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

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT
OF
REGISTERED MANAGEMENT INVESTMENT COMPANIES

 

 

 

Annual Report | August 31, 2013

Vanguard U.S. Growth 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: The ship's wheel represents leadership and guidance, essential qualities in navigating difficult seas.
This one is a replica based on an 18th-century British vessel. The HMS Vanguard, another ship of that era, served as the
flagship for Admiral Horatio Nelson when he defeated a French fleet at the Battle of the Nile.

 

Your Fund’s Total Returns

 

 

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Chairman’s Letter

Dear Shareholder,

Vanguard U.S. Growth Fund, which marks its 55th anniversary in January as our oldest growth fund, invests in large-capitalization companies with significant growth potential. Although large-cap growth stocks weren’t the market’s standout performers for the fiscal year ended August 31, 2013, the fund itself stood out with a strong return of about 19% for the 12 months.

The fund surpassed its benchmark index, the Russell 1000 Growth Index, and its peer-group average by about 3 percentage points apiece, its best performance against its comparative standards since 2005. Although the fund trailed the broad U.S. stock market, which got a boost from the strong performance of smaller-cap stocks, it did so by only about a percentage point.

After the close of the period, we announced plans to merge Vanguard Growth Equity Fund into the U.S. Growth Fund. After the merger, the U.S. Growth Fund will retain its current advisors and will add Baillie Gifford Overseas Ltd. and Jennison Associates LLC from the former Growth Equity Fund. The U.S. Growth Fund’s investment strategy and objective will not change.

If you hold shares of the fund in a taxable account, you may wish to review the information on the fund’s after-tax returns that appears later in this report.

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Stocks posted robust results despite setbacks at the finish

U.S. stocks advanced about 20% in the 12 months despite slipping in June and August. Through most of the fiscal year, stocks surged as the economy continued to show modest growth and investors appeared more receptive to risk.

Much of the market’s recent weakness stemmed from fear that the Federal Reserve would begin scaling back its stimulative bond-buying program. Heightened strife in the Middle East also contributed to anxiety in the global markets.

International stocks in aggregate finished with a return of about 13%. Developed markets in the Pacific region and Europe posted results closer to those of the United States. Returns for emerging-market stocks overall were virtually flat as economic growth slowed in China and Brazil.

Although global economic worries and tensions over conflicts abroad have unsettled markets, Jonathan Lemco, a senior sovereign debt analyst in Vanguard Taxable Credit Research Group, pointed out that investors can still manage risks amid international instability. “Vanguard

 

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believes a diversified portfolio is the best way to spread the risk of geopolitical uncertainty,” he said.

Bond returns turned negative amid worry about the Fed’s next move

Bonds, which maintained slightly positive returns through the first eight months of the period, reversed course in May and then continued to retreat as investors anticipated reductions in the Fed’s bond-buying program.

The broad U.S. taxable bond market returned –2.47% for the 12 months. The yield of the 10-year Treasury note finished at 2.76%, up from 1.56% at the end of August 2012. (Bond yields and

prices move in opposite directions.) Municipal bonds suffered more, returning –3.70% for the fiscal year.

Returns for money market funds and savings accounts were minuscule as the Fed kept its target for short-term interest rates between 0% and 0.25%.

The fund’s holdings did well across a broad array of sectors

After nearly a decade of tabulating mostly disappointing results––whether on an absolute basis or compared with the broad market, its benchmark index, and its peers––the U.S. Growth Fund recently has recorded more satisfying returns.

The fund expense ratios shown are from the prospectus dated December 27, 2012, and represent estimated costs for the current fiscal year.
For the fiscal year ended August 31, 2013, the expense ratios were 0.45% for Investor Shares and 0.31% for Admiral Shares. The peer-group
expense ratio is derived from data provided by Lipper, a Thomson Reuters Company, and captures information through year-end 2012.

Peer group: Large-Cap Growth Funds.

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Over the three years ended August 31, U.S. Growth’s average annual return of about 19% is slightly better than those of its benchmark index and the broad U.S. stock market, and more than 2 percentage points better than the average for its large-cap peers. Although three years is not a sufficient time in which to evaluate a long-term investment, we are encouraged by the fund’s direction and hopeful it will continue.

The positive results coincide with changes in the fund’s management. In October 2010, longtime Vanguard partner Wellington Management Company, llp, and Delaware Management Company, Inc. (now advising the fund as Delaware

Investments Fund Advisers), joined William Blair & Company, L.L.C., on the fund’s advisory team, replacing a previous advisor. We are pleased with both the fund’s performance and its management since the transition.

Over the 2013 fiscal year, the nine industry sectors in which the fund maintained holdings had gains, with eight of the nine producing double-digit returns.

Consumer discretionary stocks, which make up the fund’s second-largest sector, accounted for nearly one-third of the overall return. The advisors’ stock choices, together with the fund’s relatively heavy exposure to the sector, lifted performance.

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

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

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Internet and specialty retailers, media corporations, and restaurants were among the companies that benefited from favorable consumer and economic trends.

The information technology sector was U.S. Growth’s largest, representing about 37% on average of assets, and also its worst performer, with a return of about 7%. Still, this was more than triple the return of the benchmark. Strong stock choices offset the weakness generated by heavy exposure to a sector that wasn’t a market favorite. A bright spot was electronic-payment corporations, which led the sector as investors recognized the wider global use of credit cards to replace paper currency in transactions. Certain software firms also did well.

Although the consumer staples sector isn’t one of U.S. Growth’s largest, the fund’s relatively modest holdings boosted the overall return by climbing more than 50%. Green Mountain Coffee Roasters, which spiked more than 250%, was responsible for much of the gain. Another source of strength was financial stocks, especially those of diversified financial services firms, insurance companies, and asset managers that have profited from the improved investing environment.

The fund’s health care and industrial holdings each returned more than 20% in aggregate, although they lagged the gains of the benchmark’s sectors. In both sectors, U.S. Growth missed opportunities,

and the relative results were as much about the companies the fund didn’t hold as the ones it did.

For more about the advisors’ strategy and the fund’s positioning during the 12 months, please see the Advisors’ Report that follows this letter.

The long-term record reflects a checkered time in the market

For the decade ended August 31, 2013, Vanguard U.S. Growth Fund had an average annual return of 6.35% for Investor Shares. The fund trailed the performance of its benchmark, which returned 7.24% a year on average, but slightly exceeded the 5.91% annual average for peer funds.

The ten-year results no longer include the years 2000 to 2002, when the bursting of the technology bubble battered the stock market in general and the technology-laden U.S. Growth Fund in particular.

Of course, the financial crisis of 2008 and the recession still weigh on the average returns for both the fund and its comparative standards.

As I mentioned earlier in this letter, the advisors’ accomplishments over the past three years are encouraging, and we have confidence in their experience, talent, and ability to produce competitive long-term results.

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The benefit of combining low costs with diversity of thought

Investors sometimes ask why Vanguard uses a multi-advisor approach for many of its actively managed equity portfolios. Just as we recommend diversification within and across asset classes for an investor’s overall investments, we think significant benefits can accrue from using multiple advisory firms for a single portfolio: diversity of investment process and style, thought, and holdings.

All of these elements can lead to less risk and better results. Because not all investment managers invest the same way, their returns relative to the benchmark don’t move in lockstep.

As with many other investment topics, however, there are some misconceptions about the benefits of using a multi-manager approach. For example, it is often suggested that the best ideas of the advisors are diluted when they are combined in one portfolio. Recent Vanguard research has found otherwise.

Conventional wisdom also suggests that multi-manager funds tend to be expensive. At Vanguard, this is not the case, because low costs are a hallmark of all our offerings. And Vanguard research indicates that low costs can contribute greatly to investing success, helping investors keep more of a portfolio’s return. (You can read more in Analyzing Multi-Manager Funds: Does Management Structure Affect Performance? at vanguard.com/research.)

As always, thank you for investing with Vanguard.

Sincerely,

 

 

F. William McNabb III
Chairman and Chief Executive Officer
October 10, 2013

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Advisors’ Report

For the 12 months ended August 31, 2013, Vanguard U.S. Growth Fund returned about 19%. The fund’s return surpassed that of its benchmark index and the average return of large-capitalization growth funds. 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 table below presents the advisors, the percentage and amount of fund assets that each manages, and brief descriptions of their investment strategies. Each advisor has also prepared a discussion of the investment environment during the fiscal year and of how the portfolio’s positioning reflects this assessment. These reports were prepared on September 18, 2013.

Vanguard U.S. Growth Fund Investment Advisors

 

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Delaware Investments Fund Advisers

Portfolio Managers:
Christopher J. Bonavico, CFA,
Vice President, Senior Portfolio Manager,
and Equity Analyst

Christopher M. Ericksen, CFA,
Vice President, Portfolio Manager,
and Equity Analyst

Daniel J. Prislin, CFA,
Vice President, Senior Portfolio Manager,
and Equity Analyst

Jeffrey S. Van Harte, CFA,
Senior Vice President,
CIO—Focus Growth Equity

We focus on owning what we believe to be strong long-term growth companies with solid business models and competitive positions that, in our opinion, can increase market share and deliver shareholder value in various market environments.

EOG Resources was the strongest contributor to our portfolio’s performance during the fiscal year. The company is engaged in crude oil and natural gas exploration, development, and production, predominantly in North America, and is heavily involved in the shale oil industry, which we believe is an attractive long-term growth area. Although fluctuations in oil and natural gas prices can affect the stock, we don’t believe that the company’s long-term intrinsic business value depends on commodity prices. Rather, we believe that EOG’s management team has an unusual capital-allocation discipline that

increases the company’s potential to perform well through a variety of pricing and economic environments.

Teradata was the largest detractor from performance during the period. Shares of the database-software company declined as investors grew concerned about a difficult technology spending environment and management reported mixed quarterly financial results. Still, Teradata continues to sign up new clients and grow its existing client business. Indeed, it reported more encouraging financial results at the end of the period. We believe that Teradata, which specializes in aggregating data for business analytics, is well-positioned for an environment in which customers are focused on making technology buys with a definable return on investment.

Despite the overall gains in the equity market during the past few years, we believe that the many short-term swings in market sentiment show that more than just fundamental factors are affecting stock prices. Rather, the recent market volatility suggests to us that many investors are struggling with how to gauge the pace of global economic recovery and are assessing factors that threaten economic fundamentals.

Although some fundamental factors may be improving (from a very low base during the global financial crisis in 2008–2009), we don’t believe we are entering a typical post-recessionary global boom cycle. Rather, we believe that the lingering

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effects of the credit crisis years ago could result in moderate growth at best. In such a tenuous environment, we think that the quality of a company’s business model, competitive position, and management may prove to be of utmost importance.

Please note that as a result of a restructuring, Delaware Investments Fund Advisers has assumed investment advisory responsibilities for the portion of the U.S. Growth Fund’s assets previously advised by Delaware Management Company, Inc.

Wellington Management Company, llp

Portfolio Manager:
Andrew J. Shilling, CFA,
Senior Vice President
and Equity Portfolio Manager

We aim for our portion of the fund to outperform growth benchmarks and, in the longer term, the broader market. We employ proprietary fundamental research and a rigorous valuation discipline to invest in large-capitalization companies with attractive growth characteristics. Our investment approach is based on identifying companies with a clear competitive advantage that will enable them to maintain sustainable, above-average growth. We take a long-term perspective, as we believe that investors often underestimate the potential for growth.

The last fiscal year was a very strong period for developed-market stocks. Emerging-market equities fared less well,

finishing roughly where they started. Bond prices declined as interest rates rose. In the United States, value stocks outperformed growth stocks, and small-caps led their larger peers.

Security selection was the key to our portfolio’s strong relative performance, with particularly notable contributions from our stock picks in the consumer staples and information technology sectors. The portfolio also benefited from our overweight allocation to the consumer discretionary sector. Stock selection in health care, however, was a detractor.

Green Mountain Coffee Roasters was our top contributor in both absolute and benchmark-relative terms. Green Mountain is the leading provider of single-cup brewers and portion packs (K-Cups) for coffee and other hot beverages. Shares soared after the company reported better-than-expected quarterly earnings results; management also raised its full-year earnings guidance. Profit margins exceeded investors’ expectations, particularly in the K-Cup segment. We view the stock as an attractive investment for long-term investors, and we are maintaining a significant position.

Our position in medical device company Edwards Lifesciences detracted from 12-month results. The firm specializes in heart-valve technology and treatments for cardiovascular diseases. It reported disappointing results due to poor sales of transcatheter heart valves (THVs).

Of particular concern to us was

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management’s lowering of its 2013 guidance, primarily because of reduced expectations for U.S. THV sales, which we had anticipated would drive growth. We eliminated the position to pursue more attractive opportunities, as our research led us to believe the end market would be smaller than we initially expected.

At the period’s close, our largest overweight exposure was to the consumer discretionary sector, where we continue to find attractive long-term growth opportunities. Our most significant underweighting was in consumer staples.

We believe the global economy is gradually normalizing. The U.S. economy remains positioned for a continued modest recovery as consumption spending is buoyed by household balance-sheet improvements and steady job gains. However, we still are not creating jobs fast enough, and much of the decrease in the unemployment rate is due to people dropping out of the labor force. The housing market is clearly improving, and we believe the shortage of inventory should boost prices further in the near term. At this point, we are cautiously optimistic and anticipate moderate U.S. economic growth for 2013.

William Blair & Company, L.L.C.

Portfolio Managers:
James Golan, CFA, Partner

David Ricci, CFA, Partner

Continued improvement in economic data, especially concerning housing and employment, pushed U.S. stocks to all-time highs in 2013.

The market rose gradually throughout the year despite a few minor setbacks. In the fall of 2012, investors concerned about the Eurozone’s problems were calmed by the European Central Bank’s actions to ease the region’s economic and financial woes. Earlier this year, the U.S. Federal Reserve signaled an eventual slowdown in its massive bond purchases, and the prospect of this “tapering” of the Fed’s monetary easing caused a short-lived market correction. However, the fiscal period ended on a positive note, in part because investors realized that the Fed would taper only to the extent the economy stayed on a sustainable path to recovery. In addition, economic data in Europe suggested that the region may be stabilizing.

The portfolio’s outperformance during the fiscal year is attributable to stock selection and a modest style boost, as the market seconded our biases toward smaller and higher-growth companies. Green Mountain Coffee Roasters (consumer staples) and Gilead Sciences (health care) were the top contributors to relative results. Stock selection in financials (JPMorgan Chase and Affiliated Managers Group) also helped. Detracting from return were our holding in Apple (information technology) and some selections in energy (e.g., National Oilwell Varco) and industrials (e.g., Boeing).

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In coming months, the marketplace will be watching the Fed’s eventual tapering of quantitative easing for its impact on economic growth. Investors also will keep an eye on the health of Europe and the emerging-market economies. However, corporate performance remains solid and U.S. stocks have been a relative haven compared with more interest rate-sensitive asset classes, commodities, and stocks outside the United States. Broadly speaking, the U.S. housing market remains a source of support for domestic employment and growth as well.

In the end, while we factor various economic scenarios into our stock picking, we focus on constructing the portfolio from a bottom-up perspective and continue to find good ideas across sectors.

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U.S. Growth Fund

Fund Profile
As of August 31, 2013

 

 

 

These measures show the degree and timing of the fund’s fluctuations compared with the indexes over 36 months.

 

 

Investment Focus

1 The expense ratios shown are from the prospectus dated December 27, 2012, and represent estimated costs for the current fiscal year. For
the fiscal year ended August 31, 2013, the expense ratios were 0.45% for Investor Shares and 0.31% for Admiral Shares.

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U.S. Growth Fund

Performance Summary

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

Cumulative Performance: August 31, 2003, Through August 31, 2013
Initial Investment of $10,000

 

 

See Financial Highlights for dividend and capital gains information.

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U.S. Growth Fund

Fiscal-Year Total Returns (%): August 31, 2003, Through August 31, 2013

Average Annual Total Returns: Periods Ended June 30, 2013
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.

 

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U.S. Growth Fund

Financial Statements

Statement of Net Assets
As of August 31, 2013

The fund reports a complete list of its holdings in regulatory findings 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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U.S. Growth Fund

 

See Note A in Notes to Financial Statements.
* Non-income-producing security.
1 The fund invests a portion of its cash reserves in equity markets through the use of index futures contracts. After giving effect to futures
investments, the fund’s effective common stock and temporary cash investment positions represent 99.7% and 0.4%, respectively, of net
assets.
2 Considered an affiliated company of the fund as the issuer is another member of The Vanguard Group.
3 Affiliated money market fund available only to Vanguard funds and certain trusts and accounts managed by Vanguard. Rate shown is the
7-day yield.
4 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 $5,397,000 have been segregated as initial margin for open futures contracts.
6 The issuer operates under a congressional charter; its securities are generally neither guaranteed by the U.S. Treasury nor backed by the full
faith and credit of the U.S. government.
ADR—American Depositary Receipt.
See accompanying Notes, which are an integral part of the Financial Statements.

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U.S. Growth Fund

Statement of Operations

 

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

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U.S. Growth Fund

Statement of Changes in Net Assets

 

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

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U.S. Growth Fund

Financial Highlights

1 Net investment income per share and the ratio of net investment income to average net assets include $.016 and 0.09%, respectively,
resulting from a special dividend from VeriSign Inc. in December 2010.
2 Total returns do not include account service fees that may have applied in the periods shown. Fund prospectuses provide information about
any applicable account service fees.
3 Includes performance-based investment advisory fee increases (decreases) of (0.01%), (0.01%), (0.01%), (0.03%), and (0.03%).

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

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U.S. Growth Fund

Financial Highlights

1 Net investment income per share and the ratio of net investment income to average net assets include $.041 and 0.09%, respectively,
resulting from a special dividend from VeriSign Inc. in December 2010.
2 Includes performance-based investment advisory fee increases (decreases) of (0.01%), (0.01%), (0.01%), (0.03%), and (0.03%).

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

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U.S. Growth Fund

Notes to Financial Statements

Vanguard U.S. Growth Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund offers two classes of shares: Investor Shares and Admiral Shares. Investor Shares are available to any investor who meets the fund’s minimum purchase requirements. Admiral Shares are designed for investors who meet certain administrative, service, and account-size criteria.

A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. 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 may use 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 notional amounts of the contracts are not recorded in the Statement of Net Assets. Fluctuations in the value of the contracts are recorded in the Statement of Net Assets as an asset (liability) and in the Statement of Operations as unrealized appreciation (depreciation) until the contracts are closed, when they are recorded as realized futures gains (losses).

During the year ended August 31, 2013, the fund’s average investments in long and short futures contracts represented 2% and 0% of net assets, respectively, based on quarterly average aggregate settlement values.

3. Repurchase Agreements: The fund may enter into repurchase agreements with institutional counterparties. Securities pledged as collateral to the fund under repurchase agreements are held by a custodian bank until the agreements mature. Each agreement requires that the market value of the collateral be sufficient to cover payments of interest and principal. The fund further mitigates its counterparty risk by entering into repurchase agreements only with a diverse group of pre-qualified counterparties, monitoring their financial strength, and entering into master repurchase agreements

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U.S. Growth Fund

with its counterparties. The master repurchase agreements provide that, in the event of a counterparty’s default (including bankruptcy), the fund may terminate any repurchase agreements with that counterparty, determine the net amount owed, and sell or retain the collateral up to the net amount owed to the fund. Such action may be subject to legal proceedings, which may delay or limit the disposition of collateral.

4. 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, 2010–2013), and has concluded that no provision for federal income tax is required in the fund’s financial statements.

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

6. Securities Lending: To earn additional income, the fund may lend its securities to qualified institutional borrowers. Security loans 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 pre-qualified 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, provided that 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 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.

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

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

B. Delaware Investments Fund Advisers, Wellington Management Company, LLP, and William Blair & Company, L.L.C., 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 Delaware Investments Fund Advisers and Wellington Management Company, LLP, are subject to quarterly adjustments based on performance since November 30, 2010, relative to the Russell 1000 Growth Index. The basic fee of William Blair & Company, L.L.C., is subject to quarterly adjustments based on performance for the preceding five years relative to the Russell 1000 Growth Index.

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U.S. Growth Fund

The Vanguard Group manages the cash reserves of the fund on an at-cost basis.

For the year ended August 31, 2013, the aggregate investment advisory fee represented an effective annual basic rate of 0.17% of the fund’s average net assets, before a decrease of $575,000 (0.01%) based on performance.

C. The Vanguard Group furnishes at cost corporate management, administrative, marketing, and distribution services. The costs of such services are allocated to the fund under methods approved by the board of trustees. The fund has committed to provide up to 0.40% of its net assets in capital contributions to Vanguard. At August 31, 2013, the fund had contributed capital of $522,000 to Vanguard (included in Other Assets), representing 0.01% of the fund’s net assets and 0.21% of Vanguard’s capitalization. The fund’s trustees and officers are also directors and officers of Vanguard.

D. The fund has asked its investment advisors to direct certain security trades, subject to obtaining the best price and execution, to brokers who have agreed to rebate to the fund part of the commissions generated. Such rebates are used solely to reduce the fund’s management and administrative expenses. For the year ended August 31, 2013, these arrangements reduced the fund’s expenses by $108,000 (an annual rate of 0.00% of average net assets).

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

Level 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 August 31, 2013, based on the inputs used to value them:

 

F. At August 31, 2013, the aggregate settlement value of open futures contracts and the related
unrealized appreciation (depreciation) were:

 

 

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U.S. Growth Fund

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

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

For tax purposes, at August 31, 2013, the fund had $13,825,000 of ordinary income available for distribution. The fund used capital loss carryforwards of $348,592,000 to offset taxable capital gains realized during the year ended August 31, 2013. At August 31, 2013, the fund had available capital losses totaling $123,193,000 to offset future net capital gains of $31,366,000 through August 31, 2017, and $91,827,000 through August 31, 2018.

At August 31, 2013, the cost of investment securities for tax purposes was $3,296,413,000. Net unrealized appreciation of investment securities for tax purposes was $985,677,000, consisting of unrealized gains of $1,041,622,000 on securities that had risen in value since their purchase and $55,945,000 in unrealized losses on securities that had fallen in value since their purchase.

H. During the year ended August 31, 2013, the fund purchased $1,484,134,000 of investment securities and sold $1,682,021,000 of investment securities, other than temporary cash investments.

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

 

J. Management has determined that no material events or transactions occurred subsequent to August 31, 2013, that would require recognition in these financial statements. In October 2013, Vanguard announced plans to merge Vanguard Growth Equity Fund into Vanguard U.S. Growth Fund in the first quarter of 2014. After the merger, the fund will retain its current advisors and will add Baillie Gifford Overseas Ltd. and Jennison Associates LLC from the former Vanguard Growth Equity Fund. The fund’s investment strategy and objective will not change.

27

 

Report of Independent Registered
Public Accounting Firm

To the Trustees of Vanguard World Fund and the Shareholders of Vanguard U.S. Growth Fund:

In our opinion, the accompanying statement of net assets and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Vanguard U.S. Growth Fund (constituting a separate portfolio of Vanguard World Fund, hereafter referred to as the “Fund”) at August 31, 2013, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as “financial statements”) are the responsibility of the Fund’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at August 31, 2013 by correspondence with the custodians and brokers and by agreement to the underlying ownership records of the transfer agent, provide a reasonable basis for our opinion.

/s/PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
October 10, 2013

Special 2013 tax information (unaudited) for Vanguard U.S. Growth Fund

This information for the fiscal year ended August 31, 2013, is included pursuant to provisions of the
Internal Revenue Code.

The fund distributed $22,216,000 of qualified dividend income to shareholders during the fiscal year.

For corporate shareholders, 100% of investment income (dividend income plus short-term gains,
if any) qualifies for the dividends-received deduction.

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Your Fund’s After-Tax Returns

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

Calculations are based on the highest individual federal income tax and capital gains tax rates in effect at the times of the distributions and the hypothetical sales. State and local taxes were not considered. After-tax returns reflect any qualified dividend income, using actual prior-year figures and estimates for 2013. (In the example, returns after the sale of fund shares may be higher than those assuming no sale. This occurs when the sale would have produced a capital loss. The calculation assumes that the investor received a tax deduction for the loss.)

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

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

 

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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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The calculations are based on expenses incurred in the most recent six-month period. The fund’s annualized six-month expense ratios for that
period are 0.44% for Investor Shares and 0.30% for Admiral Shares. The dollar amounts shown as “Expenses Paid” are equal to the
annualized expense ratio multiplied by the average account value over the period, multiplied by the number of days in the most recent
six-month period, then divided by the number of days in the most recent 12-month period.

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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 181 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, Vanguard Growth Equity Fund, the Vanguard Municipal Bond Funds, and the Vanguard
State Tax-Exempt Funds.

 

 

 

 

Annual Report | August 31, 2013

Vanguard International Growth 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: The ship's wheel represents leadership and guidance, essential qualities in navigating difficult seas.
This one is a replica based on an 18th-century British vessel. The HMS Vanguard, another ship of that era, served as the
flagship for Admiral Horatio Nelson when he defeated a French fleet at the Battle of the Nile.

 

Your Fund’s Total Returns

 

Admiral Shares carry lower expenses and are available to investors who meet certain account-balance requirements.

 

 

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Chairman’s Letter

Dear Shareholder,

Stock markets outside the United States sprinted ahead of the U.S. broad market in the first half of fiscal 2013 but then fell behind, trailing for the year. Still, Vanguard International Growth Fund returned more than 17% for the 12 months ended August 31, 2013, besting its comparative index and the average return of international funds.

Your fund’s advisors distinguished themselves with their selections in European developed markets—and in emerging markets, where fund holdings significantly outperformed the emerging-market constituents of the benchmark index.

If you invest in the fund through a taxable account, you may want to review the table on page 33, which shows after-tax returns for investors in the highest tax bracket.

Stocks posted robust results despite setbacks at the finish

Despite a weak finish, many stock markets around the world posted double-digit gains for the 12 months ended August 31. International stocks in aggregate returned about 13%, led by developed markets in Europe and the Pacific region—which was boosted by Japan. In contrast, emerging markets overall struggled to finish nearly flat.

The U.S. market outpaced several international markets, returning about 20% for the fiscal year. As the economy

2

 

continued to show modest growth and investors appeared more receptive to risk, stocks surged, although they lost some ground during the summer.

Much of the recent weakness in global markets stemmed from fear that the U.S. Federal Reserve would begin scaling back its bond-buying stimulus program sooner rather than later. The Fed’s low-interest-rate policies have been a boon not only for the U.S. economy but also for those overseas, especially in emerging markets. Heightened strife in the Middle East also contributed to anxiety in the global markets.

Although global economic growth concerns and tensions over conflicts abroad have unsettled markets, Jonathan Lemco, a

senior sovereign debt analyst in Vanguard’s Taxable Credit Research Group, pointed out that investors can still manage risks amid international instability. “Vanguard believes a diversified portfolio is the best way to spread the risk of geopolitical uncertainty,” he said.

Bond returns turned negative amid worry about the Fed’s next move

Bonds, which generated slightly positive returns through the first eight months of the period, reversed course in May and then continued to retreat as investors anticipated reductions in the Fed’s bond-buying program.

The broad U.S. taxable bond market returned –2.47% for the 12 months. The yield of the 10-year Treasury note finished

 

3

 

at 2.76%, up from 1.56% at the end of August 2012. (Bond yields and prices move in opposite directions.) Municipal bonds suffered more, returning –3.70% for the fiscal year.

Returns for money markets and savings accounts were minuscule as the Fed kept its target for short-term interest rates between 0% and 0.25%.

Markets advanced across all regions, led by developed Europe and Japan

Stocks outside the United States advanced broadly across all regions, led by European developed markets—which made up more than half of fund assets, on average. The fund’s holdings in several countries, including France and Germany,

returned more than 30%. Even amid periodic debt-crisis flare-ups and the need for additional bailouts, the Eurozone economy showed encouraging signs that it could be emerging from its longest recession since World War II. (This was confirmed by data released in mid-August).

Long-slumbering Japan also enjoyed a powerful rally as investors were encouraged by the “Abenomics” stimulative policies of Japan’s new prime minister. Japanese stocks surged more than 55% in local currency terms (as measured by the MSCI Japan Index), but the yen’s weakness against the U.S. dollar cut that return about in half for U.S.-based investors.

The fund expense ratios shown are from the prospectus dated December 27, 2012, and represent estimated costs for the current fiscal year.
For the fiscal year ended August 31, 2013, the fund’s expense ratios were 0.48% for Investor Shares and 0.35% for Admiral Shares. The
peer-group expense ratio is derived from data provided by Lipper, a Thomson Reuters Company, and captures information through year-end
2012.

Peer group: International Funds.

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Gains among the fund’s emerging-market holdings overall were more muted than those in developed markets. In part, this reflected concerns about slower growth in China, the world’s second-largest economy, which still has a growth rate that would be the envy of many developed economies. Also, the developing world has been a major beneficiary of capital inflows resulting from easy-money policies in the United States. Fears that the Fed could soon begin to scale back its stimulus programs triggered capital outflows, dampening the outlook for emerging markets.

Almost all industry sectors in developed Europe and the Pacific region had positive returns, with consumer discretionary

stocks delivering some of the more robust gains. In emerging markets, sector returns diverged: Information technology (and the tiny telecommunications sector) led the advances while energy and materials lost the most ground.

Compared with the return of the benchmark index, the advisors’ stock picks in the United Kingdom, France, and Germany were particularly rewarding. So, too, were selections in China, where the fund’s return was more than double that of the index. And in Canada, a small slice of the fund, the advisors made a meaningful contribution by avoiding some of the disappointments among gold miners. Partly offsetting these advantages were some missed opportunities in Japan.

For a benchmark description, see the Glossary.
International Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company.

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

5

 

For more about the advisors’ strategies and the fund’s positioning during the 12 months, see the Advisors’ Report that follows this letter. Also, please note that Kave Sigaroudinia has been added as a co-manager, along with James K. Anderson, for the portion of the fund advised by Baillie Gifford Overseas Ltd.

Long-term outperformance continued in challenging decade

With an assist from another year of distinguished performance, Vanguard International Growth Fund posted an average annual return of 8.73% for Investor Shares for the decade ended August 31, 2013 extending its lead over its benchmark index. As you can see in the table on page 5, the fund also outperformed its peer group’s average annual return.

This admirable long-term track record during a decade marked by the worst global recession since the Great Depression and several European sovereign-debt bailouts is a tribute to the discipline and expertise of the fund’s three investment advisory firms.

Benefits of combining low costs with diversity of thought

Investors sometimes ask why Vanguard uses a multi-advisor approach for many of its actively managed equity portfolios. Just as we recommend diversification within and across asset classes for an investor’s overall investments, we think significant benefits can accrue from using multiple advisory firms for a single portfolio: diversity of investment process and style, thought, and holdings.

All of these elements can lead to less risk and better results. Because not all investment managers invest the same way, their returns relative to the benchmark don’t move in lockstep.

As with many investment topics, however, there are some misconceptions about the benefits of using a multi-manager approach. For example, it is often suggested that the best ideas of the advisors are diluted when they are combined in one portfolio. Recent Vanguard research has found otherwise.

Conventional wisdom also suggests that multi-manager funds tend to be expensive. At Vanguard, this is not the case; low costs are a hallmark of all our offerings. And Vanguard research indicates that low costs can contribute greatly to investing success, helping investors keep more of a portfolio’s return. (You can read more in Analyzing Multi-Manager Funds: Does Management Structure Affect Performance? at vanguard.com/research.)

As always, thank you for entrusting your assets to Vanguard.

Sincerely,

F. William McNabb III
Chairman and Chief Executive Officer
September 16, 2013

6

 

Advisors’ Report

For the fiscal year ended August 31, 2013, Vanguard International Growth Fund returned 17.54% for Investor Shares (17.66% for Admiral Shares). 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 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 fiscal year and of how the portfolio’s positioning reflects this assessment. These comments were prepared on September 17, 2013.

 

7

 

Baillie Gifford Overseas Ltd.

Portfolio Managers:
James K. Anderson,
Head of Global Equities

Kave Sigaroudinia,
Head of EAFE Alpha Research

We have been resolutely upbeat over the last several years, in contrast to a financial world that has seemed excessively pessimistic. Improvement is increasingly apparent to those who look for it, as the financial experiments of the past five years have begun to produce results. The examples of reform in Europe and China, as well as signs of recovery in the United States, bode well for longer-term investors. Greater globalization, rapid changes in technology, faster adoption rates for new technologies, and the concentration of profitability in a relatively small number of winning companies continue to shape our portion of the fund.

Our focus in managing these assets has not changed: We aim to identify and invest in companies with strong, durable competitive advantages and substantial growth potential. Our firms are exposed to attractive trends such as the rapid expansion of Chinese consumption and the disruptive influence of the internet on many traditional business models. As always, we strive to identify companies with exceptional management teams that are willing to take appropriate risks and focus on long-term opportunities.

The Chinese social network Tencent was our outstanding performer as its established operations became more profitable and it expanded its newer mobile platform both domestically and overseas. Luxury goods group Kering also contributed as management’s focus on strengthening its brands improved its sales. Our recently purchased shares of Japanese internet and telecom provider Softbank did well as the company completed the acquisition of Sprint in the United States and increased its stake in Alibaba, the dominant Chinese e-commerce platform. On the other hand, some of our holdings in emerging markets, such as Banco Itaú in Brazil and HDFC in India, declined. Investors have been concerned about countries such as Brazil and India that have funded their growth in recent years through overseas borrowings.

During the year, we expressed our relative optimism about Spain by taking a new position in Banco Popular, which stands out as a likely winner in the capital-constrained and consolidating Spanish banking sector. We also acquired shares in Kinnevik, a Swedish family holding company that has stakes in a number of e-commerce businesses globally, and in Magnit, a leading Russian food retailer. We sold holdings in Axel Springer, OGX, SAB Miller, Petrobras, BHP Billiton, and adidas Group to fund the new investments.

We remain positive about the outlook for equity markets and committed to our approach of investing in growth companies for the long run.

8

 

Please note that portfolio manager James K. Anderson is taking a six-month sabbatical during the second half of calendar-year 2013. During this time, Kave Sigaroudinia, who serves as co-manager with Mr. Anderson, will serve as the sole portfolio manager. Mr. Anderson is expected to resume his role as co-manager early in 2014.

Schroder Investment Management
North America Inc.

Portfolio Managers:
Virginie Maisonneuve, CFA
Head of Global and International Equities

Simon Webber, CFA

International markets posted double-digit gains for the fiscal year, although investors’ appetite for risk was transitory as the economic environment remained uncertain. For much of the period, global central bank action was beneficial, as was the increasing belief that the economic recovery is gaining traction, led by the United States.

Eurozone tensions eased, but Italian political gridlock and the Cyprus bailout triggered a bout of risk aversion in February. Although cyclicals soon recovered, the possibility that the Federal Reserve might begin tapering its asset purchasing toward the end of the year weighed on investor sentiment. This, and the resultant rise in Treasury yields, dominated market movements in later months.

Emerging markets had a difficult year, in part because of slowing growth in China and lower global demand for these markets’ exports. More recently, the prospect of rising interest rates and concern about the current account deficits of certain countries triggered sharp outflows from emerging-market debt, equities, and currencies.

Turning to our portion of the fund, our success was driven by telecoms and information technology. Our Indian telecom, Idea Cellular, defied a difficult period for Indian stocks as investors increasingly recognized its impressive growth prospects in a structurally attractive market. Samsung Electronics remained strong as it increased its share of the all-important mid-range smartphone market. In the same sector, shares of Infineon Technologies rose in anticipation of an earnings recovery in the semiconductor cycle. Our holdings in health care, consumer staples, utilities, financials, and industrials also performed well.

The most significant detractor over the 12 months was the materials sector, as it faced challenges in struggling emerging markets—the key driver of demand for resources. Our weakest materials holding was Newcrest Mining. The gold-mining company suffered from a number of production setbacks caused by weather disruption, ore grade degradation that increased production costs across the industry, and equipment issues. More recently, it was hurt by falling gold prices

9

 

in response to rising real interest rates in the United States and a reduction in global economic tail risk that had driven demand for gold as a safe haven.

Our holdings in emerging markets had a positive absolute return even as the index lost ground there. Performance in Continental Europe also added value relative to the index, benefiting from our focus on companies in core Europe with a strong global footprint. Japan was the largest detractor because of a combination of stock selection and our slight underweight positioning.

We expect the global economy to improve through 2013 and into 2014, led by developed markets as they slowly heal from the crisis and embark on the path to normalization. We view the possibility that the Fed may begin tapering its asset purchases at the end of this year as an encouraging sign. The key factors for the global economy will be the pace of the rollback and how it will affect currencies around the world, as well as its indirect effect on emerging markets. While we anticipate further short-term pressure on these markets, it does not alter their structural growth story. We expect to use this period of cyclical weakness to build positions for the long term.

Important risks remain. We are monitoring closely developments in Syria, in particular their impact on oil prices. Although it’s not our base case scenario, substantial

increases in oil prices could rock the fragile global economic recovery. Other potential sources of volatility include political or economic setbacks to the healing process in Europe, the German elections, negotiations around the U.S. budget, missteps as central banks begin moving away from their extremely easy monetary policies, and the November meeting of leaders in China that will set the tone of reform for years to come.

M&G Investment
Management Limited

Portfolio Manager:
Greg Aldridge

International equity markets generally rose from the middle of November, with a degree of optimism gaining ground over the risk aversion that had dominated much of the first half of 2012. The waters became choppier in the middle of the period as the potential for the U.S. Federal Reserve to begin tapering its asset-buying program led to widespread sell-offs. However, increasingly resilient markets shook off misgivings and again rose strongly as investors became more willing to take on risk. The end of the fiscal year saw some of those gains wiped out amid concerns over escalating tensions in Syria and uncertainty in some emerging-market economies, despite relatively positive economic data from the United States, Europe, and China. Even so, markets finished in firmly positive territory.

10

 

Our holdings within the consumer discretionary and industrial sectors, both of which outperformed the wider index, added considerable value. The leading contributor to returns was U.K.-based auto retailer and distributor Inchcape. The company’s strength stems from its unique global distribution network. It also boasts good structural growth drivers, particularly its expanding retail operations in numerous emerging markets, where demand for luxury vehicles is increasing.

European aerospace giant EADS continued to benefit from its excellent industry positioning, robust order book, and operational successes. German banking and retail IT provider Wincor Nixdorf has experienced sustained growth in emerging markets that has lifted net sales and profits. Techtronic Industries, a Hong Kong-based manufacturer of power tools and domestic appliances, profited from its growing U.S. market share. And Japanese carmaker Toyota gained on the back of a weakening yen, with profit implications that cheered investors and bolstered the company’s share price.

On the downside was our above-index allocation to Brazil, as sentiment in the country remained weak. Largely because of the resource-heavy nature of Brazil’s economy, the materials sector has generally been out of favor over the past year. Accordingly, oil company Petroleo Brasileiro (Petrobras) was the greatest laggard, and iron ore miner Vale also dragged on returns. Another underperformer was Taiwan-based contract PC maker Compal Electronics.

As active stockpickers, we continued to selectively purchase shares in companies that have compelling scarce assets, structural growth drivers, the potential for sustainably high returns, and attractive valuations. These included international dialysis group Fresenius Medical Care, Chinese real estate group Hang Lung Properties, and Standard Chartered, a U.K.-based bank that generates a majority of its revenues from emerging markets. We also added Swedish bank Svenska Handelsbanken and South Korean firm Samsung Electronics. Samsung is benefiting from the shift in consumer preference from PCs toward mobile devices. It has become a high-returning business, and we feel it is able to protect those returns with a strong brand, leading market position, and outstanding technology in both mobile phones and semiconductors.

In light of the purchase of Samsung, we sold our holdings in Compal Electronics, which has struggled in the face of uncertainty about demand for notebook computers. We also closed a number of positions in favor of more attractively valued companies with stronger growth prospects. These sales included Sims Metal Management, an Australian-listed global recycling group; Wienerberger, an Austrian brick and tile manufacturer; and Fibria Cellulose, a Brazilian pulp producer. CFAO, a French firm that distributes cars and pharmaceuticals throughout Africa, left the portfolio after the Japanese conglomerate TTC bid to take over the company.

11

 

International Growth Fund

Fund Profile
As of August 31, 2013

 

 

 

These measures show the degree and timing of the fund’s fluctuations compared with the indexes over 36 months.

 

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

Allocation by Region (% of equity exposure)

1 The expense ratios shown are from the prospectus dated December 27, 2012, and represent estimated costs for the current fiscal year. For
the fiscal year ended August 31, 2013, the expense ratios were 0.48% for Investor Shares and 0.35% for Admiral Shares.

12

 

International Growth Fund

 

13

 

 

		Average Annual Total Returns
		Periods Ended August 31, 2013
					Final Value
		One	Five	Ten	of a $10,000
		Year	Years	Years	Investment
	International Growth Fund Investor
	Shares	17.54%	3.76%	8.73%	$23,084
••••••••	Spliced International Index	12.98	0.24	6.83	19,368
– – – –	International Funds Average	15.74	1.48	7.03	19,723
	MSCI All Country World Index ex
	USA	12.98	1.48	8.34	22,271
For a benchmark description, see the Glossary.
International Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company.

				Final Value
	One	Five	Ten	of a $50,000
	Year	Years	Years	Investment
International Growth Fund Admiral Shares	17.66%	3.91%	8.91%	$117,414
Spliced International Index	12.98	0.24	6.83	96,841
MSCI All Country World Index ex USA	12.98	1.48	8.34	111,356

 

 

For a benchmark description, see the Glossary.

	Inception	One	Five	Ten
	Date	Year	Years	Years
Investor Shares	9/30/1981	15.23%	1.05%	8.79%
Admiral Shares	8/13/2001	15.40	1.21	8.98

15

 

International Growth Fund

Financial Statements

Statement of Net Assets
As of August 31, 2013

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).

 

16

 

International Growth Fund

 

17

 

International Growth Fund

 

18

 

International Growth Fund

 

19

 

International Growth Fund

See Note A in Notes to Financial Statements.
^ Part of security position is on loan to broker-dealers. The total value of securities on loan is $268,098,000.
* Non-income-producing security.
1 The fund invests a portion of its cash reserves in equity markets through the use of index futures contracts. After giving effect to futures
investments, the fund’s effective common stock and temporary cash investment positions represent 99.4% and 2.3%, respectively, of
net assets.
2 Affiliated money market fund available only to Vanguard funds and certain trusts and accounts managed by Vanguard. Rate shown is the
7-day yield.
3 Includes $283,500,000 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 $36,491,000 have been segregated as initial margin for open futures contracts.
6 Securities with a value of $7,581,000 have been segregated as collateral for open forward currency contracts.
7 The issuer operates under a congressional charter; its securities are generally neither guaranteed by the U.S. Treasury nor backed by the
full faith and credit of the U.S. government.
ADR—American Depositary Receipt.
GDR—Global Depositary Receipt.
See accompanying Notes, which are an integral part of the Financial Statements.

20

 

International Growth Fund

Statement of Operations

 

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

21

 

International Growth Fund

Statement of Changes in Net Assets

 

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

22

 

International Growth Fund

Financial Highlights

1 Net Investment income per share and the ratio of net investment income to average net assets include $.061 and 0.48%, respectively,
resulting from income accrued in connection with a spinoff in October 2008 by Reinet Investments SA of British American Tobacco plc.
2 Total returns do not include transaction or account service fees that may have applied in the periods shown. Fund prospectuses provide
information about any applicable transaction and account service fees.
3 Includes performance-based investment advisory fee increases (decreases) of 0.03%, 0.04%, 0.03%, 0.03%, and 0.03%.

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

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