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

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT
OF
REGISTERED MANAGEMENT INVESTMENT COMPANIES

Investment Company Act file number: 811-03916

Name of Registrant: Vanguard Specialized Funds

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

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

Date of fiscal year end: January 31

Date of reporting period: February 1, 2012 – July 31, 2012

Item 1: Reports to Shareholders

 

 

 

 

> Vanguard Energy Fund returned about –6% for the six months ended July 31, 2012.

> The fund’s return trailed that of its benchmark index but surpassed the average return of its peer funds.

> The energy sector underperformed the broad U.S. stock market. Weakness among integrated oil and gas companies and those involved in exploration and production weighed most on the fund’s performance.

 

 

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: Vanguard was named for the HMS Vanguard, flagship of British Admiral Horatio Nelson. A ship—whose performance and safety depend on the work of all hands—has served as a fitting metaphor for the Vanguard crew as we strive to help clients reach their financial goals.

 

Your Fund’s Total Returns

Global Natural Resources Funds Average: Derived from data provided by Lipper Inc.

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,

Vanguard Energy Fund returned about –6% for the fiscal half-year ended July 31, 2012. The fund’s return lagged that of its benchmark index but was well ahead of the average return of global natural resources funds, which invest in energy as well as materials stocks.

The fund’s disappointing results for the six months can be attributed to a combination of factors, including the sharp decline in crude oil prices since March, historically low natural gas prices, and continued uncertainties about global economic growth. Disappointing stock choices, particularly among South American oil companies, kept the fund a step behind its benchmark.

The energy sector as a whole has been one of the market’s weakest performers for the period, as investors have grown increasingly concerned about lessening global demand for oil and its potential effect on the sector’s profitability.

On a separate note, I want to inform you that Vanguard has eliminated the redemption fee for your fund, effective May 23. The fund’s trustees determined that the fee, one of several measures in place to discourage frequent trading and protect the interests of long-term investors, was no longer needed.

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U.S. stocks delivered solid gains; international equities slumped
U.S. stocks handily outperformed their international counterparts, returning about 5% for the six months ended July 31. Stocks of large companies fared best as investors seemed to be seeking stability amid the uncertainty surrounding Europe’s debt troubles.

International stocks were generally weak, with currency effects further hindering results for U.S.-based investors. Though European stocks posted a modest advance in local-currency terms, their return was negative once converted into U.S. dollars—a result of the dollar’s strengthening against the euro during the six months. Signs of slowing economic growth hurt returns for emerging markets and the developed markets of the Pacific region.

Questions about the finances of European governments and banks continued to preoccupy investors, and global stock markets moved sharply up and down in response to the latest headlines. Although the situation in Europe is very fluid, Vanguard economists believe the most likely scenario is that the Eurozone will “muddle through” for several years, with occasional spikes in market volatility, as fiscal tightening continues in the face of weak economic growth.

 

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Bonds kept up a steady advance as Treasury yields kept dwindling
U.S. Treasury securities stretched their gains during the period as investors lost more of their appetite for risk. Bond prices moved higher, and the yield of the 10-year U.S. Treasury note fell to a record low in July, closing below 1.5%. (Bond yields and prices move in opposite directions.) The broad U.S. taxable bond market posted a return of nearly 3%, and municipal bonds had about the same result for the six months.

Investors have enjoyed years of strong bond returns, but they shouldn’t be surprised if future results are weaker. As yields tumble, the scope for further declines—and price increases—diminishes.

As it has since December 2008, the Federal Reserve Board held its target for the shortest-term interest rates between 0% and 0.25%, keeping a tight lid on the returns from money market funds and savings accounts.

Oil and natural gas price declines dampened the fund’s results
The Energy Fund’s six-month performance was influenced by the weakness in the global economy, particularly in Europe, which accounts for about 20% of the global consumption of crude oil. A slowdown in growth in China and a dimmer outlook for the U.S. economic recovery also discouraged investors early on, contributing to a slump in energy prices and energy stocks.

The fund expense ratios shown are from the prospectus dated May 29, 2012, and represent estimated costs for the current fiscal year. For the six months ended July 31, 2012, the fund’s annualized expense ratios were 0.30% for Investor Shares and 0.24% for Admiral Shares. The peer-group expense ratio is derived from data provided by Lipper Inc. and captures information through year-end 2011.

Peer group: Global Natural Resources Funds.

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The price of West Texas Intermediate crude oil, which peaked at $106 a barrel in March, plunged nearly 22% in June. Meanwhile, natural gas prices stayed near

decade lows as increased production (partly as a result of improvements in drilling technology) and an unusually warm winter kept prices depressed.

 

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Oil and natural gas prices greatly influence the profitability of the companies in which the Energy Fund invests. And few, if any, of the fund’s largest holdings remained unscathed by the price declines.

However, a slight rebound in both oil and gas prices in July lifted some energy stocks. Better news about economic growth in China and the United States, together with the prospect of tighter crude oil supplies owing to tensions in the Persian Gulf, helped push up oil prices. Some utilities switched to natural gas and demand rose as the hot U.S. summer led more people to turn on air conditioners. Although helpful, these movements weren’t enough to significantly lift the performance of energy stocks for the six-month period.

Still, certain segments of the Energy Fund did better than others. Refining and marketing companies, a relatively small proportion of the fund’s holdings, did best. These companies beefed up their profit margins as they were able to buy oil at bargain prices and then sell it to some consumers at higher prices.

The story was very different for integrated oil and gas companies. Composing the Energy Fund’s largest chunk of assets— about 46%, on average—these giant integrated companies detracted most from the fund’s performance. The weakest results came from some of the largest oil producers in South America, which suffered double-digit losses. Local currency depreciation pushed up equipment and service costs for a Brazilian oil giant, and Argentina’s government moved to nationalize its largest oil company.

Oil and gas exploration and production companies, the fund’s second-largest segment by asset size, also did poorly. Lackluster oil and gas prices led many of these companies to curtail their activities.

The Advisors’ Report that follows this letter provides additional details about the management of the fund during the fiscal half-year.

The role sector funds can play in a balanced, diversified portfolio
One of Vanguard’s guiding principles is that balance and broad diversification can help investors manage the risks inherent in investing. And when used thoughtfully, sector funds can enhance the diversification of a portfolio that lacks exposure to a certain part of the market or is overly concentrated in a few market segments.

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These funds can also give investors the opportunity to act on a conviction that a particular sector will outperform the broader market. We recognize that this is a popular use of sector funds, but it’s one we’d urge investors to be cautious about. Our research and our experience suggest that it is difficult to profit consistently from such convictions. The top-returning sector can change at any moment, which is why chasing short-term performance often leads to disappointment.

Although we acknowledge the challenges and risks of sector investing, Vanguard has designed its funds—whether they’re actively managed or index-tracking—to help give investors a better chance of reaching their goals. The deep investment knowledge of the funds’ advisors is an asset no matter what the market environment. And the same can be said for the funds’ low costs.

For those reasons, we believe the Energy Fund can play a role in a well-diversified portfolio for investors who can tolerate the highs and lows that inevitably accompany such a narrowly focused holding.

Thank you for entrusting your assets to Vanguard.

Sincerely,

F. William McNabb III
Chairman and Chief Executive Officer
August 13, 2012

 

Advisors’ Report

Vanguard Energy Fund returned –6.05% for Investor Shares and –6.03% for Admiral Shares in the six months ended July 31, 2012. Your fund is managed by two advisors, a strategy that enhances the fund’s diversification by providing exposure to distinct yet complementary investment approaches. It’s not uncommon for different advisors to have different views about individual securities or the broader investment environment.

The advisors, the amount and percentage of fund assets each manages, and brief descriptions of their investment strategies are presented in the table below. The advisors have also 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 August 16, 2012.

 

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Wellington Management Company, llp

Portfolio Manager:
Karl E. Bandtel, Senior Vice President

The investment environment
Energy stocks posted negative returns over the past six months, underperforming broad-market equity indexes in most regions of the world as investors turned to less economically sensitive market sectors.

Commodity prices were mixed. On one hand, the price of West Texas Intermediate crude oil fell approximately $10, closing the period near $88 per barrel. On the other hand, after a prolonged period of declining prices, North American natural gas began climbing above its historically depressed levels. The Henry Hub Spot price of U.S. natural gas finished the period at nearly $3 per million BTUs, up by roughly one half-dollar.

Our successes
Our position in Canada-based Progress Energy Resources was the portfolio’s top contributor for the period. This mid-capitalization company engages in natural gas exploration and production. Its stock surged in late June following news that the Malaysian state oil and gas company Petronas had agreed to acquire all outstanding shares at a significant premium.

The portfolio’s holdings in Cabot Oil & Gas, a natural gas-focused energy producer, also boosted performance. Cabot shares gained following an announcement that the company had sold its position in southern Texas’s Pearsall Shale to Osaka Gas of Japan at a higher-than-expected price. Cabot is a low-cost producer with a strong balance sheet. We believe the company should benefit from reduced natural gas production and, ultimately, higher prices.

Our shortfalls
YPF explores for, develops, and produces oil and natural gas in South America, the United States, and Indonesia. It also refines, markets, transports, and distributes oil and other petroleum products, petroleum derivatives, petrochemicals, and liquid petroleum gas. The Argentina-based company was our biggest detractor during the period. Shares fell when the Argentine government took over day-to-day control of the firm by decree in an effort to protect the country’s hydrocarbon resources.

The listed YPF shares are not subject to nationalization and are trading as before. We continue to hold the stock. Because the government owns a 51% majority stake, the remaining minority shareholders are now the government’s partners. YPF has an attractive asset profile at a very low valuation relative to the rest of the energy universe because of investor concerns that the Argentine government will not treat minority owners well.

CONSOL Energy, a coal and natural gas producer and energy services provider, also saw its stock price decline during the period, based on a deteriorating near-term outlook for coal. We were able to take advantage of this weakness and increase our position at attractive valuations.

The company has sustainable sources

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of profitability and solid production capability. In our view, the market is underestimating the long-term value of CONSOL’s undeveloped natural gas assets. We expect the company will adapt to the price environment and continue to increase its earnings.

The fund’s positioning
We are staying the course with our strategy and portfolio positioning. Our outlook, patient and oriented toward the long term, remains favorable for the energy sector. However, as always, we remind shareholders of the uncertainty concerning the direction of commodity prices, which can make the stocks of energy companies especially volatile.

Crude oil prices will likely continue to vary with changes in the outlook for both supply and demand. Although natural gas pricing remains driven by regional factors, we think the wide price arbitrage with other fuels and changing views about nuclear power generation will spur global long-term demand.

The portfolio remains focused on upstream companies and skewed in favor of low-cost producers with compelling valuations based on our assessment of their long-term resource bases. In our view, many of these firms have the ability to create value for shareholders even absent rising commodity prices.

Our investment process remains steady, with an emphasis on large-cap integrated oil companies and exploration and production companies. Maintaining a large-cap, low-turnover bias, our global holdings span the energy sub-sectors.

Vanguard Equity Investment Group

Portfolio Manager:
James D. Troyer, CFA, Principal

For the first half of the fiscal year, the stocks in our benchmark energy index returned –5.51%, trailing the broad U.S. stock market by 10.5 percentage points. Although energy stocks in emerging markets had exhibited a strong six-month performance by this time last year, they were a mixed bag in the recent period. Energy stocks in Colombia, Malaysia, and Turkey had the strongest results, and those in Spain, Brazil, and Indonesia the weakest. The worst-performing country in the energy sector was Spain, where Argentina’s decision to expropriate most of Repsol’s holdings in its YPF subsidiary detracted most.

Broadly, concerns over Europe and signs of slowing economic growth in the United States and emerging markets affected performance and contributed to market volatility. Looking ahead to the rest of the year, brighter spots include low inflation and interest rates and signs of improvement in the housing sector. However, lingering uncertainty about Europe, expiring domestic tax cuts, a stubborn unemployment rate, and the results of the upcoming U.S. presidential election could continue to weigh on the markets.

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While the portfolio’s performance is influenced by the broader macro environment, we do not maintain a view on the overall market for energy securities or on relative country performance. Rather, our quantitative approach to investing focuses on specific stock fundamentals within the sector. Our core signals include valuation, which measures the price we pay for earnings and cash flows, and market sentiment, which captures how investors reflect their opinion of a company through their activity in the market. During the past six months, both of these signals aided our results.

In this period, our best performers came from various regions. Overweight positions in outperforming securities such as Caltex Australia (+17.8%), Seadrill (Norway, +10.7%), and HollyFrontier (United States, +32.5%) boosted our results compared with the benchmark index. Underweight positions in securities that did poorly, such as OGX (Brazil, –70.9%), Canadian Natural Resources (–30.6%), and Repsol (Spain, –39.7%), also helped our relative return.

Unfortunately, we were not able to avoid all the laggards. Overweight positions in securities that underperformed the benchmark, such as Gazprom (Russia, –18.9%), China Coal Energy (–24.9%), Continental Resources (United States, –32.6%), and Anadarko Petroleum (United States, –13.8%), detracted from our relative results.

We thank you for your investment in the Energy Fund and look forward to the second half of the fiscal year.

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Energy Fund

Fund Profile
As of July 31, 2012

 

 

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.

1 The expense ratios shown are from the prospectus dated May 29, 2012, and represent estimated costs for the current fiscal year. For the six months ended July 31, 2012, the annualized expense ratios were 0.30% for Investor Shares and 0.24% for Admiral Shares.

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Energy Fund

 

 

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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 vanguard.com/performance.) Note, too, that both investment returns and principal value can fluctuate widely, so an investor’s shares, when sold, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the sale of fund shares.

Fiscal-Year Total Returns (%): January 31, 2002, Through July 31, 2012

Average Annual Total Returns: Periods Ended June 30, 2012
This table presents returns through the latest calendar quarter—rather than through the end of the fiscal period.
Securities and Exchange Commission rules require that we provide this information.

 

See Financial Highlights for dividend and capital gains information.

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Energy Fund

Financial Statements (unaudited)

Statement of Net Assets
As of July 31, 2012

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).

 

 

15

 

Energy Fund

 

 

16

 

Energy Fund

 

 

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Energy Fund

 

See Note A in Notes to Financial Statements.
* Non-income-producing security.
^ Part of security position is on loan to broker-dealers. The total value of securities on loan is $34,489,000.
1The 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 97.8% and 2.6%, 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 July 31, 2012, the value of this security represented 0.3% of net assets.
4 Considered an affiliated company of the fund as the fund owns more than 5% of the outstanding voting securities of such company.
5 Affiliated money market fund available only to Vanguard funds and certain trusts and accounts managed by Vanguard. Rate shown is the 7-day yield.
6 Includes $36,769,000 of collateral received for securities on loan.
7 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 in exchange for senior preferred stock.
8 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.
9 Securities with a value of $2,102,000 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.

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Energy Fund

1 Dividends are net of foreign withholding taxes of $11,155,000.
2 Dividend income, interest income, and realized net gain (loss) from affiliated companies of the fund were $541,000, $87,000, and ($3,153,000), respectively.

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

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Energy Fund

1 Includes fiscal 2013 and 2012 short-term gain distributions totaling $0 and $54,868,000, 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 $114,746,000 and ($25,183,000).

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

20

 

Energy Fund

Financial Highlights

The expense ratio, net income ratio, and turnover rate for the current period have been annualized.
1 Calculated based on average shares outstanding.
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 (0.04%) for fiscal 2013, 0.01% for fiscal 2012, 0.00% for fiscal 2011, 0.03% for fiscal 2010, and 0.01% for fiscal 2009.

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

21

 

Energy Fund

Financial Highlights

The expense ratio, net income ratio, and turnover rate for the current period have been annualized.
1 Calculated based on average shares outstanding.
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 (0.04%) for fiscal 2013, 0.01% for fiscal 2012, 0.00% for fiscal 2011, 0.03% for fiscal 2010, and 0.01% for fiscal 2009.

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

22

 

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 invests in securities of foreign issuers, which may subject it to investment risks not normally associated with investing in securities of U.S. 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, 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 at 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).

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Energy Fund

4. Repurchase Agreements: The fund may enter into 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. In the event of default or bankruptcy by the other party to the agreement, the fund may sell or retain the collateral; however, such action 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 for all open federal income tax years (January 31, 2009–2012), and for the period ended July 31, 2012, 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 fees charged to borrowers plus 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 for the preceding three years 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 through July 31, 2010, and the current benchmark, MSCI ACWI Energy Index, thereafter. The benchmark change will be fully phased in by July 2013.

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 $157,000 for the six months ended July 31, 2012.

For the six months ended July 31, 2012, the aggregate investment advisory fee represented an effective annual basic rate of 0.14% of the fund’s average net assets, before a decrease of $2,343,000 (0.04%) 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 July 31, 2012, the fund had contributed capital of $1,688,000 to Vanguard (included in Other Assets), representing 0.01% of the fund’s net assets and 0.68% of Vanguard’s capitalization. The fund’s trustees and officers are also directors and officers of Vanguard.

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Energy Fund

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 six months ended July 31, 2012, these arrangements reduced the fund’s expenses by $77,000 (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 July 31, 2012, based on the inputs used to value them:

 

F. At July 31, 2012, the aggregate settlement value of open futures contracts and the related unrealized appreciation (depreciation) were:

 

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

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Energy Fund

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. The fund’s tax-basis capital gains and losses are determined only at the end of each fiscal year.

During the six months ended July 31, 2012, the fund realized net foreign currency losses of $449,000, which decreased distributable net income for tax purposes; accordingly, such losses have been reclassified from accumulated net realized losses to undistributed net investment income. Certain of the fund’s investments are in securities considered to be “passive foreign investment companies,” for which any unrealized appreciation and/or realized gains are required to be included in distributable net income for tax purposes. During the six months ended July 31, 2012, the fund realized gains on the sale of passive foreign investment companies of $2,698,000, which have been included in current and prior periods’ taxable income; accordingly, such gains have been reclassified from accumulated net realized losses to undistributed net investment income. Passive foreign investment companies held at July 31, 2012, had unrealized appreciation of $12,860,000 as of January 31, 2012, the most recent mark-to-market date for tax purposes. This amount has been distributed and is reflected in the balance of undistributed net investment income.

At July 31, 2012, the cost of investment securities for tax purposes was $8,649,844,000. Net unrealized appreciation of investment securities for tax purposes was $3,137,329,000, consisting of unrealized gains of $3,697,478,000 on securities that had risen in value since their purchase and $560,149,000 in unrealized losses on securities that had fallen in value since their purchase.

H. During the six months ended July 31, 2012, the fund purchased $1,336,020,000 of investment securities and sold $1,192,835,000 of investment securities, other than temporary cash investments.

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

 

1 Net of redemption fees for fiscal 2013 and 2012 of $642,000 and $2,001,100, respectively (fund totals). Effective May 23, 2012, the redemption fee was eliminated.

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Energy Fund

J. The fund has invested in a company that is considered to be an affiliated company of the fund because the fund owns more than 5% of the outstanding voting securities of the company. Transactions during the period in securities of this company were as follows:

 

K. In preparing the financial statements as of July 31, 2012, management considered the impact of subsequent events for potential recognition or disclosure in these financial statements.

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About Your Fund’s Expenses

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

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

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

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

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

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

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

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

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

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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 0.30% for Investor Shares and 0.24% 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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Trustees Approve Advisory Arrangements

The board of trustees of Vanguard Energy Fund has renewed the fund’s investment advisory arrangements with The Vanguard Group, Inc., through its Equity Investment Group, and Wellington Management Company, LLP. The board determined that the retention of the fund’s advisors was in the best interests of the fund and its shareholders.

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

Nature, extent, and quality of services
The board considered the quality of the fund’s investment management over both the short and long term, and took into account the organizational depth and stability of each advisor. The board noted the following:

Wellington Management Company, LLP. Founded in 1928, Wellington Management is among the nation’s oldest and most respected institutional investment managers. The investment team uses a bottom-up approach in which stocks are selected based on the advisor’s estimates of fundamental investment value. The investment team includes experienced industry analysts who identify companies that offer significant potential for capital appreciation and possess high-quality earnings sustainable through cyclical market fluctuations. The advisor’s investment process emphasizes company fundamentals, management track record, and security valuation. The firm has advised the fund since the fund’s inception in 1984.

The Vanguard Group, Inc. Vanguard has been managing investments for more than three decades. The Equity Investment Group adheres to a sound, disciplined investment management process; the team has considerable experience, stability, and depth. Vanguard has managed a portion of the fund since 2005.

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

Investment performance
The board considered the short- and long-term performance of the fund, including any periods of outperformance or underperformance of a relevant benchmark and peer group. The board concluded that each advisor has carried out its investment strategy in disciplined fashion, and that performance results have been in line with expectations. Information about the fund’s most recent performance can be found in the Performance Summary section of this report.

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Cost
The board concluded that the fund’s expense ratio was well below the average expense ratio charged

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

The board did not consider profitability of Wellington Management in determining whether to approve the advisory fee, because Wellington Management is independent of Vanguard, and the advisory fee is the result of arm’s-length negotiations. The board does not conduct a profitability analysis of Vanguard, because of Vanguard’s unique “at-cost” structure. Unlike most other mutual fund management companies, Vanguard is owned by the funds it oversees, and produces “profits” only in the form of reduced expenses for fund shareholders.

The benefit of economies of scale
The board concluded that the fund’s shareholders benefit from economies of scale because of

breakpoints in the fund’s advisory fee schedule for Wellington Management. The breakpoints reduce the effective rate of the fee as the fund’s assets managed by Wellington Management increase. The board also concluded that the fund’s low-cost arrangement with Vanguard ensures that the fund will realize economies of scale as it grows, with the cost to shareholders declining as the fund’s assets managed by Vanguard increase.

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

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Glossary

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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The People Who Govern Your Fund

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

A majority of Vanguard’s board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. The independent board members have distinguished backgrounds in business, academia, and public service. Each of the trustees and executive officers oversees 179 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.

 

 

 

Connect with Vanguard® > vanguard.com

 

 

 

 

 

> Vanguard Precious Metals and Mining Fund returned –29.63% as the prices for gold-related and other mining-related equities retreated.

> The fund lagged its comparative benchmarks, largely because of its heavy weightings in a handful of weak performers.

> The fund’s recent retreat is consistent with the pattern of sharp ups and downs in the metals and mining sector.

 

 

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: Vanguard was named for the HMS Vanguard, flagship of British Admiral Horatio Nelson. A ship—whose performance and safety depend on the work of all hands—has served as a fitting metaphor for the Vanguard crew as we strive to help clients reach their financial goals.

 

Your Fund’s Total Returns

 

 

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Chairman’s Letter

Dear Shareholder,

Precious metals and mining stocks tumbled in the six months ended July 31, 2012, reflecting signs of economic weakness across developed and developing markets and investors‘ reduced fervor for gold. Vanguard Precious Metals and Mining Fund returned –29.63%. The fund’s return trailed the similarly weak return of its benchmark and the average return of its peer group.

Please note that Vanguard eliminated the redemption fee for your fund, effective May 23. This 1% fee, which applied to shares redeemed within one year of purchase, was one of several measures in place to protect the interests of long-term investors and discourage frequent trading. The fund’s trustees determined that the fee was no longer needed.

U.S. stocks delivered solid gains; international equities slumped
U.S. stocks outperformed their international counterparts handily, returning about 5% for the six months ended July 31. Stocks of large companies fared best as investors seemed to be seeking stability amid the uncertainty surrounding Europe’s debt troubles.

International stocks were generally weak, with currency effects further hindering results for U.S.-based investors. Though European stocks posted a modest advance in local-currency terms, their return was negative once converted into U.S. dollars—a result of the dollar’s strengthening

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against the euro during the six months. Signs of slowing economic growth hurt returns for emerging markets and the developed markets of the Pacific region.

Questions about the finances of European governments and banks continued to preoccupy investors, and global stock markets moved sharply up and down in response to the latest headlines. Although the situation in Europe is very fluid, Vanguard economists believe the most likely scenario is that the Eurozone will “muddle through” for several years, with occasional spikes in market volatility, as fiscal tightening continues in the face of weak economic growth.

Bonds kept up a steady advance as Treasury yields kept dwindling
U.S. Treasury securities stretched their gains during the period, as investors lost more of their appetite for risk. Bond prices moved higher, and the yield of the 10-year U.S. Treasury note fell to a record low in July, closing below 1.5%. (Bond yields and prices move in opposite directions.) The broad U.S. taxable bond market posted a return of nearly 3%, and municipal bonds had about the same result for the six months.

Investors have enjoyed several years of strong bond returns, but they shouldn’t be surprised if future results are weaker. As yields tumble, the scope for further declines—and price increases—diminishes.

 

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