Address of Registrant:	P.O. Box 2600
	Valley Forge, PA 19482

Name and address of agent for service:	Heidi Stam, Esquire
	P.O. Box 876
	Valley Forge, PA 19482

Item 1: Reports to Shareholders

 

 

 

 

Past performance 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 www.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.

 

 

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.

Your Fund’s Total Returns

 

 

 

 

 

 

1 A lower-cost class of shares available to many longtime shareholders and to those with significant investments in the fund.

2 Derived from data provided by Lipper Inc.

 

 

1

 

President’s Letter

 

Dear Shareholder,

The energy sector, a leading performer in calendar 2007 and well into 2008, finished our fiscal year near the middle of the pack in the bear market. When oil prices did an abrupt about-face last July, energy stock prices followed a similarly steep downward spiral.

For the fiscal year ended January 31, Vanguard Energy Fund returned a disappointing –38.51% for Investor Shares and –38.46% for Admiral Shares. This was about 5 percentage points ahead of the average result for competing natural resources funds, which had the lead in the fiscal first half.

But the fund’s return lagged about 9 percentage points behind the –29.19% return of the benchmark Standard & Poor’s Energy Sector Index. Keep in mind that, although this index provides a useful comparison, it includes only United States-based companies and is dominated by a few large holdings.

If you invest in the Energy Fund through a taxable account, you may wish to review information about the fund’s after-tax performance provided later in this report.

Stocks fell worldwide as the credit crisis deepened

The 12 months ended January 31 was one of the worst ever one-year spans for stocks. The broad U.S. stock market declined steeply, returning about –39%; international stocks returned –45%. The

 

2

trouble stemmed from the financial sector, where some of the world’s largest institutions imploded largely because of their exposure to low-quality mortgages in the United States. The effects of the credit crisis were wide and deep, with virtually no country or industry sector spared.

The stock market struggled through the first part of the fiscal year, then declined sharply in September, October, and November. December offered a brief reprieve before the market fell again in January.

In a flight to safety, investors chose low-yield Treasuries

As economic uncertainty and market volatility grew more pronounced in the second half of the year, investors sought the relative safety of short-term government issues. This drove prices for Treasuries higher, and their yields lower. In some cases, investors were willing to accept very low—or even slightly negative—yields for the short-term safekeeping of their assets.

At the same time, the Federal Reserve Board steered short-term interest rates lower in its ongoing campaign to encourage lending. During your fund’s fiscal year, the target for the federal funds rate dropped from 3.00% to a range of 0%–0.25%.

For the full 12-month period, the broad taxable bond market returned 2.59%, and tax-exempt bonds returned –0.16%—somewhat pedestrian (if disappointing) returns that masked a year of uncommon volatility for bonds.

 

 

 

 

3

It was a rollercoaster ride for oil prices and energy stocks

After climbing from about $90 per barrel in January 2008 to a record of more than $145 per barrel in mid-July, the spot price of West Texas Intermediate crude oil (an industry benchmark) dropped sharply to about $40–$45 per barrel in January 2009. Natural gas prices traced a similar path.

As economies around the globe skidded into recession, energy demand slackened. Production cutbacks announced by the Organization of Petroleum Exporting Countries to put the brakes on the free-fall in oil prices had little apparent impact. Just as soaring energy prices boosted exploration, production, and related activities, the dramatic pullback in prices had a chilling effect across the oil patch.

When energy prices fall, the major integrated oil and gas producers—with complex operations that range from exploring in the remote corners of the world to refining crude oil along the Gulf Coast of the United States—are often better-positioned than smaller, less-diversified companies. Although the majors’ producing operations can be hurt by lower prices, their refineries can benefit from improved profit margins.

But in the past fiscal year, refining was squeezed as consumers reacted to gasoline pump prices above $4 per gallon and airlines cut flights in response to soaring jet fuel costs. This segment of the portfolio, which represented more than 50% of assets, on average, returned about –33% and trimmed more than 15 percentage points from the fund’s return.

Among the hardest hit of the integrated producers were companies based overseas, including some that had enjoyed eye-popping returns a year earlier when they announced potentially significant discoveries. Disappointments included Russia’s Gazprom (–73%) and LUKOIL

 

 

 

 

1 The fund expense ratios shown are from the prospectus dated May 29, 2008. For the fiscal year ended January 31, 2009, the Energy Fund’s expense ratios were 0.28% for Investor Shares and 0.21% for Admiral Shares. The peer-group expense ratio is derived from data provided by Lipper Inc. and captures information through year-end 2008.

 

4

(–51%), Canada’s Suncor Energy (–59%), Petróleo Brasileiro (–51%), and BG Group (British Gas, –37%).

Your fund’s advisors—Wellington Management Company, LLP, and Vanguard Quantitative Equity Group—invest in some foreign stocks to help prudently diversify the portfolio, placing it in contrast with the benchmark index. For example, one U.S.-based company (ExxonMobil) represented almost one-third of the index during the fiscal year, but less than one-tenth of your portfolio.

 

This more diversified strategy has served shareholders well over the long term. During the past 12 months, however, the inclusion of foreign holdings and the resulting relatively light exposure to some of the better-performing U.S. integrated behemoths—such as ExxonMobil (–10%) and Chevron (–13%)—helped keep the fund’s return behind that of the benchmark index.

 

Among smaller slices of the portfolio—including gas utilities, drilling companies, and oil and gas storage and transportation companies—the advisors’ allocation decisions helped the funds’ performance relative to the benchmark index.

Over ten years, the fund achieved a track record to be proud of

Over a decade that now spans two recessions, equity performance in general has been disappointing. Average annual returns for the broad U.S. and international stock markets were –1.83% and 1.34%, respectively. Your fund stands out in sharp contrast, with a 15.16% average annual return over the ten years ended January 31—well ahead of the result for its benchmark index and the average return of peer funds. Keep in mind that this period coincided with a spectacular boom in energy prices, which is not something to count on, as we have witnessed in the last several months.

 

 

 

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 www.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.

 

 

1 Derived from data provided by Lipper Inc.

 

5

The fund’s performance is a tribute to the disciplined and complementary investment strategies of your fund’s advisors, which help provide diversification even within a sector-specific fund holding only about 100–105 stocks. Wellington Management Company focuses on the bottom-up selection of stocks it considers to be undervalued, while Vanguard Quantitative Equity Group uses a risk-controlled, computer-based approach to evaluate and rank stocks. And your fund’s low expenses help investors keep more of the fund’s return, an advantage that compounds over time.

For more about the advisors’ strategies and the fund’s positioning during the year, see the Advisors’ Report, which begins on page 7.

Diversification and balance are still the way to go

For more than a year, global financial markets have been reeling from an unnerving confluence of events—including record-high oil prices, credit market gridlock, and major economies falling into deep recession. Portfolios that were balanced and diversified have suffered too, of course. But our experience suggests that these time-tested fundamentals—plus low costs—can help put investors in a better position to benefit from the eventual recovery in financial markets.

As your fund’s outstanding long-term record reveals, focusing on one market segment can be rewarding. But we encourage investors not to narrow their investment horizons, no matter how tempting this may be. The Energy Fund, which marks its 25th anniversary later this year, can provide you with low-cost exposure to an important slice of the overall market as part of a balanced, diversified portfolio consistent with your long-term goals and risk tolerance.

Thank you for entrusting your assets to Vanguard.

Sincerely,

 

 

F. William McNabb III

President and Chief Executive Officer

February 12, 2009

 

 

6

Advisors’ Report

 

For the fiscal year ended January 31, 2009, the Investor Shares of Vanguard Energy Fund returned –38.51% and the Admiral Shares –38.46%. Your fund is managed by two advisors, a strategy that enhances the fund’s diversification by providing exposure to distinct, yet complementary, investment approaches.

The advisors, the amount and percentage of fund assets each manages, and brief descriptions of their investment strategies are presented in the table below. The advisors have also provided a discussion of the investment environment that existed during the year and of how their portfolio positioning reflects this assessment. These reports were prepared on February 17, 2009.

 

Wellington Management Company, LLP

Portfolio Managers:

Karl E. Bandtel, Senior Vice President

James A. Bevilacqua, Senior Vice President

After crude oil reached record highs above $140 per barrel in mid-July, demand for energy-related commodities weakened as the financial crisis widened and the world economy slipped into recession. Oil prices then spiraled lower, closing the fiscal year near $40. Although the difficult credit markets may continue to dampen demand for energy in the coming year, a contraction of supply—evidenced by the wave of cuts in production and capital expenditures announced by oil-producing countries and U.S. natural gas producers—will likely help create a floor for energy prices.

 

 

 

 

7

Natural gas prices, which started the period near $8 per thousand cubic feet, fell during the second half of the fiscal year as producers continued to invest for an environment of growth, which increased supplies. As the period closed, economic weakness intensified, keeping gas prices low.

Top contributors to the performance of our portion of the Energy Fund included ExxonMobil and Nabors Industries; detractors included Weatherford International, Gazprom, and Schlumberger. We established new positions in Chesapeake Energy and India’s Reliance Industries, and added to our existing positions in ExxonMobil and Baker Hughes. We eliminated holdings in Repsol (Spain) and LUKOIL (Russia), and reduced our position in ConocoPhillips as we found better opportunities in which to invest.

Vanguard Quantitative Equity Group

Portfolio Manager:

James D. Troyer, CFA, Principal

Even though the stock market’s volatility over the past year has set a high level for comparison, the swings in the energy sector may have been more intense. After several years of price increases, oil began fiscal 2009 near $90 per barrel. It rose more than 50% to above $140 per barrel but had fallen to about $40 per barrel at the end of January, providing a stark example of the difficulty in forecasting price movements. Global energy stocks followed suit, rising in the first half of the period only to decline sharply in the second half of the fiscal year.

These large overall movements in the market, which investment jargon calls “beta,” are generally more important to a portfolio’s total return than an advisor’s stock-picking ability, or “alpha.” Our strategy focuses on the “alpha” component and tries to match the “beta” of the market, since we don’t believe that we are able to add value by forecasting broad market movements. Thus, we are always fully invested, and we hold numerous stocks in an attempt to keep our portfolio similar to the overall characteristics of our benchmark. The resulting portfolio includes many small positions in individual equities as we seek to capture the market’s tendency to over-or underreact to new information.

Our positions in National Oilwell Varco, Halliburton, and Chesapeake Energy were particularly successful. Detracting from our relative performance were our holdings of Plains Exploration & Production, Addax Petroleum, and Arch Coal. The largest contribution to the relative return of our portfolio by any individual stock was slightly more than half of 1 percentage point, which underscores our earlier comment about many small holdings.

We believe the markets are reasonably efficiently priced, so we do not take large stakes in individual stocks. Instead, we

 

8

focus on our objective, which is to make many small systematic investments, rigorously tested and applied in an effort to catch relatively small mispricings across large numbers of stocks. The success or failure of a few holdings is not as important as the average return we earn over our entire portfolio.

Over the long run, our quantitative process has demonstrated the ability to add value, and we continue to believe that a portfolio with a lower price/earnings ratio and a higher return on equity than the benchmark index offers an attractive choice as part of a diversified investment plan. We thank you for your investment and trust.

 

 

9

Energy Fund

 

Fund Profile

As of January 31, 2009

 

 

 

 

 

 

 

 

 

 

Investment Focus

 

 

 

1 S&P Energy Sector Index.

2 Dow Jones Wilshire 5000 Index.

3 30-day SEC yield for the fund; annualized dividend yield for the indexes. See the Glossary.

4 The expense ratios shown are from the prospectus dated May 29, 2008. For the fiscal year ended January 31, 2009, the expense ratios were 0.28% for Investor Shares and 0.21% for Admiral Shares.

5 Sector percentages combine U.S. and international holdings.

6 For an explanation of R-squared, beta, and other terms used here, see the Glossary.

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

 

 

10

Energy Fund

 

 

 

 

11

Energy 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 www.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: January 31, 1999–January 31, 2009

Initial Investment of $25,000

 

 

 

 

 

 

 

1 Total returns do not reflect the 1% fee assessed on redemptions of shares held less than one year, nor for the Investor Shares do they include the account service fee that may be applicable to certain accounts with balances below $10,000.

2 Derived from data provided by Lipper Inc.

3 Performance for the fund’s Admiral Shares and the comparative standards is calculated since the Admiral Shares’ inception: November 12, 2001.

 

 

12

Energy Fund

 

Fiscal-Year Total Returns (%): January 31, 1999–January 31, 2009

 

 

Average Annual Total Returns: Periods Ended December 31, 2008

This table presents average annual total 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.

 

 

 

1 Total returns do not reflect the 1% fee assessed on redemptions of shares held less than one year, nor for the Investor Shares do they include the account service fee that may be applicable to certain accounts with balances below $10,000.

2 Return since inception.

Note: See Financial Highlights tables for dividend and capital gains information.

 

 

13

Energy Fund

 

Financial Statements

 

Statement of Net Assets

As of January 31, 2009

 

The fund provides a complete list of its holdings 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 www.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).

 

 

 

 

14

Energy Fund

 

 

 

 

15

Energy Fund

 

 

 

 

16

Energy Fund

 

 

 

 

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 98.0% and 2.5%, respectively, of net assets.

2 Considered an affiliated company of the fund as the issuer is another member of The Vanguard Group.

3 Security exempt from registration under Rule 144A of the Securities Act of 1933. Such securities may be sold in transactions exempt from registration, normally to qualified institutional buyers. At January 31, 2009, the value of this security represented 0.06% of net assets.

4 Affiliated money market fund available only to Vanguard funds and certain trusts and accounts managed by Vanguard. Rate shown is the 7-day yield.

5 Includes $18,690,000 of collateral received for securities on loan.

6 The issuer operates under a congressional charter; its securities are neither issued nor guaranteed by the U.S. government.

7 Securities with a value of $26,478,000 have been segregated as initial margin for open futures contracts.

ADR—American Depositary Receipt.

GDR—Global Depositary Receipt.

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

 

 

17

Energy Fund

 

Statement of Operations

 

 

 

1 Dividends are net of foreign withholding taxes of $17,128,000.

2 Dividend income, interest income, and realized net gain (loss) from affiliated companies of the fund were $784,000, $4,104,000, and $0, respectively.

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

 

 

18

Energy Fund

 

Statement of Changes in Net Assets

 

 

 

1 Includes fiscal 2009 and 2008 short-term gain distributions totaling $0 and $64,462,000, respectively. Short-term gain distributions are treated as ordinary income dividends for tax purposes.

2 Net Assets—End of Period includes undistributed (overdistributed) net investment income of ($9,611,000) and ($7,458,000).

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

 

 

19

Energy Fund

 

Financial Highlights

 

 

 

1 Calculated based on average shares outstanding.

2 Includes increases from redemption fees of $.03, $.02, $.03, $.03, and $.02.

3 Total returns do not reflect the 1% fee assessed on redemptions of shares held less than one year, nor do they include the account service fee that may be applicable to certain accounts with balances below $10,000.

4 Includes a performance-based investment advisory fee increase of 0.01%.

5 Excludes the value of portfolio securities received or delivered as a result of in-kind purchases or redemptions of the fund’s capital shares. See accompanying Notes, which are an integral part of the Financial Statements.

 

20

Energy Fund

 

Financial Highlights

 

 

 

1 Calculated based on average shares outstanding.

2 Includes increases from redemption fees of $.06, $.03, $.05, $.03, and $.03.

3 Total returns do not reflect the 1% fee assessed on redemptions of shares held less than one year.

4 Includes a performance-based investment advisory fee increase of 0.01%.

5 Excludes the value of portfolio securities received or delivered as a result of in-kind purchases or redemptions of the fund’s capital shares.

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

 

 

21

Energy Fund

 

Notes to Financial Statements

 

Vanguard Energy Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund may invest in securities of foreign issuers, which may subject it to investment risks not normally associated with investing in securities of United States corporations. 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, tenure, 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 affected by events occurring before the fund’s pricing time but after the close of the securities’ primary markets, are valued at their fair values calculated according to procedures adopted by the board of trustees. These procedures include obtaining quotations from an independent pricing service, monitoring news to identify significant market- or security-specific events, and evaluating changes in the values of foreign market proxies (for example, ADRs, futures contracts, or exchange-traded funds), between the time the foreign markets close and the fund’s pricing time. When fair-value pricing is employed, the prices of securities used by a fund to calculate its net asset value may differ from quoted or published prices for the same securities. 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. Foreign Currency: Securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars using exchange rates obtained from an independent third party as of the fund’s pricing time on the valuation date. Realized gains (losses) and unrealized appreciation (depreciation) on investment securities include the effects of changes in exchange rates since the securities were purchased, combined with the effects of changes in security prices. Fluctuations in the value of other assets and liabilities resulting from changes in exchange rates are recorded as unrealized foreign currency gains (losses) until the assets or liabilities are settled in cash, at which time they are recorded as realized foreign currency gains (losses).

 

3. Futures Contracts: The fund uses index futures contracts to a limited extent, with the objective of maintaining full exposure to the stock market while maintaining liquidity. The fund may purchase or sell futures contracts to achieve a desired level of investment, whether to accommodate portfolio turnover or cash flows from capital share transactions. The primary risks associated with the use of futures contracts are imperfect correlation between changes in market values of stocks held by the fund and the prices of futures contracts, and the possibility of an illiquid market.

 

Futures contracts are valued based upon their quoted daily settlement prices. The aggregate principal 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).

 

22

Energy Fund

 

4. Repurchase Agreements: The fund may invest in repurchase agreements. Securities pledged as collateral for 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; however, in the event of default or bankruptcy by the other party to the agreement, retention of the collateral may be subject to legal proceedings.

 

5. 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 on federal income tax returns for all open tax years (tax years ended January 31, 2006–2009), and has concluded that no provision for federal income tax is required in the fund’s financial statements.

 

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

 

7. Security Lending: The fund may lend its securities to qualified institutional borrowers to earn additional income. Security loans are required to be secured at all times by collateral at least equal to the market value of 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. Security lending income represents the income earned on investing cash collateral, less expenses associated with the loan.

 

8. Other: Dividend income is recorded on the ex-dividend date. Interest income includes income distributions received from Vanguard Market Liquidity Fund and is accrued daily. 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. Fees assessed on redemptions of capital shares are credited to paid-in capital.

 

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. Wellington Management Company, LLP, provides 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 is subject to quarterly adjustments based on performance since May 1, 2007, relative to a combined index composed of the S&P Citigroup BMI World Energy Index and the S&P 500 Energy Equal Weighted Blend Index.

 

The Vanguard Group provides investment advisory services to a portion of the fund on an at-cost basis; the fund paid Vanguard advisory fees of $117,000 for the year ended January 31, 2009.

 

For the year ended January 31, 2009, the aggregate investment advisory fee represented an effective annual basic rate of 0.10% of the fund’s average net assets before an increase of $1,392,000 (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

 

23

Energy Fund

 

contributions to Vanguard. At January 31, 2009, the fund had contributed capital of $1,943,000 to Vanguard (included in Other Assets), representing 0.03% of the fund’s net assets and 0.78% of Vanguard’s capitalization. The fund’s trustees and officers are also directors and officers of Vanguard.

 

D. 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.

 

During the year ended January 31, 2009, the fund realized net foreign currency gains of $473,000, which increased distributable net income for tax purposes; accordingly, such gains have been reclassified from accumulated net realized losses to overdistributed net investment income. The fund’s realized losses for the year ended January 31, 2009, include taxes paid on realized capital gains on Indian securities of $12,000, which are treated as decreases to taxable income; accordingly these amounts have been reclassified from accumulated net realized losses to overdistributed net investment income.

 

The fund used a tax accounting practice to treat a portion of the price of capital shares redeemed during the year as distributions from net investment income and realized capital gains. Accordingly, the fund has reclassified $19,247,000 from undistributed net investment income, and $50,634,000 from accumulated net realized gains, to paid-in capital.

 

For tax purposes, at January 31, 2009, the fund had $5,877,000 of ordinary income available for distribution. Tax-basis capital gains required to be distributed in December 2008 included net capital gains realized through October 31, 2008. Subsequently, the fund realized capital losses of $166,517,000, which are available to offset future net capital gains.

 

At January 31, 2009, the cost of investment securities for tax purposes was $6,425,779,000. Net unrealized appreciation of investment securities for tax purposes was $929,788,000, consisting of unrealized gains of $1,958,475,000 on securities that had risen in value since their purchase and $1,028,687,000 in unrealized losses on securities that had fallen in value since their purchase.

 

At January 31, 2009, the aggregate settlement value of open futures contracts expiring in March 2009 and the related unrealized appreciation (depreciation) were:

 

 

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

 

E. During the year ended January 31, 2009, the fund purchased $2,485,299,000 of investment securities and sold $2,903,035,000 of investment securities other than temporary cash investments.

 

24

Energy Fund

 

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

 

 

G. In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157 (“FAS 157”), “Fair Value Measurements.” FAS 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements in financial statements, effective for the fund’s current fiscal period.

 

The various inputs that may be used to determine the value of the fund’s investments are summarized in three broad levels. The inputs or methodologies used for valuing 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 fund’s investments as of January 31, 2009, based on the inputs used to value them:

 

 

 

1 Net of redemption fees of $5,850,000 and $3,474,000 (fund totals).

 

 

25

Report of Independent Registered Public Accounting Firm

 

To the Trustees of Vanguard Specialized Funds and the Shareholders of Vanguard Energy 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 Energy Fund (constituting a separate portfolio of Vanguard Specialized Funds, hereafter referred to as the “Fund”) at January 31, 2009, 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 January 31, 2009 by correspondence with the custodians and brokers, and by agreement to the underlying ownership records for Vanguard Market Liquidity Fund, provide a reasonable basis for our opinion.

 

 

PricewaterhouseCoopers LLP

Philadelphia, Pennsylvania

 

March 20, 2009

 

 

 

 

This information for the fiscal year ended January 31, 2009, is included pursuant to provisions of the Internal Revenue Code.

 

The fund distributed $481,524,000 as capital gain dividends (from net long-term capital gains) to shareholders during the fiscal year.

 

The fund distributed $172,326,000 of qualified dividend income to shareholders during the fiscal year.

 

For corporate shareholders, 33.2% 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 2009. (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.

 

 

 

 

 

1 Total returns do not reflect the 1% fee assessed on redemptions of shares held less than one year, nor do they include the account service fee that may be applicable to certain accounts with balances below $10,000.

 

 

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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.

 

 

 

 

1 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 0.33% for Investor Shares and 0.26% 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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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 the 1% fee on redemptions of shares held for less than one year, nor do they include the account service fee described in the 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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Glossary

 

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.

 

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. The percentage of a fund’s average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors.

 

Foreign Holdings. The percentage of a fund represented by stocks 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.

 

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.

 

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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.

 

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 (in the case of bonds) 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.

 

 

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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 156 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 www.vanguard.com.

 

 

 

 

 

1 These individuals are “interested persons” as defined in the Investment Company Act of 1940.

2 December 2002 for Vanguard Equity Income Fund, Vanguard Growth Equity Fund, the Vanguard Municipal Bond Funds, and the Vanguard State Tax-Exempt Funds.

 

 

Connect with Vanguard^® > www.vanguard.com