Core Funds; for the Russell 1000 Value Index Fund, Large-Cap Value Funds; and for the Russell 1000 Growth Index Fund, Large-Cap Growth Funds.

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communication. Electrical and telecommunications utilities contributed most of the sector’s returns over the period.

Next in line for all three funds were consumer staples stocks. Returns ranged from more than 7% for the Value Index Fund to nearly 9% for the Growth Index Fund. Most of the returns came from personal care, soft drink, and tobacco companies.

The energy sector recorded the poorest results for all three funds. Returns ranged from about –11% for the Value Index Fund to about –41% for the Growth Index Fund,

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which had less than 1% exposure to the troubled sector. Although lower oil prices helped consumers, they punished the energy industry in general. Crude oil producers, gas pipeline firms, and oil well equipment and services companies hurt results most. As a group, integrated oil and gas companies declined but held up better than others in the sector. Some of the giants in this segment advanced.

The financial services sector detracted from the returns of all three funds, particularly the Value Index Fund, which had an exposure of about 30% on average. Commercial and investment banks, asset managers, insurance companies, and consumer lenders struggled. All three funds also were saddled with negative results from health care, materials and processing, and consumer discretionary stocks. The producer durables sector held up better, producing single-digit gains; the technology sector was mostly flat.

Doing what’s best for clients: That’s how we were built
It’s hard for me to believe, but this year will be my 30th with Vanguard. I knew little about the company when I started in June 1986, but I soon learned what makes Vanguard unique.

Simply put, we’re built differently.

We don’t have stockholders or outside owners. Instead, Vanguard is owned by its funds, which in turn are owned by you—Vanguard clients.

This structure matters because it ensures that our interests are completely aligned with those of our clients. We never have to weigh what’s best for clients against what’s best for the company’s owners; their interests are one and the same. Our client-owned structure is what allows us to run our funds at cost, and it’s why Vanguard’s expense ratios remain among the lowest in the industry. (See the insight box on page 5 for more on this.)

At the same time, we continually dedicate resources to enhance Vanguard’s service and investment capabilities. We aspire to provide the highest possible quality at the lowest possible price. That was true 30 years ago, it’s true today, and it will remain our focus for decades to come. After all, we’re built to put the long-term interests of our clients first.

As always, thank you for investing with Vanguard.

Sincerely,

F. William McNabb III
Chairman and Chief Executive Officer
March 14, 2016

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Russell 1000 Index Fund

Fund Profile
As of February 29, 2016

 

 

 

 

 

Investment Focus

1 The expense ratios shown are from the prospectus dated December 22, 2015, and represent estimated costs for the current fiscal year. For the six months ended February 29, 2016, the annualized expense ratios were 0.11% for ETF Shares and 0.07% for Institutional Shares.

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Russell 1000 Index Fund

Performance Summary

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

Fiscal-Year Total Returns (%): September 20, 2010, Through February 29, 2016

Average Annual Total Returns: Periods Ended December 31, 2015
This table presents returns through the latest calendar quarter—rather than through the end of the fiscal period. Securities and Exchange Commission rules require that we provide this information.

 

See Financial Highlights for dividend and capital gains information.

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Russell 1000 Index Fund

Financial Statements (unaudited)

Statement of Net Assets—Investments Summary
As of February 29, 2016

This Statement summarizes the fund’s holdings by asset type. Details are reported for each of the fund’s 50 largest individual holdings and for investments that, in total for any issuer, represent more than 1% of the fund’s net assets. The total value of smaller holdings is reported as a single amount within each category.

The fund reports a complete list of its holdings in regulatory filings four times in each fiscal year, at the quarter-ends. For the second and fourth fiscal quarters, the complete listing of the fund’s holdings is available electronically on vanguard.com and on the Securities and Exchange Commission’s website (sec.gov), or you can have it mailed to you without charge by calling 800-662-7447. For the first and third fiscal quarters, the fund files the lists with the SEC on Form N-Q. Shareholders can look up the fund’s Forms N-Q on the SEC’s website. Forms N-Q may also be reviewed and copied at the SEC’s Public Reference Room (see the back cover of this report for further information).

 

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