PDF 2011: The year in review - Vanguard

2011: The year in review

2011: The year too much happened?

Vanguard was named for Lord Nelson's flagship at the Battle of the Nile. The nautical images in this report provide a fitting metaphor for the Vanguard crew's mission of helping clients reach their financial goals.

Chairman's message 1 Overseeing and refining our fund offerings 6 Serving our clients 8 Vanguard directors and officers 20

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F. William McNabb III Chairman and Chief Executive Officer

Chairman's message

Many years from now, people may look back at market returns for 2011 and think that nothing happened. After all, the broad U.S. stock market returned less than 1%. Meanwhile, short-term interest rates remained virtually unchanged, the broad U.S. bond market fared slightly better than its long-term historical average, and international stock returns were disappointing. (See Figure 1.)

But in some respects, 2011 was a year in which too much happened. It was jarring, jolting, and difficult to process. Revolutions swept across the Middle East. An earthquake, tsunami, and nuclear crisis devastated Japan. European debt problems pushed large economies to the brink of collapse. And in the United States, politicians debated our own fiscal troubles while debt-ceiling clocks counted down toward zero and market volatility spiked.

Figure 1. Market barometer

One year

Stocks Russell 1000 Index (Large-caps) Russell 2000 Index (Small-caps) Dow Jones U.S. Total Stock Market Index MSCIAll Country World Index ex USA (International)

1.50% ?4.18

0.52 ?13.71

Bonds Barclays Capital U.S. Aggregate Bond Index (Broad taxable market) Barclays Capital Municipal Bond Index (Broad tax-exempt market) Citigroup 3-Month Treasury Bill Index

7.84% 10.70

0.08

CPI Consumer Price Index

2.96%

Average annual total returns Periods ended December 31, 2011

Three years

Five years

14.81% 15.63 15.24 10.70

?0.02% 0.15 0.28 ?2.92

6.77% 8.57 0.11

6.50% 5.22 1.36

2.39%

2.26%

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

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Figure 2. Average expense ratios: Vanguard versus the industry

1.5% 1.2 0.9

All funds: 1.12%*

0.6

Vanguard:

0.3

0.20%

0.0 1976 1981 1986 1991 1996 2001 2006 2011

Vanguard

Industry

Expense ratios as of December 31, 2011. Vanguard expense ratios range from 0.005?1.84%. Average expense ratios are represented as a percentage of net assets.

* Sources: 1975?1977 Weisenberger Panorama; and Lipper Inc. thereafter.

Figure 3. The value to clients of our low costs Estimates in millions of dollars $20,000

15,000

$15,149

10,000

5,000

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: Vanguard.

The chart shows the total additional fund operating costs that Vanguard shareholders would have paid each year if we had charged the fund industry's average expense ratio (1.12% in 2011).

92 basis points on $1.65 trillion in mutual fund assets under management could translate into approximately $15 billion in savings.

Calculation: 92 basis points comes from subtracting the industry average expense ratio of 1.12% from the Vanguard average expense ratio of 0.20%. This number is then multiplied by Vanguard's assets under management of $1.65 trillion to get the result of $15 billion.

This hypothetical illustration does not represent any particular investment and only holds true if the returns are identical. There is no assurance that individual investors will experience similar savings.

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How did Vanguard fare?

As I've met with Vanguard clients and crew over the past few months, people have asked whether Vanguard was successful in 2011. Well, the ultimate measure of success for our company is the success of our clients: Did they make money? The answer to that is: not much. As the leader of this company, I am keenly aware of that, and it has to be the first topic addressed in any discussion of the past year.

That said, I am proud of what Vanguard accomplished in 2011. We controlled the factors that we could control. We remained diligent stewards of our clients' assets, and we continued to position our firm to serve our clients for the long term. Here are some highlights:

?We lowered the cost of investing. W$1e5,0fo00und ways to reduce investment costs and 1t2o,0m00ake our funds more accessible to more people. In May, we lowered the minimum initial investmen9t,0t0o0$1,000 for our Target Retirement Funds. In Se6p,t0e0m0 ber, we introduced lower-cost share classes--AdmiralTM Shares, Institutional Shares, and Institu3t,i0o0n0al Plus Shares--to nine more index funds. (In 20011 alone, investors saved nearly $400 million by investi2n0g00in2001 200 Admiral Shares over Investor Shares.) In October, we introduced a new 401(k) plan service for small companies with costs that are among the lowest in the industry.

Overall, our mutual funds' average expense ratio for 2011 decreased 1 basis point to 20 basis points. If Vanguard had charged the industry average expense ratio of 1.12% on our shareholders' average assets of $1.65 trillion during the year, their returns would have been $15.15 billion less. (See Figures 2 and 3.)

?Managers guided funds prudently. Even though our funds' absolute investment returns were underwhelming across most categories due to the underwhelming performance of the markets, our investment managers did an admirable job steering Vanguard funds through an incredibly volatile market. According to Lipper Inc., 81% of Vanguard funds outperformed the average returns of their peer funds in 2011. Over longer time frames, Vanguard funds have performed even better. (See Figure 4.)

? Investors sought out Vanguard. Throughout the year, new and existing clients continued to invest with Vanguard. As a result, Vanguard had a total net cash flow into our U.S.-based funds of $80.1 billion (Source: Vanguard). We ended 2011 with $1.66 trillion in U.S. fund assets under management.

?We added new funds. We take a measured approach to offering new funds. In 2011, we introduced two new funds that complement our existing offerings. In January 2011, we launched the Total International Stock ETF--a separate share class of Total International Stock Index Fund, which was introduced in 1996. In June, we introduced the actively managed Emerging Markets Select Stock Fund.

?We expanded our global reach. We began operations in Canada and launched six new exchange-traded funds (ETFs) on the Toronto Stock Exchange, and we continue to build momentum in our efforts to serve more investors in the United Kingdom, Europe, Australia, and Asia.

Figure 4. Percentage of Vanguard funds whose returns beat their peer-group averages Note: All performance periods ended December 31, 2011.

1 year

81%

3 years 5 years

70%

83%

10 years

89%

Source: Vanguard. Comparative performance data provided by Lipper Inc.

For the one-year period, 10 of 10 Vanguard money market funds, 60 of 86 bond funds, 29 of 30 balanced funds, and 175 of 211 stock funds outperformed their Lipper averages. For the three-year period, 10 of 10 Vanguard money market funds, 33 of 65 bond funds, 19 of 29 balanced funds, and 129 of 167 stock funds outperformed their Lipper averages. For the five-year period, 10 of 10 Vanguard money market funds, 51 of 57 bond funds, 24 of 26 balanced funds, and 115 of 147 stock funds outperformed their Lipper averages. For the ten-year period, 10 of 10 Vanguard money market funds, 47 of 52 bond funds, 12 of 14 balanced funds, and 78 of 90 stock funds outperformed their Lipper averages. Results will vary for other time periods. Only funds with a minimum, one-, three-, five-, or ten-year history, respectively, were included in the comparison.

Note that the competitive performance data shown represent past performance, which is not a guarantee of future results, and that all investments are subject to risks. For the most recent performance, visit our website at performance.

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