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: 811-05962

 

 

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

Date of fiscal year end: December 31

Date of reporting period: January 31, 2016 – June 30, 2016

Item 1: Reports to Shareholders

Semiannual Report | June 30, 2016

Vanguard Variable Insurance 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.

 

A Message from Vanguard’s Chairman

Dear Planholder,

The long-anticipated U.K. referendum on whether to remain in the European Union was the defining event for capital markets in the first half of 2016. The momentous June 23 vote to leave the EU has global economic implications. It will take considerable time for Brexit details to be worked out, so we can expect uncertainty to persist, and the ride may be bumpy at times.

Meanwhile, we shouldn’t lose sight of other notable developments. Oil prices, which seemed to find their footing later in 2015, fell below $30 per barrel early in 2016 before recovering some ground. This put more pressure on oil exporters, such as Brazil—which was already grappling with a political crisis. Closer to home, Congress in late June approved legislation to help Puerto Rico deal with about $70 billion of tax-exempt debt. And central bank policies stayed in the spotlight, leading negative interest rates to spread across Europe and into Japan while the Federal Reserve held U.S. rates steady amid concern about job growth and the global economy.

The heightened volatility in capital markets that surrounded the Brexit vote reminds us that no one can control the markets’ direction or reliably predict where they’ll go in the short term. However, investors can control how they react to unstable and turbulent markets.

During periods of market adversity, it’s more important than ever to keep sight of one of Vanguard’s key principles: Maintain perspective and long-term discipline. Whether you’re investing for yourself or on behalf of clients, your success is affected greatly by how you respond—or don’t respond—during turbulent markets. (You can read Vanguard’s Principles for Investing Success at vanguard.com/research.)

As I’ve written in the past, the best course for long-term investors is generally to ignore daily market moves and not make decisions based on emotion. Vanguard’s internal fund advisors—our Equity Investment and Fixed Income Groups—maintain a healthy dose of discipline and don’t try to time the markets. We look for the same characteristics in the external fund managers we select.

This report starts with a brief overview of the financial markets during the past six months. In the pages that follow, you’ll find a review of your portfolio’s performance. Each portfolio in Vanguard Variable Insurance Fund can serve as part of an investment program that includes a combination of stock, bond, and money market funds appropriate for your own long-term goals, risk tolerance, and time horizon.

Before I close, I’d like to thank two advisors for their distinguished, long-term service to Vanguard Variable Insurance Fund portfolios. Each firm has managed portfolio assets since inception and recently marked a milestone anniversary. Wellington Management Company has been the sole manager of Vanguard Balanced Portfolio for 25 years and of Vanguard High Yield Bond Portfolio for 20 years. Granahan Investment Management has managed a portion of Vanguard Small Company Growth Portfolio for 20 years.

As always, we appreciate your confidence in Vanguard.

Sincerely,

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

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Market Perspective

Events in the first half of 2016 ran contrary to most expectations
The six-month period ended June 30, 2016, was notable for the unexpected events that transpired and the expected events that did not. The U.K. “Brexit” vote to leave the European Union stood out in the first category, as did the Bank of Japan’s adoption of a negative interest rate policy. The Federal Reserve’s deferral of further interest rate hikes was prominent in the second. Together, these and other developments led investors to generally favor the relative safety of bonds.

The path was rocky again for global stock markets
Major stock markets around the world tumbled in the wake of the momentous June 23 Brexit vote as investors began digesting the outcome and pondering its implications for the global economy. By month’s end, however, many markets had recovered all or most of their lost ground.

Even apart from Brexit, the half year did not lack for challenges. The U.S. economy had another weak first quarter, oil prices fell again before stabilizing, and concerns persisted about corporate profits, slower growth in China, and Japan’s struggling economy. Still, the broad U.S. stock market returned nearly 4% for the six months.

International stocks were weaker, returning about –1%. European stocks in particular slumped as Brexit uncertainty hit closer to home. Developed Pacific markets also retreated. Emerging-market stocks were a bright spot, returning nearly 8%.

Strong demand boosted bond returns above stocks
Central bank policy again played a major role in bond returns. As anticipated, the European Central Bank announced more stimulus efforts, including purchases of investment-grade, euro-denominated corporate bonds (which began in June). And in a surprise move, the Bank of Japan adopted negative interest rates for certain bank deposits.

These steps, coupled with strong demand for a safe harbor from stock market volatility, helped drive the yield of benchmark 10-year German and Japanese government bonds below zero for the first time. In another first, Japan’s 20-year government bond yield also turned negative just after the close of the period.

Against this backdrop, demand was strong at home and from abroad for the still positive yields of U.S. Treasury bonds. The yield of the benchmark 10-year Treasury note fell nearly a full percentage point, from 2.30% at the end of December to 1.47% at the end of June. (Bond prices and yields move in opposite directions.)

The broad U.S. bond market’s return of more than 5% was strong, but that was eclipsed by the nearly 12% return of international bonds (as measured by the Barclays Global Aggregate Index ex USD). U.S. investors benefited from the dollar’s weakening against many currencies (except Britain’s pound), but international bond returns were higher than those of U.S. bonds even without this currency benefit.

 

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Vanguard^® Balanced Portfolio

Advisor’s Report

Vanguard Balanced Portfolio returned 4.99% for the six months ended June 30, 2016. The fund outperformed the 4.87% return of its blended benchmark (a mix of 65% large-capitalization stocks and 35% high-quality corporate bonds) and the 2.30% average return of peer funds. Both the stock and bond portions of the portfolio outperformed their respective benchmarks, the Standard & Poor’s 500 Index (+3.84%) and the Barclays U.S. Credit A or Better Bond Index (+6.59%).

Please note that the returns for Vanguard Variable Insurance Fund are different from those of Vanguard Variable Annuity (and other plans that invest in the fund), which take into account insurance-related expenses.

The investment environment
Stock markets in the United States and abroad posted mixed returns for the period. The MSCI World Index returned about 1%, and the MSCI EAFE Index returned about –4%.

Data releases continued to paint a promising picture for the U.S. economy, including an upward revision to first-quarter gross domestic product (GDP), a multiyear low in the unemployment rate, and healthy housing market trends. As widely expected, the Federal Reserve last December instituted its first rate hike since 2006. Large-cap value stocks generally outperformed large-cap growth stocks, as measured by the Russell 1000 Value and Russell 1000 Growth Indexes.

High-quality and government-backed assets have performed strongly, reflecting a global risk-off sentiment amid market uncertainty and volatility. U.S. monetary policy and growth have increasingly diverged from those in other parts of the world. Many central banks stand ready to further ease policy, with some resorting to radical measures to counter falling inflation and stimulate growth.

Concerns over the United Kingdom’s vote to leave the European Union have created a great deal of uncertainty in both the long and short term.

Our successes
The fixed income portfolio’s outperfor­mance was led by strong issuer selection in investment-grade credit. Selection in industrials aided relative results most. An out-of-benchmark allocation to asset-backed securities also helped.

Strong selection in the health care, industrials, and consumer discretionary sectors as well as an underweight allocation to information technology drove outperformance within the equity portfolio. Positions in Verizon, Comcast, and Chevron contributed most to absolute returns; an allocation to NextEra Energy contributed most to relative results.

Verizon performed well after the release of better-than-expected earnings results, supported by growth in wireless and FiOS. Our investment thesis is based on the company’s dominant competitive position, customer loyalty, strong 4G service, marketing ability, and long-term growth in mobile and tablet data usage.

Comcast remains the market leader in innovation across its various businesses as management embraces new technologies and seeks ways to improve the customer experience with improved mobility of content. Management has focused on spreading capital across the business where they see strong return on investment and long-term benefit for the investor.

Chevron has maintained a strong balance sheet and solid cash flow generation, making it a strong candidate for dividend growth.

 

1 Weighted 65% S&P 500 Index and 35% Barclays U.S. Credit A or Better Bond Index.
2 Derived from data provided by Lipper, a Thomson Reuters Company.
3 The portfolio expense ratio shown is from the prospectus dated April 29, 2016, and represents estimated costs for the current fiscal year. For the six months ended June 30, 2016, the Balanced Portfolio’s annualized expense ratio was 0.23%. The peer-group expense ratio is derived from data provided by Lipper, a Thomson Reuters Company, and captures information through year-end 2015.

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Vanguard Balanced Portfolio

Our shortfalls
In the equity portfolio, an overweight allocation coupled with weak selection in the financial sector hurt relative results most. Selection in consumer staples and information technology also detracted from relative returns.

Wells Fargo, Bank of America, and Mitsubishi UFJ Financial Group (MUFG) hurt absolute results most. Our lack of exposure to strong benchmark performer AT&T was a relative detractor.

In financials, Wells Fargo, the stock portfolio’s largest holding as of the end of the period, declined based on worries about the sector broadly, especially about banks with loans to energy-related businesses. Japan-based MUFG lagged because of margin pressure from negative interest rates. Financial companies are viewed as highly rate-sensitive, and investors became increasingly concerned that rates would not rise quickly enough to support near-term profitability. A weak trading environment also weighed on Wells Fargo and other bank stocks.

In fixed income, duration and yield curve positioning detracted most from relative performance. An underweight allocation to basic industry issuers also hurt.

Portfolio positioning
Late in the half year, the “Brexit” referendum outcome and ensuing market volatility led to a modest change in our outlook. We had been looking for a U.S. GDP growth rate of 1.5%–2%, but we now expect closer to 1%–1.5%, and the possibility of a recession (though not likely) has come back into view.

We are more cautious, particularly about financials, because normalizing rates will take still longer to happen. In the equity portfolio, we are unlikely to further overweight financials until we have more clarity on the rate outlook, despite record low valuations. Because the Fed has been so transparent about its criteria for raising rates, it will need all the requisite data points to move forward with tightening. Its decision, though, is highly dependent on global markets and is now likely to be driven more by developments outside the United States than by domestic trends. The negative interest rates and high leverage levels of central banks globally are uncharted territory, and have created something of a negative feedback loop for U.S. rates.

Our investment thesis for financial stocks remains that they have highly attractive valuations combined with strong balance sheets, and that potential exists for a decline in regulatory pressures. Based on these characteristics, financials compare well with safety stocks at extended valuations. Coming into the half year, we believed that bank stocks would behave defensively because they had less credit exposure and high capital ratios. But with continued negative interest rates, U.S. banks are unlikely to benefit from Fed rate increases this year. The lower-for-longer rate environment could delay the earnings improvements that we would expect and could affect the timing of financial stocks’ revival.

We are now looking in other market segments for companies with solid cash flow, safe dividend yields, and reasonable valuations, including Boeing and others in the defense industry. Businesses such as defense that are seen as cyclical, but that have stable earnings, are attractively valued because of the association with cyclicality. This example of our capital cycle framework illustrates how we aim to add value by investing in companies in industries that are waiting for a recovery to begin.

We are overweighted in health care stocks, favoring large-cap pharmaceutical companies, including Merck and AstraZeneca. We believe that their solid pipelines are underappreciated by investors and should suffice for a return to modest growth.

The equity portfolio remains underweighted in information technology—most significantly in Apple—and consumer discretionary.

On the fixed income side, we are cautiously positive about the U.S. credit markets. The economic and credit cycles look to be tiring, but the powerful flood of global capital into our bond market—and credit in particular—shows no sign of abating. Low and negative yields in other major economic zones are still driving capital flows toward the higher yields and safety of the U.S. markets.

Although our credit selections will remain thematic and well-researched, we expect investment-grade corporate bond returns to be attractive and will maintain our overall exposure to them. We cannot recall a period when global forces were as important to the U.S. economy and policies as they are today. Therefore, we are mindful of global events even though our focus is on the U.S. bond market.

We anticipate ongoing volatility and expect that macroeconomic factors, more than fundamentals, may continue to drive the market for the near future as key questions about elections and monetary policy are resolved. In this context, we are focused on identifying solid company-specific investment catalysts and mispriced individual securities, rather than investing based on broad themes. We remain disciplined in applying our investment process, which enables us to create a balanced portfolio that we believe should perform well in various environments.

Edward P. Bousa, CFA,
Senior Managing Director and
Equity Portfolio Manager

John C. Keogh,
Senior Managing Director and
Fixed Income Portfolio Manager

Wellington Management Company llp

July 20, 2016

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Vanguard Balanced Portfolio

Portfolio Profile
As of June 30, 2016

 

 

 

 

 

 

Portfolio Asset Allocation

1 30-day SEC yield for the portfolio. See definition on the next page.
2 Annualized.
3 The portfolio expense ratio shown is from the prospectus dated April 29, 2016, and represents estimated costs for the current fiscal year. For the six months ended June 30, 2016, the annualized expense ratio was 0.23%.
4 For an explanation of R-squared, beta, and other terms used here, see definitions on the next page.
5 Composite Stock/Bond Index, weighted 65% S&P 500 Index and 35% Barclays Capital U.S. Credit A or Better Bond Index.
6 Dow Jones U.S. Total Stock Market Float Adjusted Index.
7 S&P 500 Index.
8 Barclays U.S. Credit A or Better Bond Index.
9 Barclays U.S. Aggregate Bond Index.
10 Before expenses.
11 The holdings listed exclude any temporary cash investments and equity index products.

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Vanguard Balanced Portfolio

 

 

Equity Investment Focus

Fixed Income Investment Focus

 

 

30-Day SEC Yield. A portfolio’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 portfolio’s security holdings in the previous 30 days are used to calculate the portfolio’s hypothetical net income for that period, which is then annualized and divided by the portfolio’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 portfolio’s actual experience. As a result, the portfolio’s income distributions may be higher or lower than implied by the SEC yield.

Beta. A measure of the magnitude of a portfolio’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 portfolio 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 portfolio and the index.

Credit Quality. Credit-quality ratings are measured on a scale that generally ranges from AAA (highest) to D (lowest). U.S. Treasury, U.S. Agency, and U.S. Agency mortgage-backed securities appear under “U.S. Government.” Credit-quality ratings are obtained from Barclays and are from Moody’s, Fitch, and S&P. When ratings from all three agencies are used, the median rating is shown. When ratings from two of the agencies are used, the lower rating for each issue is shown. “Not Rated” is used to classify securities for which a rating is not available. Not rated securities include a fund’s investment in Vanguard Market Liquidity Fund or Vanguard Municipal Cash Management Fund, each of which invests in high-quality money market instruments and may serve as a cash management vehicle for the Vanguard funds, trusts, and accounts.

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

R-Squared. A measure of how much of a portfolio’s past returns can be explained by the returns from the market in general, as measured by a given index. If a portfolio’s total returns were precisely synchronized with an index’s returns, its R-squared would be 1.00. If the portfolio’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 portfolio and the index.

1 Source: Moody’s Investors Service.
2 The agency and mortgage-backed securities sectors may include issues from government-sponsored enterprises; such issues are not backed by the full faith and credit of the U.S. government.

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Vanguard Balanced Portfolio

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 portfolio. (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 portfolio distributions or on the sale of portfolio shares. Nor do the returns reflect fees and expenses associated with the annuity or life insurance program through which a shareholder invests. If these fees and expenses were included, the portfolio’s returns would be lower.

Fiscal-Year Total Returns (%): December 31, 2005–June 30, 2016

Average Annual Total Returns: Periods Ended June 30, 2016

 

1 Six months ended June 30, 2016.
2 Weighted 65% S&P 500 Index and 35% Barclays U.S. Credit A or Better Bond Index.
See Financial Highlights for dividend and capital gains information.

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Vanguard Balanced Portfolio

Financial Statements (unaudited)

Statement of Net Assets
As of June 30, 2016

The portfolio 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 portfolio’s semiannual and annual reports to shareholders. For the first and third fiscal quarters, the portfolio files the lists with the Securities and Exchange Commission on Form N-Q. Shareholders can look up the portfolio’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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Vanguard Balanced Portfolio

 

 

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Vanguard Balanced Portfolio

 

 

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Vanguard Balanced Portfolio

 

 

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