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

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT
OF
REGISTERED MANAGEMENT INVESTMENT COMPANIES

 

Annual Report | January 31, 2017

Vanguard Energy Fund

 

A new format, unwavering commitment

As you begin reading this report, you’ll notice that we’ve made some improvements to the opening sections—based on feedback from you, our clients.

Page 1 starts with a new ”Your Fund’s Performance at a Glance,” a concise, handy summary of how your fund performed during the period.

In the renamed ”Chairman’s Perspective,” Bill McNabb will focus on enduring principles and investment insights.

We’ve modified some tables, and eliminated some redundancy, but we haven’t removed any information.

At Vanguard, we’re always looking for better ways to communicate and to help you make sound investment decisions. Thank you for entrusting your assets to us.

 

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: No matter what language you speak, Vanguard has one consistent message and set of principles. Our primary
focus is on you, our clients. We conduct our business with integrity as a faithful steward of your assets. This message is shown
translated into seven languages, reflecting our expanding global presence.

 

Your Fund’s Performance at a Glance

• For the year ended January 31, 2017, Vanguard Energy Fund returned nearly 33%, ahead of its benchmark index and the average return of global natural resources funds.

• Energy stocks generally posted strong results during the second half of the year as oil prices recovered after historic lows. A strengthening global economy and efforts by oil-producing nations to limit production aided the turnaround.

• Natural gas prices tumbled about 18% in January because of a global supply glut.

The uncertain price environment did not dampen production, as natural gas continues to supplant coal for energy production.

• The fund benefited from strong stock selection and overweight positions among oil and gas drillers as well as exploration and production companies. An underweight position in oil and gas storage and transportation companies detracted.

• For the ten years ended January 31, the fund’s average annual return exceeded those of its benchmark and peer funds.

 

 

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

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The fund expense ratios shown are from the prospectus dated May 25, 2016, and represent estimated costs for the current fiscal year. For the
fiscal year ended January 31, 2017, the fund’s expense ratios were 0.41% for Investor Shares and 0.33% for Admiral Shares. The peer-group
expense ratio is derived from data provided by Lipper, a Thomson Reuters Company, and captures information through year-end 2016.

Peer group: Global Natural Resources Funds.

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Chairman’s Perspective

Bill McNabb
Chairman and Chief Executive Officer

Dear Shareholder,

As investors, we’re accustomed to hearing about risk. There’s market risk, inflation risk, currency risk, and so on. No form of risk, though, challenges investors quite the way uncertainty can. In my experience, how well we respond to uncertainty can be a key to long-term investing success.

Of course, we never have the luxury of complete clarity when investing—none of us has a crystal ball, after all—but the current environment seems to have more than its fair share of uncertainty.

There are plenty of question marks surrounding the economy as a new administration rolls out its policies, the Federal Reserve shifts its thinking, and global growth, especially in China, continues to worry market watchers. A general feeling of unsettledness is reflected in many questions I’ve been getting from clients in recent months.

Confronting the challenge of the unknowable

First, a bit about the difference between risk and uncertainty. Risk can be measured, albeit not with 100% accuracy. An investor armed with the right data can calculate a reasonable probability of, say, a given company missing earnings expectations.

Uncertainty can’t be quantified that easily. There are “black swan” events that fall completely outside the realm of the expected. The data needed to make sense of such an event are either not known or unknowable.

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In times of uncertainty, it’s easy for investors to make bad decisions. Markets often respond to surprise events with volatility. We had plenty of those in 2016, and I expect similar market-rattling events to occur this year. Some investors may interpret volatility as a sign of trouble and flee to whatever they perceive as a safe haven. Others may see buying opportunities at every turn. Both are likely to fall prey to common investor biases, like these:

• Focusing on just the information that confirms our decisions.

• Buying into the mistaken belief that past performance indicates future results.

• Sticking to the familiar at the cost of smart diversification.

The problem with these natural inclinations is that they can make us forget about our long-term investment plan. That’s never a good thing.

Help yourself avoid unforced errors

Sound investing was ingrained in me from an early age. My mother and father did a good job of saving for retirement by building a diversified portfolio. They recognized that diversification is the most logical response to a future that is, inevitably, uncertain. But my family, just like yours, can succumb to common biases.

During the 1990s tech boom, my mom, who has always paid close attention to the markets, wanted to invest in some of the high-flying stocks of the moment. She had

 

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read about them and heard about them on TV, which confirmed her thinking that they were good buys. Years later, she wanted to sell some holdings when stocks were at their low point during the financial crisis, just before the stock market rebounded. Those were scary times, and she was just trying to protect the nest egg she had so diligently built up over all those years. I’m happy to say she rethought both decisions.

None of us, of course, is immune from mistakes. I can fall into traps as well, so I’ve tried to develop habits that help me counter the biases that affect most of us as investors. These habits don’t require great investment acumen.

For example, I try to remove emotion from the investing equation. At the end of every year, I look at my retirement account and determine if I need to rebalance. Rarely, though, do I spend time trying to figure out why a certain fund over- or under-performed. I don’t want to be tempted by market noise.

Another way to cope with uncertainty: Save more. Just as we can’t know for sure where the markets are headed, we can’t predict when we might have to contend with a health or career setback. Putting away something extra isn’t easy, but it can give us the flexibility to make the most of bad situations.

The one thing we can be sure of

In investing, there is always going to be uncertainty—and a little pain. It’s difficult to continue to dollar-cost average into a tumbling market. Likewise, short-term noise can tempt us to not rebalance on a regular basis. Disciplined rebalancing is vital to achieving long-term goals. To paraphrase legendary investor John Neff, the best time to invest can be when your stomach is churning most.

Because my portfolio is fully diversified, it always contains something that under-performs expectations. There almost always are surprises on the upside, too. This is the power of diversification and a secret to investment success.

Sincerely,

F. William McNabb III
Chairman and Chief Executive Officer
February 14, 2017

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Advisors’ Report

Vanguard Energy Fund returned 32.73% for Investor Shares and 32.83% for Admiral Shares for the 12 months ended January 31, 2017, ahead of its benchmark index and the average return of global natural resources peer funds. Your fund is managed by two advisors, a strategy that enhances fund 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 also have 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 10, 2017.

Wellington Management Company llp

Portfolio Manager:

Gregory LeBlanc, CFA,
Senior Managing Director,
Global Industry Analyst

The investment environment

U.S. and global oil prices experienced bouts of volatility during the fiscal year, with West Texas Intermediate crude oil ending January at $53 per barrel. The fund’s benchmark, the MSCI All Country

 

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World Energy Index, returned 28.5%, outpacing global equities, as measured by the MSCI All Country World Index, which returned 18.6%.

The oil market has been rebalancing—albeit slowly—and demand remains robust. For much of the year, inventory levels in the United States remained above the five-year average. We continued to see U.S. production decline as a result of massive capital retrenchment in 2015 and 2016. At the November 30 OPEC meeting, member and nonmember countries agreed to cut production. Looking ahead, the focus will remain on inventory levels and whether countries will follow through with the reductions.

Our successes

Security selection drove relative results during the period. Our ability to capture opportunities stemming from the increasing quality dispersion in upstream assets continues to be an important source of returns. This was evidenced by our overweight exposure to Pioneer Natural Resources and Energen, which were among the top contributors to relative outperformance. We trimmed both positions on strength.

Our underweight exposure to benchmark constituent Exxon Mobil also was beneficial. We believe that the company will be challenged to increase production over the next few years, especially in a range-bound price environment.

Our shortfalls

We continue to focus the portfolio’s natural gas exposure on low-cost, high-quality assets in the lowest-cost basins, such as Antero Resources, EQT, and Cabot Oil & Gas. Unfortunately, these positions were among the portfolio’s top relative detractors during the period.

During the first quarter of 2016, natural gas prices collapsed on the back of unseasonably weak demand due to a strong El Niño, resilient Northeast production, and high inventory levels. This weighed on the share price of our natural gas-related holdings. Fundamentals have also been improving with lower associated gas production, Marcellus pipeline delays, and strong power demand. We remain constructive on the outlook for the names we hold, given their attractive cost structures.

The fund’s positioning

The portfolio’s overweight allocation to exploration and production focuses on the most cost-efficient North American shale companies. Not only can these businesses survive in an environment where oil prices are less than $60 per barrel, they can grow—and they stand to benefit even more if prices increase. We believe that the market continues to underestimate the productivity gains that the most innovative exploration and production companies can make, and we hope to take advantage of that in 2017.

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Vanguard Quantitative Equity Group

Portfolio Managers:

James P. Stetler, Principal

Michael R. Roach, CFA

Binbin Guo, Principal, Head of Equity
Research and Portfolio Strategies

Global energy markets enjoyed strong results over the fiscal year as the MSCI All Country World Energy Index returned more than 28%, easily beating the 19% return of global equities as measured by the MSCI All Country World Index.

The investment environment

Although the past 12 months have been turbulent for the energy sector, oil company fundamentals improved, helping to stabilize prices over the latter half of the year. Crude oil prices recovered from historic lows as OPEC, Russia, and other oil-producing nations coordinated to limit production following a massive buildup of inventories and production capacity. Many companies that had reduced capital spending and idled rigs to adapt to the lower price environment began increasing operational rig counts during the summer.

Natural gas prices fell at times in response to low oil prices at the beginning of 2016 and a global supply glut. But natural gas companies made less significant efforts to limit production as liquefied natural gas exports increased in response to growing demand in Mexico and overseas.

Investment objective and strategy

Although it’s important to understand how our overall performance is affected by the macro factors we’ve described, our approach to investing focuses on specific fundamentals—not on technical analysis of stock price movements. We compare all stocks in our investment universe within the same industry groups in order to identify those with characteristics that we believe will outperform over the long run.

To do this, we use a strict quantitative process that systematically focuses on several key fundamental factors. We believe that attractive stocks exhibit four key themes: (1) high quality—healthy balance sheets and consistent cash-flow generation; (2) effective use of capital—sound investment policies that favor internal over external funding; (3) strong market sentiment—market confirmation of our view; and (4) reasonable valuation—avoidance of overpriced stocks. Using these results, we construct our portfolio with the goal of maximizing expected return and minimizing exposure to risks that our research indicates do not improve returns.

Our successes and shortfalls

For the 12 months, the results from our combined model were positive. Our valuation and management decisions models contributed significantly, while our sentiment model and, to a much lesser extent, our quality model, hurt relative performance.

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Our positions in sub-industries further upstream in the production process (oil and gas drilling, oil and gas exploration and production, and oil and gas equipment and services) posted the strongest results and drove performance.

We also benefited from overweight positions in several U.S. drilling companies and in international oil service companies. Security selection among integrated energy companies also aided performance.

An underweight position in oil and gas storage and transportation companies detracted. And our overweight allocation to refiners based on attractive valuations hurt performance, as many of these companies tend to lag when oil prices rise.

Our most successful overweight holdings included Seadrill, Worleyparsons, Subsea 7, Idemitsu Kosan, and Hindustan Petroleum. Our results were dragged down by underweighting Valero Energy, Marathon Petroleum, Anadarko Petroleum, and Halliburton.

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Energy Fund

Fund Profile
As of January 31, 2017

 

 

 

 

1 The expense ratios shown are from the prospectus dated May 25, 2016, and represent estimated costs for the current fiscal year. For the fiscal
year ended January 31, 2017, the expense ratios were 0.41% for Investor Shares and 0.33% 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.

Cumulative Performance: January 31, 2007, Through January 31, 2017
Initial Investment of $10,000

 

 

See Financial Highlights for dividend and capital gains information.

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Energy Fund

Fiscal-Year Total Returns (%): January 31, 2007, Through January 31, 2017

For a benchmark description, see the Glossary.

Average Annual Total Returns: Periods Ended December 31, 2016
This table presents returns through the latest calendar quarter—rather than through the end of the fiscal period.
Securities and Exchange Commission rules require that we provide this information.

 

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Energy Fund

Financial Statements

Statement of Net Assets
As of January 31, 2017

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).

 

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Energy Fund

 

 

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Energy Fund

 

 

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Energy Fund

 

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Energy Fund

 

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Energy Fund

Statement of Operations

 

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

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Energy Fund

Statement of Changes in Net Assets

 

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

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Energy Fund

Financial Highlights

 

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

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Energy Fund

Financial Highlights

 

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

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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. investment companies. 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 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.

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. Counterparty risk involving futures is mitigated because a regulated clearinghouse is the counterparty instead of the clearing broker. To further mitigate counterparty risk, the fund trades futures contracts on an exchange, monitors the financial strength of its clearing brokers and clearinghouse, and has entered into clearing agreements with its clearing brokers. The clearinghouse imposes initial margin requirements to secure the fund’s performance and requires daily settlement of variation margin representing changes in the market value of each contract.

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Energy Fund

Futures contracts are valued at their quoted daily settlement prices. The aggregate settlement values of the contracts are not recorded in the Statement of Net Assets. Fluctuations in the value of the contracts are recorded in the Statement of Net Assets as an asset (liability) and in the Statement of Operations as unrealized appreciation (depreciation) until the contracts are closed, when they are recorded as realized futures gains (losses).

During the year ended January 31, 2017, the fund’s average investments in long and short futures contracts represented 1% and 0% of net assets, respectively, based on the average of aggregate settlement values at each quarter-end during the period.

4. Repurchase Agreements: The fund enters into repurchase agreements with institutional counter-parties. Securities pledged as collateral to the fund under repurchase agreements are held by a custodian bank until the agreements mature, and in the absence of a default, such collateral cannot be repledged, resold, or rehypothecated. Each agreement requires that the market value of the collateral be sufficient to cover payments of interest and principal. The fund further mitigates its counterparty risk by entering into repurchase agreements only with a diverse group of prequalified counterparties, monitoring their financial strength, and entering into master repurchase agreements with its counterparties. The master repurchase agreements provide that, in the event of a counter-party’s default (including bankruptcy), the fund may terminate any repurchase agreements with that counterparty, determine the net amount owed, and sell or retain the collateral up to the net amount owed to the fund. Such action may be subject to legal proceedings, which may delay or limit the disposition of collateral.

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, 2014–2017), 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. Securities Lending: To earn additional income, the fund lends its securities to qualified institutional borrowers. Security loans are subject to termination by the fund at any time, and are required to be secured at all times by collateral in an amount at least equal to the market value of securities loaned. Daily market fluctuations could cause the value of loaned securities to be more or less than the value of the collateral received. When this occurs, the collateral is adjusted and settled on the next business day. The fund further mitigates its counterparty risk by entering into securities lending transactions only with a diverse group of prequalified counterparties, monitoring their financial strength, and entering into master securities lending agreements with its counterparties. The master securities lending agreements provide that, in the event of a counterparty’s default (including bankruptcy), the fund may terminate any loans with that borrower, determine the net amount owed, and sell or retain the collateral up to the net amount owed to the fund; however, such actions may be subject to legal proceedings. While collateral mitigates counterparty risk, in the absence of a default the fund may experience delays and costs in recovering the securities loaned. The fund invests cash collateral received in Vanguard Market Liquidity Fund, and records a liability in the Statement of Net Assets for the return of the collateral, during the period the securities are on loan. Securities lending income represents fees charged to borrowers plus income earned on invested cash collateral, less expenses associated with the loan. During the term of the loan, the fund is entitled to all distributions made on or in respect of the loaned securities.

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Energy Fund

8. Credit Facility: The fund and certain other funds managed by The Vanguard Group (“Vanguard”) participate in a $3.1 billion committed credit facility provided by a syndicate of lenders pursuant to a credit agreement that may be renewed annually; each fund is individually liable for its borrowings, if any, under the credit facility. Borrowings may be utilized for temporary and emergency purposes, and are subject to the fund’s regulatory and contractual borrowing restrictions. The participating funds are charged administrative fees and an annual commitment fee of 0.10% of the undrawn amount of the facility; these fees are allocated to the funds based on a method approved by the fund’s board of trustees and included in Management and Administrative expenses on the fund’s Statement of Operations. Any borrowings under this facility bear interest at a rate based upon the higher of the one-month London Interbank Offered Rate, federal funds effective rate, or overnight bank funding rate plus an agreed-upon spread.

The fund had no borrowings outstanding at January 31, 2017, or at any time during the period then ended.

9. 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. Premiums and discounts on debt securities purchased are amortized and accreted, respectively, to interest income over the lives of the respective securities. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold.

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

B. The investment advisory firm 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 relative to the MSCI ACWI Energy Index for the preceding three years.

Vanguard provides investment advisory services to a portion of the fund as described below; the fund paid Vanguard advisory fees of $272,000 for the year ended January 31, 2017.

For the year ended January 31, 2017, the aggregate investment advisory fee paid to all advisors represented an effective annual basic rate of 0.14% of the fund’s average net assets, before an increase of $2,757,000 (0.03%) based on performance.

C. In accordance with the terms of a Funds’ Service Agreement (the “FSA”) between Vanguard and the fund, Vanguard furnishes to the fund investment advisory, corporate management, administrative, marketing, and distribution services at Vanguard’s cost of operations (as defined by the FSA). These costs of operations are allocated to the fund based on methods and guidelines approved by the board of trustees. Vanguard does not require reimbursement in the current period for certain costs of operations (such as deferred compensation/benefits and risk/insurance costs); the fund’s liability for these costs of operations is included in Payables to Vanguard on the Statement of Net Assets.

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Energy Fund

Upon the request of Vanguard, the fund may invest up to 0.40% of its net assets as capital in Vanguard. At January 31, 2017, the fund had contributed to Vanguard capital in the amount of $799,000, representing 0.01% of the fund’s net assets and 0.32% of Vanguard’s capitalization. The fund’s trustees and officers are also directors and employees, respectively, of Vanguard.

D. The fund has asked its investment advisor to direct certain security trades, subject to obtaining the best price and execution, to brokers who have agreed to rebate to the fund part of the commissions generated. Such rebates are used solely to reduce the fund’s management and administrative expenses. For the year ended January 31, 2017, these arrangements reduced the fund’s expenses by $109,000 (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 January 31, 2017, based on the inputs used to value them:

 

F. At January 31, 2017, 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.

For tax purposes, at January 31, 2017, the fund had $4,644,000 of ordinary income available for distribution. The fund had available capital losses totaling $905,394,000 that may be carried forward indefinitely to offset future net capital gains.

At January 31, 2017, the cost of investment securities for tax purposes was $7,511,471,000. Net unrealized appreciation of investment securities for tax purposes was $3,334,317,000, consisting of unrealized gains of $3,581,024,000 on securities that had risen in value since their purchase and $246,707,000 in unrealized losses on securities that had fallen in value since their purchase.

H. During the year ended January 31, 2017, the fund purchased $2,766,620,000 of investment securities and sold $2,682,177,000 of investment securities, other than temporary cash investments.

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

 

J. Management has determined that no material events or transactions occurred subsequent to January 31, 2017, that would require recognition or disclosure in these financial statements.

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Report of Independent Registered
Public Accounting Firm

To the Board of 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”) as of January 31, 2017, 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 as of January 31, 2017 by correspondence with the custodian and brokers and by agreement to the underlying ownership records of the transfer agent, provide a reasonable basis for our opinion.

/s/PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
March 14, 2017

Special 2016 tax information (unaudited) for Vanguard Energy Fund

This information for the fiscal year ended January 31, 2017, is included pursuant to provisions of the
Internal Revenue Code.

The fund distributed $160,565,000 of qualified dividend income to shareholders during the fiscal year.

For corporate shareholders, 53.9% 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 2017. (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.

Average Annual Total Returns: Energy Fund Investor Shares
Periods Ended January 31, 2017

 

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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 0.43% for Investor Shares and 0.34% 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 (184/366).

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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.

Benchmark Information

Spliced Energy Index: S&P 500 Index through November 30, 2000; S&P Energy Sector Index
through May 31, 2010; MSCI All Country World Energy Index thereafter.

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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 198 Vanguard funds.

The following table provides information for each trustee and executive officer of the fund. The mailing address of the trustees and officers is P.O. Box 876, Valley Forge, PA 19482. 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.

InterestedTrustee¹

F. William McNabb III

Born 1957. Trustee Since July 2009. Chairman of the Board. Principal Occupation(s) During the Past Five Years and Other Experience: Chairman of the Board of The Vanguard Group, Inc., and of each of the investment companies served by The Vanguard Group, since January 2010; Director of The Vanguard Group since 2008; Chief Executive Officer and President of The Vanguard Group, and of each of the investment companies served by The Vanguard Group, since 2008; Director of Vanguard Marketing Corporation; Managing Director of The Vanguard Group (1995–2008).

IndependentTrustees

Emerson U. Fullwood

Born 1948. Trustee Since January 2008. Principal Occupation(s) During the Past Five Years and Other Experience: Executive Chief Staff and Marketing Officer for North America and Corporate Vice President (retired 2008) of Xerox Corporation (document management products and services); Executive in Residence and 2009–2010 Distinguished Minett Professor at the Rochester Institute of Technology; Lead Director of SPX FLOW, Inc. (multi-industry manufacturing); Director of the United Way of Rochester, the University of Rochester Medical Center, Monroe Community College Foundation, North Carolina A&T University, and Roberts Wesleyan College.

Rajiv L. Gupta

Born 1945. Trustee Since December 2001.² Principal Occupation(s) During the Past Five Years and Other Experience: Chairman and Chief Executive Officer (retired 2009) and President (2006–2008) of Rohm and Haas Co. (chemicals); Director of Arconic Inc. (diversified manufacturer), HP Inc. (printer and personal computer manufacturing), and Delphi Automotive plc (automotive components); Senior Advisor at New Mountain Capital.

Amy Gutmann

Born 1949. Trustee Since June 2006. Principal Occupation(s) During the Past Five Years and Other Experience: President of the University of Pennsylvania; Christopher H. Browne Distinguished Professor of Political Science, School of Arts and Sciences, and Professor of Communication, Annenberg School for Communication, with secondary faculty appointments in the Department of Philosophy, School of Arts and Sciences, and at the Graduate School of Education, University of Pennsylvania; Trustee of the National Constitution Center; Chair of the Presidential Commission for the Study of Bioethical Issues.

JoAnn Heffernan Heisen

Born 1950. Trustee Since July 1998. Principal Occupation(s) During the Past Five Years and Other Experience: Corporate Vice President and Chief Global Diversity Officer (retired 2008) and Member of the Executive Committee (1997–2008) of Johnson & Johnson (pharmaceuticals/medical devices/consumer products); Director of Skytop Lodge Corporation (hotels) and the Robert Wood Johnson Foundation; Member of the Advisory Board of the Institute for Women’s Leadership at Rutgers University.

 

F. Joseph Loughrey

Born 1949. Trustee Since October 2009. Principal Occupation(s) During the Past Five Years and Other Experience: President and Chief Operating Officer (retired 2009) of Cummins Inc. (industrial machinery); Chairman of the Board of Hillenbrand, Inc. (specialized consumer services), Oxfam America, and the Lumina Foundation for Education; Director of SKF AB (industrial machinery), Hyster-Yale Materials Handling, Inc. (forklift trucks), and the V Foundation for Cancer Research; Member of the Advisory Council for the College of Arts and Letters and Chair of the Advisory Board to the Kellogg Institute for International Studies, both at the University of Notre Dame.

Mark Loughridge

Born 1953. Trustee Since March 2012. Principal Occupation(s) During the Past Five Years and Other Experience: Senior Vice President and Chief Financial Officer (retired 2013) at IBM (information technology services); Fiduciary Member of IBM’s Retirement Plan Committee (2004–2013); Director of the Dow Chemical Company; Member of the Council on Chicago Booth.

Scott C. Malpass

Born 1962. Trustee Since March 2012. Principal Occupation(s) During the Past Five Years and Other Experience: Chief Investment Officer and Vice President at the University of Notre Dame; Assistant Professor of Finance at the Mendoza College of Business at Notre Dame; Member of the Notre Dame 403(b) Investment Committee, the Board of Advisors for Spruceview Capital Partners, and the Investment Advisory Committee of Major League Baseball; Board Member of TIFF Advisory Services, Inc., and Catholic Investment Services, Inc. (investment advisors).

André F. Perold

Born 1952. Trustee Since December 2004. Principal Occupation(s) During the Past Five Years and Other Experience: George Gund Professor of Finance and Banking, Emeritus at the Harvard Business School (retired 2011); Chief Investment Officer and Co-Managing Partner of HighVista Strategies LLC (private investment firm); Overseer of the Museum of Fine Arts Boston.

Peter F. Volanakis

Born 1955. Trustee Since July 2009. Principal Occupation(s) During the Past Five Years and Other Experience: President and Chief Operating Officer (retired 2010) of Corning Incorporated (communications equipment); Chairman of the Board of Trustees of Colby-Sawyer College; Member of the Board of Hypertherm, Inc. (industrial cutting systems, software, and consumables).

Executive Officers

Glenn Booraem

Born 1967. Treasurer Since May 2015. Principal Occupation(s) During the Past Five Years and Other Experience: Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies served by The Vanguard Group; Controller of each of the investment companies served by The Vanguard Group (2010–2015); Assistant Controller of each of the investment companies served by The Vanguard Group (2001–2010).

Thomas J. Higgins

Born 1957. Chief Financial Officer Since September 2008. Principal Occupation(s) During the Past Five Years and Other Experience: Principal of The Vanguard Group, Inc.; Chief Financial Officer of each of the investment companies served by The Vanguard Group; Treasurer of each of the investment companies served by The Vanguard Group (1998–2008).

Peter Mahoney

Born 1974. Controller Since May 2015. Principal Occupation(s) During the Past Five Years and Other Experience: Principal of The Vanguard Group, Inc.; Controller of each of the investment companies served by The Vanguard Group; Head of International Fund Services at The Vanguard Group (2008–2014).

Anne E. Robinson

Born 1970. Secretary Since September 2016. Principal Occupation(s) During the Past Five Years and Other Experience: Managing Director of The Vanguard Group, Inc.; General Counsel of The Vanguard Group; Secretary of The Vanguard Group and of each of the investment companies served by The Vanguard Group; Director and Senior Vice President of Vanguard Marketing Corporation; Managing Director and General Counsel of Global Cards and Consumer Services at Citigroup (2014–2016); Counsel at American Express (2003–2014).

 

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, the Vanguard Municipal Bond Funds, and the Vanguard State Tax-Exempt Funds.

 

 

 

Annual Report | January 31, 2017

Vanguard Precious Metals and Mining Fund

 

A new format, unwavering commitment

As you begin reading this report, you’ll notice that we’ve made some improvements to the opening sections—based on feedback from you, our clients.

Page 1 starts with a new ”Your Fund’s Performance at a Glance,” a concise, handy summary of how your fund performed during the period.

In the renamed ”Chairman’s Perspective,” Bill McNabb will focus on enduring principles and investment insights.

We’ve modified some tables, and eliminated some redundancy, but we haven’t removed any information.

At Vanguard, we’re always looking for better ways to communicate and to help you make sound investment decisions. Thank you for entrusting your assets to us.

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: No matter what language you speak, Vanguard has one consistent message and set of principles. Our primary
focus is on you, our clients. We conduct our business with integrity as a faithful steward of your assets. This message is shown
translated into seven languages, reflecting our expanding global presence.

 

Your Fund’s Performance at a Glance

• For the 12 months ended January 31, 2017, Vanguard Precious Metals and Mining Fund returned 75.99%. That result was slightly ahead of the average return of peer funds but behind the 95.06% return of the benchmark S&P Global Custom Metals and Mining Index.

• Keep in mind that these outsized returns are indicative of a highly volatile segment of the market. The fund—which invests in companies that are involved in the mining of or exploration for precious and rare metals and minerals—had recorded negative returns for the previous five fiscal years.

• Against a backdrop of rising commodity prices in the 12-month period, mining companies experienced significant gains.

• For the ten years ended January 31, 2017, the Precious Metals and Mining Fund had an average annual return of –3.83%. That return lagged the results of the fund’s comparative standards.

 

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

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The fund expense ratio shown is from the prospectus dated May 25, 2016, and represents estimated costs for the current fiscal year. For the
fiscal year ended January 31, 2017, the fund’s expense ratio was 0.43%. The change from the estimated expense ratio reflects a
performance-based investment advisory fee adjustment. The peer-group expense ratio is derived from data provided by Lipper, a Thomson
Reuters Company, and captures information through year-end 2016.

Peer group: Precious Metals Equity Funds.

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Chairman’s Perspective

Bill McNabb
Chairman and Chief Executive Officer

Dear Shareholder,

As investors, we’re accustomed to hearing about risk. There’s market risk, inflation risk, currency risk, and so on. No form of risk, though, challenges investors quite the way uncertainty can. In my experience, how well we respond to uncertainty can be a key to long-term investing success.

Of course, we never have the luxury of complete clarity when investing—none of us has a crystal ball, after all—but the current environment seems to have more than its fair share of uncertainty.

There are plenty of question marks surrounding the economy as a new administration rolls out its policies, the Federal Reserve shifts its thinking, and global growth, especially in China, continues to worry market watchers. A general feeling of unsettledness is reflected in many questions I’ve been getting from clients in recent months.

Confronting the challenge of the unknowable

First, a bit about the difference between risk and uncertainty. Risk can be measured, albeit not with 100% accuracy. An investor armed with the right data can calculate a reasonable probability of, say, a given company missing earnings expectations.

Uncertainty can’t be quantified that easily. There are “black swan” events that fall completely outside the realm of the expected. The data needed to make sense of such an event are either not known or unknowable.

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In times of uncertainty, it’s easy for investors to make bad decisions. Markets often respond to surprise events with volatility. We had plenty of those in 2016, and I expect similar market-rattling events to occur this year. Some investors may interpret volatility as a sign of trouble and flee to whatever they perceive as a safe haven. Others may see buying opportunities at every turn. Both are likely to fall prey to common investor biases, like these:

• Focusing on just the information that confirms our decisions.

• Buying into the mistaken belief that past performance indicates future results.

• Sticking to the familiar at the cost of smart diversification.

The problem with these natural inclinations is that they can make us forget about our long-term investment plan. That’s never a good thing.

Help yourself avoid unforced errors

Sound investing was ingrained in me from an early age. My mother and father did a good job of saving for retirement by building a diversified portfolio. They recognized that diversification is the most logical response to a future that is, inevitably, uncertain. But my family, just like yours, can succumb to common biases.

During the 1990s tech boom, my mom, who has always paid close attention to the markets, wanted to invest in some of the high-flying stocks of the moment. She had

 

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read about them and heard about them on TV, which confirmed her thinking that they were good buys. Years later, she wanted to sell some holdings when stocks were at their low point during the financial crisis, just before the stock market rebounded. Those were scary times, and she was just trying to protect the nest egg she had so diligently built up over all those years. I’m happy to say she rethought both decisions.

None of us, of course, is immune from mistakes. I can fall into traps as well, so I’ve tried to develop habits that help me counter the biases that affect most of us as investors. These habits don’t require great investment acumen.

For example, I try to remove emotion from the investing equation. At the end of every year, I look at my retirement account and determine if I need to rebalance. Rarely, though, do I spend time trying to figure out why a certain fund over- or under-performed. I don’t want to be tempted by market noise.

Another way to cope with uncertainty: Save more. Just as we can’t know for sure where the markets are headed, we can’t predict when we might have to contend with a health or career setback. Putting away something extra isn’t easy, but it can give us the flexibility to make the most of bad situations.

The one thing we can be sure of

In investing, there is always going to be uncertainty—and a little pain. It’s difficult to continue to dollar-cost average into a tumbling market. Likewise, short-term noise can tempt us to not rebalance on a regular basis. Disciplined rebalancing is vital to achieving long-term goals. To paraphrase legendary investor John Neff, the best time to invest can be when your stomach is churning most.

Because my portfolio is fully diversified, it always contains something that under-performs expectations. There almost always are surprises on the upside, too. This is the power of diversification and a secret to investment success.

Sincerely,

F. William McNabb III
Chairman and Chief Executive Officer
February 14, 2017

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Advisor’s Report

Vanguard Precious Metals and Mining Fund returned about 76% for the fiscal year ended January 31, 2017. This lagged the customized benchmark index, which returned about 95%, but was slightly ahead of the average return of 75% for the precious metals-oriented funds peer group.

Market environment

Initial concerns about the health of the global economy, weak commodity prices, and the timing of a rise in U.S. interest rates gave way to a sustained rally from mid-February 2016 as China’s economy appeared to stabilize. The U.S. economy also started to regain momentum at this time and commodity prices rebounded. After initial panic in the immediate aftermath of Brexit, the United Kingdom’s shocking vote in June to leave the European Union, investor risk appetite quickly recovered and most stock markets resumed an upward trend.

For much of the review period, precious metals performed well, thanks to increased demand resulting from Brexit-related uncertainty. Also adding to the appeal of precious metals were worries about a potential European banking crisis, the prospect of persistently low or negative interest rates, and quantitative easing in a number of economies.

However, Donald Trump’s surprising victory in the U.S. presidential election in November led to a stock market rally, especially in the United States, as investors anticipated fiscal stimulus and massive infrastructure expenditure. A backdrop of Chinese stimulus measures

and global economic growth further supported investor sentiment. The final quarter of 2016 also saw diversified metals stocks rally significantly after a poor performance earlier in the year. Precious metals lagged, although they picked up a little in January 2017.

Shares in silver, copper, and diversified metals companies were the strongest performers over the full year, while precious metals and gold producers slightly lagged behind the custom benchmark. Both categories produced robust gains in absolute terms, however.

The fund’s performance

For much of the past three years, the fund’s overweight exposure to precious metals was beneficial for returns. However, over the 12-month period under review, this exposure was less helpful, as the fund’s relatively light exposure to diversified metals and miners hurt performance, particularly during the rally in these assets in the days just after the U.S. election and into the end of the year. The fund’s overweight exposure to precious metals held back relative returns, although stock selection was beneficial.

Precious metals companies featured prominently among top contributors to performance, including Hochschild Mining, B2Gold, Kaminak Gold, First Majestic Silver, and Alamos Gold. Hochschild Mining is a recovery story; the firm has been rebuilding its balance sheet over the past 18 months and investors have lately started to recognize its solid fundamentals. The share price of Kaminak Gold, a junior miner, was boosted by a takeover

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approach from Goldcorp, one of the world’s largest gold producers, which is also held in the portfolio.

In contrast, given the strong rally in diversified metals in late 2016, the fund’s performance was hurt by its relatively light presence in these assets. More specifically, not holding some of the largest companies in this area—such as Antofagasta, U.K.-listed mining company Anglo American, First Quantum Minerals, Teck Resources, Freeport-McMoRan, and U.K. miner Glencore—was detrimental for returns.

Stock selection within miners specializing solely in gold cost some performance; detractors included Randgold Resources, Primero Mining, and Barrick Gold. We sold the position in Primero Mining after the Canadian gold miner failed to deliver on its business plan strategy.

Other detractors included Dominion Diamond, because of weakness in the diamond market, and Canadian copper miner Nevsun Resources, because of its acquisition of Reservoir Minerals during the year.

Portfolio activity

We started a number of new positions over the review period, with all holdings meeting a set of criteria based on our framework of quality, growth, and valuation. We continue to focus on companies’ management teams, their business plan strategy, and their execution. We also look for firms that have the potential to grow into a mid- or large-capitalization concern over time. Such firms are likely to have good management teams with a strong track record as well as the right technical team in place to put assets into production. The willingness and ability of management to reassess geology is also deemed important.

New holdings include Americas Silver, Barkerville Gold Mines, and Beadell Resources. Americas Silver is attractively valued, growing well, and has good exposure to zinc. Furthermore, the firm focuses on return on investor capital. In our view, gold miners Barkerville and Beadell have exploration potential and the ability to become major players in time.

We also added to our copper exposure by initiating holdings in Grupo Mexico and Southern Copper. We are optimistic about prospects for copper, and the move increases diversification in the portfolio.

Turning to sales, a number of holdings were removed from the portfolio after being taken over: For example, Kaminak Gold was taken over by Goldcorp, and Lake Shore Gold was taken over by Tahoe Resources. Tahoe Resources is also held in the portfolio; the position detracted over the period.

In other transactions, Newmarket Gold was bought by Kirkland Lake Gold, a previous holding in the portfolio that we closed when the firm’s chief executive was replaced. True Gold Mining exited the portfolio after being taken over by gold producer Endeavour Mining, which was added to the portfolio.

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We sold the holding in multinational materials technology firm Umicore because we felt it was fully valued. We also sold our holdings in Anglo American and Antofagasta after disappointing performance. The disposal of these stocks meant that we did not experience further weakness in mid-2016, although we were not able to benefit from the rally in diversified metals later in the year.

Portfolio positioning and outlook

We continue to have overweight exposure to precious metals and mining stocks, with a relatively light presence in diversified miners. Given the potential for volatility because of uncertainty about the implications of the Brexit decision and the new U.S. president, we expect gold prices to stay strong, in the short term at least. After the initial optimism in the wake of President Trump’s election,

a degree of caution has set in and the U.S. Federal Reserve has put policy moves on hold for the time being. The EU political cycle may well produce some upsets; the French presidential elections are just one in a range of political tests for the region this year.

We will continue to implement our investment philosophy and process: maintaining a long-term approach, and identifying high-quality companies with strong management teams, best-in-class assets, and costs that compare favorably with those of their competitors.

Jamie J. Horvat
Portfolio Manager

M&G Investment Management Limited

February 16, 2017

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Precious Metals and Mining Fund

Fund Profile
As of January 31, 2017

 

 

 

 

1 The expense ratio shown is from the prospectus dated May 25, 2016, and represents estimated costs for the current fiscal year. For the fiscal year
ended January 31, 2017, the expense ratio was 0.43%.

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Precious Metals and Mining Fund

Performance Summary

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

Cumulative Performance: January 31, 2007, Through January 31, 2017
Initial Investment of $10,000

 

 

See Financial Highlights for dividend and capital gains information.

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