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

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT
OF
REGISTERED MANAGEMENT INVESTMENT COMPANIES

 

 

Semiannual Report | July 31, 2018

Vanguard Energy Fund

 

Vanguard’s Principles for Investing Success

We want to give you the best chance of investment success. These principles, grounded in Vanguard’s research and experience, can put you on the right path.

Goals. Create clear, appropriate investment goals.

Balance. Develop a suitable asset allocation using broadly diversified funds. Cost. Minimize cost.

Discipline. Maintain perspective and long-term discipline.

A single theme unites these principles: Focus on the things you can control.

We believe there is no wiser course for any investor.

 

Please note: The opinions expressed in this report are just that—informed opinions. They should not be considered promises
or advice. Also, please keep in mind that the information and opinions cover the period through the date on the front of this
report. Of course, the risks of investing in your fund are spelled out in the prospectus.
See the Glossary for definitions of investment terms used in this report.
About the cover: Nautical images have been part of Vanguard’s rich heritage since its start in 1975. For an
incoming ship, a lighthouse offers a beacon and safe path to shore. You can similarly depend on Vanguard to put
you first––and light the way––as you strive to meet your financial goals. Our client focus and low costs,
stemming from our unique ownership structure, assure that your interests are paramount.

 

Your Fund’s Performance at a Glance

• For the six months ended July 31, 2018, Vanguard Energy Fund returned nearly 5%. It outpaced its benchmark, the MSCI ACWI Energy Index, and the average return of its global natural resources peer funds.

• The fund, managed by two advisors, seeks long-term capital appreciation through its multicapitalization exposure to global energy stocks.

• Energy stocks generally posted strong results for the period; oil futures gained more than 20% in the first half of 2018. Natural gas prices continued to be restrained. However, they rallied during the last three months as demand for power generation increased and many coal-fired power plants switched to natural gas.

• Oil and gas exploration and production, oil and gas refining and marketing, and integrated oil and gas were among the best-performing sectors on a relative basis. Results were held back by oil and gas equipment and services and oil and gas drilling.

 

 

 

The fund expense ratios shown are from the prospectus dated May 25, 2018, and represent estimated costs for the current fiscal year. For
the six months ended July 31, 2018, the fund’s annualized expense ratios were 0.39% for Investor Shares and 0.31% for Admiral Shares.
The peer-group expense ratio is derived from data provided by Lipper, a Thomson Reuters Company, and captures information through
year-end 2017.

Peer group: Global Natural Resources Funds.

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CEO’s Perspective

Tim Buckley
President and Chief Executive Officer

Dear Shareholder,

I feel extremely fortunate to have the chance to lead a company filled with people who come to work every day passionate about Vanguard’s core purpose: to take a stand for all investors, to treat them fairly, and to give them the best chance for investment success.

When I joined Vanguard in 1991, I found a mission-driven team focused on improving lives—helping people retire more comfortably, put their children through college, and achieve financial security. I also found a company with purpose in an industry ripe for improvement.

It was clear, even early in my career, that the cards were stacked against most investors. Hidden fees, performance-chasing, and poor advice were relentlessly eroding investors’ dreams.

We knew Vanguard could be different and, as a result, could make a real difference. We have lowered the costs of investing for our shareholders significantly. And we’re proud of the performance of our funds.

Vanguard is built for Vanguard investors—we focus solely on you, our fund shareholders. Everything we do is designed to give our clients the best chance for investment success. In my role as CEO, I’ll keep this priority

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front and center. We’re proud of what we’ve achieved, but we’re even more excited about what’s to come.

Steady, time-tested guidance

Our guidance for investors, as always, is to stay the course, tune out the hyperbolic headlines, and focus on your goals and what you can control, such as costs and how much you save. This time-tested advice has served our clients well over the decades.

Regardless of how the markets perform in the short term, I’m incredibly optimistic about the future for our investors. We have a dedicated team serving you, and we will never stop striving to make

Vanguard the best place for you to invest through our high-quality funds and services, advice and guidance to help you meet your financial goals, and an experience that makes you feel good about entrusting us with your hard-earned savings.

Thank you for your continued loyalty.

Sincerely,

Mortimer J. Buckley
President and Chief Executive Officer
August 16, 2018

 

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Advisors’ Report

For the six months ended July 31, 2018, Vanguard Energy Fund returned nearly 5%. It outpaced its benchmark, the MSCI ACWI Energy Index, and the average return of its 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 period and of how their portfolio positioning reflects this assessment. These reports were prepared on August 9, 2018.

Wellington Management Company llp

Portfolio Manager:

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

The investment environment

Global energy stocks, as measured by the fund’s benchmark, returned 4.07% for the six months. The broader market, as measured by the MSCI All Country World Index, returned –2.60%.

 

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takeaway capacity has hurt the region over the six months, but we are confident that this will be temporary and have maintained our position.

Heading into the latter half of 2018, we remain encouraged by the positive macro backdrop for oil; inventories are coming down and spare capacity is at a low level. We also see room for improved sentiment as stocks discount prices below the current oil price. Recent company updates suggest that capital discipline continues for U.S. production. Despite pipeline bottlenecks in the near term, we are encouraged that many companies are evolving their business models to include capital return in addition to volume growth.

Vanguard Quantitative Equity Group

Portfolio Managers:

James P. Stetler

Binbin Guo, Principal, Head of
Alpha Equity Investments

The investment environment

Energy stocks rallied as West Texas International (WTI) oil futures rose more than 20% in the first half of 2018. The gain can be attributed to the dispute over oil-marketing rights that is affecting Libya’s export capacity. The White House has also indicated possible sanctions for countries that don’t reduce their imports of Iranian crude to zero by November 4. Iran currently exports around 2.4 million barrels a day.

During the first quarter of 2018, natural gas futures continued their slide, falling more than 7%. However, during the second quarter, they rebounded by nearly 7%. The cold weather at the end of January took the price to $3.661, but it quickly fell back to the $3 level. The higher price was due to increased demand for power generation, partially because many coal-fired plants have switched to natural gas.

Investment objective and strategy

It’s important to understand how our overall performance is affected by the macroeconomic factors we’ve described. However, our approach to investing focuses on specific fundamentals rather than on technical analysis of stock price movements. We compare all stocks in an industry group 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 fundamental factors. We believe that attractive stocks exhibit four key themes: high quality—healthy balance sheets and consistent cash-flow generation; sound management decisions—investment policies that favor internal over external funding; strong market sentiment—market confirmation of our view; and 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.

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Our successes and shortfalls

For the six months, our quality, sentiment, and management decisions models boosted performance, but our valuation model detracted.

Our positions in oil and gas exploration, integrated oil and gas, and oil and gas equipment services posted the strongest returns. Results were not as strong for oil and gas refining and marketing, oil and gas storage and transportation, and gas utilities.

Our most successful overweighted holdings were HollyFrontier and Marathon Oil. Our portfolio also benefited from underweights to SK Innovation, Halliburton, and Vestas Wind Systems. Results were dragged down by underweighted allocations to Hess and Andeavor as well as overweights to GS Holdings, Hindustan Petroleum, and GCL-Poly Energy Holdings.

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Energy Fund

Fund Profile
As of July 31, 2018

 

 

 

 

1 The expense ratios shown are from the prospectus dated May 25, 2018, and represent estimated costs for the current fiscal year. For the six
months ended July 31, 2018, the annualized expense ratios were 0.39% for Investor Shares and 0.31% for Admiral Shares.

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Energy Fund

 

Sector categories are based on the Global Industry Classification
Standard (“GICS”), except for the “Other” category (if applicable),
which includes securities that have not been provided a GICS
classification as of the effective reporting period.

 

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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, 2008, Through July 31, 2018

For a benchmark description, see the Glossary.
Note: For 2019, performance data reflect the six months ended July 31, 2018.

Average Annual Total Returns: Periods Ended June 30, 2018
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, 2018

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

 

• See Note A in Notes to Financial Statements.
^ Includes partial security positions on loan to broker-dealers.
The total value of securities on loan is $60,409,000.
* Non-income-producing security.
1 The fund invests a portion of its cash reserves in equity
markets through the use of index futures contracts. After
giving effect to futures investments, the fund’s effective
common stock and temporary cash investment positions
represent 97.6% and 3.2%, respectively, of net assets.
2 Considered an affiliated company of the fund as the issuer
is another member of The Vanguard Group.
3 Affiliated money market fund available only to Vanguard
funds and certain trusts and accounts managed by Vanguard.
Rate shown is the 7-day yield.
4 Includes $62,106,000 of collateral received for securities
on loan.
5 Securities with a value of $4,633,000 have been segregated
as initial margin for open futures contracts.
ADR—American Depositary Receipt.
GDR—Global Depositary Receipt.

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Energy Fund

 

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

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

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Statement of Operations

 

16

 

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

The expense ratio, net investment income ratio, and turnover rate for the current period have been annualized.
1 Calculated based on average shares outstanding.
2 Net investment income per share and the ratio of net investment income to average net assets include $.342 and 0.67%, respectively,
from income received as a result of the General Electric Co. and Baker Hughes Inc. merger in July 2017.
3 Total returns do not include account service fees that may have applied in the periods shown. Fund prospectuses provide information
about any applicable account service fees.
4 Includes performance-based investment advisory fee increases (decreases) of 0.01%, 0.00%, 0.03%, 0.03%, 0.03%, and 0.04%.

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

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Energy Fund

Financial Highlights

 

The expense ratio, net investment income ratio, and turnover rate for the current period have been annualized.
1 Calculated based on average shares outstanding.
2 Net investment income per share and the ratio of net investment income to average net assets include $.643 and 0.67%, respectively,
from income received as a result of the General Electric Co. and Baker Hughes Inc. merger in July 2017.
3 Total returns do not include account service fees that may have applied in the periods shown. Fund prospectuses provide information
about any applicable account service fees.
4 Includes performance-based investment advisory fee increases (decreases) of 0.01%, 0.00%, 0.03%, 0.03%, 0.03%, and 0.04%.

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

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Energy Fund

Vanguard provides investment advisory services to a portion of the fund as described below; the fund paid Vanguard advisory fees of $288,000 for the six months ended July 31, 2018.

For the six months ended July 31, 2018, the aggregate investment advisory fee paid to all advisors represented an effective annual basic rate of 0.15% of the fund’s average net assets, before an increase of $448,000 (0.01%) 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. All other costs of operations payable to Vanguard are generally settled twice a month.

Upon the request of Vanguard, the fund may invest up to 0.40% of its net assets as capital in Vanguard. At July 31, 2018, the fund had contributed to Vanguard capital in the amount of $511,000, representing 0.01% of the fund’s net assets and 0.20% of Vanguard’s capitalization. The fund’s trustees and officers are also directors and employees, respectively, of Vanguard.

D. 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). Any investments valued with significant unobservable inputs are
noted on the Statement of Net Assets.

The following table summarizes the market value of the fund’s investments as of July 31, 2018, based on the inputs used to value them:

 

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Energy Fund

E. 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. For tax purposes, at January 31, 2018, the fund had available capital losses totaling $839,189,000 that may be carried forward indefinitely to offset future net capital gains. The fund will use these capital losses to offset net taxable capital gains, if any, realized during the year ending January 31, 2019; should the fund realize net capital losses for the year, the losses will be added to the loss carryforward balance above.

At July 31, 2018, the cost of investment securities for tax purposes was $5,861,468,000. Net unrealized appreciation of investment securities for tax purposes was $3,959,448,000, consisting of unrealized gains of $4,043,500,000 on securities that had risen in value since their purchase and $84,052,000 in unrealized losses on securities that had fallen in value since their purchase.

F. During the six months ended July 31, 2018, the fund purchased $1,104,739,000 of investment securities and sold $1,388,465,000 of investment securities, other than temporary cash investments.

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

 

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Energy Fund

H. Transactions during the period in investments where the issuer is another member of The Vanguard Group were as follows:

 

I. Management has determined that no events or transactions occurred subsequent to July 31, 2018, that would require 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 0.39% for Investor Shares and 0.31% 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 (181/365).

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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 208 Vanguard funds.

Information for each trustee and executive officer of the fund appears below. 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.

Interested Trustees¹

F. William McNabb III

Born in 1957. Trustee since July 2009. Principal occupation(s) during the past five years and other experience: chairman of the board (January 2010–present) of Vanguard and of each of the investment companies served by Vanguard, trustee (2009–present) of each of the investment companies served by Vanguard, and director (2008–present) of Vanguard. Chief executive officer and president (2008–2017) of Vanguard and each of the investment companies served by Vanguard, managing director (1995–2008) of Vanguard, and director (1997–2018) of Vanguard Marketing Corporation. Director (2018–present) of UnitedHealth Group.

Mortimer J. Buckley

Born in 1969. Trustee since January 2018. Principal occupation(s) during the past five years and other experience: chief executive officer (January 2018–present) of Vanguard; chief executive officer, president, and trustee (January 2018–present) of each of the investment companies served by Vanguard; president and director (2017–present) of Vanguard; and president (February 2018–present) of Vanguard Marketing Corporation. Chief investment officer (2013–2017), managing director (2002–2017), head of the Retail Investor Group (2006–2012), and chief information officer (2001–2006) of Vanguard. Chairman of the board (2011–2017) of the Children’s Hospital of Philadelphia.

Independent Trustees

Emerson U. Fullwood

Born in 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). Former president of the Worldwide Channels Group, Latin America, and Worldwide Customer Service and executive chief staff officer of Developing Markets of Xerox. 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 University of Rochester Medical Center, the Monroe Community College Foundation, the United Way of Rochester, North Carolina A&T University, and Roberts Wesleyan College. Trustee of the University of Rochester.

Amy Gutmann

Born in 1949. Trustee since June 2006. Principal occupation(s) during the past five years and other experience: president (2004–present) 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.

1 Mr. McNabb and Mr. Buckley are considered “interested persons,” as defined in the Investment Company Act of 1940, because
they are officers of the Vanguard funds.

 

JoAnn Heffernan Heisen

Born in 1950. Trustee since July 1998. Principal occupation(s) during the past five years and other experience: corporate vice president of Johnson & Johnson (pharmaceuticals/medical devices/consumer products) and member of its executive committee (1997–2008). Chief global diversity officer (retired 2008), vice president and chief information officer (1997–2006), controller (1995–1997), treasurer (1991–1995), and assistant treasurer (1989–1991) of Johnson & Johnson. 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 in 1949. Trustee since October 2009. Principal occupation(s) during the past five years and other experience: president and chief operating officer (retired 2009) and vice chairman of the board (2008–2009) 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 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 in 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) of IBM (information technology services). Fiduciary member of IBM’s Retirement Plan Committee (2004–2013), senior vice president and general manager (2002–2004) of IBM Global Financing, vice president and controller (1998–2002) of IBM, and a variety of other prior management roles at IBM. Member of the Council on Chicago Booth.

Scott C. Malpass

Born in 1962. Trustee since March 2012. Principal occupation(s) during the past five years and other experience: chief investment officer (1989–present) and vice president (1996–present) of the University of Notre Dame. Assistant professor of finance at the Mendoza College of Business, University of Notre Dame, and member of the Notre Dame 403(b) Investment Committee. Chairman of the board of TIFF Advisory Services, Inc. Member of the board of Catholic Investment Services, Inc. (investment advisors), the board of advisors for Spruceview Capital Partners, and the board of superintendence of the Institute for the Works of Religion.

Deanna Mulligan

Born in 1963. Trustee since January 2018. Principal occupation(s) during the past five years and other experience: president (2010–present) and chief executive officer (2011–present) of The Guardian Life Insurance Company of America. Chief operating officer (2010–2011) and executive vice president (2008–2010) of Individual Life and Disability of The Guardian Life Insurance Company of America. Member of the board of The Guardian Life Insurance Company of America, the American Council of Life Insurers, the Partnership for New York City (business leadership), and the Committee Encouraging Corporate Philanthropy. Trustee of the Economic Club of New York and the Bruce Museum (arts and science). Member of the Advisory Council for the Stanford Graduate School of Business.

André F. Perold

Born in 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.

Sarah Bloom Raskin

Born in 1961. Trustee since January 2018. Principal occupation(s) during the past five years and other experience: deputy secretary (2014–2017) of the United States Department of the Treasury. Governor (2010–2014) of the Federal Reserve Board. Commissioner (2007–2010) of financial regulation for the State of Maryland. Member of the board of directors (2012–2014) of Neighborhood Reinvestment Corporation. Director of i(x) Investments, LLC.

Peter F. Volanakis

Born in 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) and director of Corning Incorporated (2000–2010) and Dow Corning (2001–2010). Director (2012) of SPX Corporation (multi-industry manufacturing). Overseer of the Amos Tuck School of Business Administration, Dartmouth College (2001–2013). 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 in 1967. Principal occupation(s) during the past five years and other experience: principal of Vanguard. Investment stewardship officer (2017–present), treasurer (2015–2017), controller (2010–2015), and assistant controller (2001–2010) of each of the investment companies served by Vanguard.

Christine M. Buchanan

Born in 1970. Principal occupation(s) during the past five years and other experience: principal of Vanguard and global head of Fund Administration at Vanguard. Treasurer (2017–present) of each of the investment companies served by Vanguard. Partner (2005–2017) at KPMG LLP (audit, tax, and advisory services).

Brian Dvorak

Born in 1973. Principal occupation(s) during the past five years and other experience: principal of Vanguard. Chief compliance officer (2017–present) of Vanguard and each of the investment companies served by Vanguard. Assistant vice president (2017–present) of Vanguard Marketing Corporation. Vice president and director of Enterprise Risk Management (2011–2013) at Oppenheimer Funds, Inc.

Thomas J. Higgins

Born in 1957. Principal occupation(s) during the past five years and other experience: principal of Vanguard. Chief financial officer (2008–present) and treasurer (1998–2008) of each of the investment companies served by Vanguard.

Peter Mahoney

Born in 1974. Principal occupation(s) during the past five years and other experience: principal of Vanguard. Controller (2015–present) of each of the investment companies served by Vanguard. Head of International Fund Services (2008–2014) at Vanguard.

Anne E. Robinson

Born in 1970. Principal occupation(s) during the past five years and other experience: general counsel (2016–present) of Vanguard. Secretary (2016–present) of Vanguard and of each of the investment companies served by Vanguard. Managing director (2016–present) of Vanguard. Director and senior vice president (2016–2018) of Vanguard Marketing Corporation. Managing director and general counsel of Global Cards and Consumer Services (2014–2016) at Citigroup. Counsel (2003–2014) at American Express.

Michael Rollings

Born in 1963. Principal occupation(s) during the past five years and other experience: finance director (2017–present) and treasurer (2017) of each of the investment companies served by Vanguard. Managing director (2016–present) of Vanguard. Chief financial officer (2016–present) of Vanguard. Director (2016–present) of Vanguard Marketing Corporation. Executive vice president and chief financial officer (2006–2016) of MassMutual Financial Group.

 

 

 

 

Semiannual Report | July 31, 2018

Vanguard Health Care Fund

 

Vanguard’s Principles for Investing Success

We want to give you the best chance of investment success. These principles, grounded in Vanguard’s research and experience, can put you on the right path.

Goals. Create clear, appropriate investment goals.

Balance. Develop a suitable asset allocation using broadly diversified funds. Cost. Minimize cost.

Discipline. Maintain perspective and long-term discipline.

A single theme unites these principles: Focus on the things you can control.

We believe there is no wiser course for any investor.

 

Please note: The opinions expressed in this report are just that—informed opinions. They should not be considered promises or advice. Also, please keep in mind that the information and opinions cover the period through the date on the front of this report. Of course, the risks of investing in your fund are spelled out in the prospectus.

See the Glossary for definitions of investment terms used in this report.

About the cover: Nautical images have been part of Vanguard’s rich heritage since its start in 1975. For an incoming ship, a lighthouse offers a beacon and safe path to shore. You can similarly depend on Vanguard to put you first––and light the way––as you strive to meet your financial goals. Our client focus and low costs, stemming from our unique ownership structure, assure that your interests are paramount.

 

Your Fund’s Performance at a Glance

• For the six months ended July 31, 2018, Vanguard Health Care Fund returned 2.21% for Investor Shares and 2.24% for Admiral Shares. These results surpassed the return of the fund’s benchmark (+1.54%) and trailed the average return of peer funds (+3.34%).

• The fund’s advisor, Wellington Management Company llp, takes a value-oriented, long-term approach to its management of the portfolio.

• Health care stocks generated higher returns than six of the 11 industry sectors.

The aging population, creation of new and innovative drugs, and increased accessibility to health care worldwide have added to the sector’s attractiveness over the years.

• Pharmaceutical stocks fueled the fund’s outperformance. The advisor’s health care facilities and health care equipment stocks also boosted results, while its biotechnology and health care distributor stocks detracted.

 

 

The fund expense ratios shown are from the prospectus dated May 25, 2018, and represent estimated costs for the current fiscal year. For
the six months ended July 31, 2018, the fund’s annualized expense ratios were 0.34% for Investor Shares and 0.29% 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 2017.

Peer group: Global Health/Biotechnology Funds.

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CEO’s Perspective

Tim Buckley
President and Chief Executive Officer

Dear Shareholder,

I feel extremely fortunate to have the chance to lead a company filled with people who come to work every day passionate about Vanguard’s core purpose: to take a stand for all investors, to treat them fairly, and to give them the best chance for investment success.

When I joined Vanguard in 1991, I found a mission-driven team focused on improving lives—helping people retire more comfortably, put their children through college, and achieve financial security. I also found a company with purpose in an industry ripe for improvement.

It was clear, even early in my career, that the cards were stacked against most investors. Hidden fees, performance-chasing, and poor advice were relentlessly eroding investors’ dreams.

We knew Vanguard could be different and, as a result, could make a real difference. We have lowered the costs of investing for our shareholders significantly. And we’re proud of the performance of our funds.

Vanguard is built for Vanguard investors—we focus solely on you, our fund shareholders. Everything we do is designed to give our clients the best chance for investment success. In my role as CEO, I’ll keep this priority

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front and center. We’re proud of what we’ve achieved, but we’re even more excited about what’s to come.

Steady, time-tested guidance

Our guidance for investors, as always, is to stay the course, tune out the hyperbolic headlines, and focus on your goals and what you can control, such as costs and how much you save. This time-tested advice has served our clients well over the decades.

Regardless of how the markets perform in the short term, I’m incredibly optimistic about the future for our investors. We have a dedicated team serving you, and we will never stop striving to make

Vanguard the best place for you to invest through our high-quality funds and services, advice and guidance to help you meet your financial goals, and an experience that makes you feel good about entrusting us with your hard-earned savings.

Thank you for your continued loyalty.

Sincerely,

Mortimer J. Buckley
President and Chief Executive Officer
August 16, 2018

 

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Advisor’s Report

For the six months ended July 31, 2018, Vanguard Health Care Fund returned 2.21% for Investor Shares and 2.24% for Admiral Shares. It outperformed its benchmark, the MSCI All Country World Health Care Index, which returned 1.54%, but trailed the 3.34% average return of global health/ biotechnology funds.

The investment environment

We view the health care sector through a custom lens of subsectors. We combine biotechnology and pharmaceuticals and think of them in terms of capitalization: biopharma small-cap, biopharma mid-cap, and biopharma large-cap. The other subsectors are health care services and medical technology.

Medical technology was the top-performing subsector in the benchmark for the period; biopharma large-caps came in second. Health care services stocks lagged. The biopharma mid-caps subsector was the only one to post negative results. Biopharma small-caps are not meaningfully represented in the benchmark.

Two announcements of interest to health care investors were made during the period. In May, President Trump released a “blueprint” to lower drug prices and reduce out-of-pocket costs for consumers; in June, Amazon announced that it would acquire internet pharmacy PillPack, thus entering the pharmacy business. Both news items are indicative of change in the complex health care industry.

Our successes

Stock selection was strongest in the bio-pharma large-cap and medical technology subsectors. Eisai, in the biopharma large-cap subsector, was the fund’s top relative performer. Shares of Eisai returned over 50% for the period. The Japanese pharmaceuticals company entered into a strategic collaboration with Merck for developing and commercializing its cancer drug Lenvima. It also reported positive Phase 2 data for its investigational antibody for Alzheimer’s disease. Eisai and its partner Biogen now have two positive data sets targeting beta amyloid, increasing our confidence that these antibodies will show disease-modifying benefits in larger studies.

Our avoidance of biopharma large-cap AbbVie also helped performance compared with the benchmark, as the stock returned about –16%. A pipeline setback for the company’s novel cancer drug, along with concerns about how changes to the rebate structure in the United States might affect sales of its main profit contributor Humira, weighed on AbbVie’s stock price.

Another top contributor to the fund’s relative performance was biopharma large-cap Eli Lilly, which returned over 20% for the period. In July, Eli Lilly reported better-than-expected earnings results that were driven by its diabetes franchise, and it announced plans to take a minority stake of its Elanco Animal Health unit public. The positive Alzheimer’s data from Eisai and Biogen also boosted performance, as Eli Lilly has a long history of research and a number of Phase 2 assets in this area.

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Our shortfalls

Stock selection was weakest in the biopharma mid-cap and health care services subsectors. Our overweight allocation to biopharma mid-cap stocks and our underweight allocation to medical technology stocks detracted from relative results.

The biggest detractor was our position in McKesson, in the health care services subsector, which returned about –25%. Pressure on generic prices, the announcement of President Trump’s blueprint to lower drug prices, and the threat of Amazon entering the industry triggered concerns and subsequent declines in stock prices across the pharmaceutical supply chain, including many drug distributors such as McKesson. Of these developments, a change to branded pharmaceuticals’ list prices would be most problematic, as McKesson would need time to renegotiate its contracts with manufacturers. Although the fundamentals are entering a period of uncertainty, we believe the stock’s valuation significantly discounts many of these risks.

Alnylam Pharmaceuticals, in the biopharma mid-cap subsector, also hindered relative results. In late 2017, its share price surged after the company reported excellent Phase 3 results for its lead small interfering RNA (siRNA) drug patisiran for the treatment of hereditary ATTR amyloidosis, a rare genetic disorder. More recently, the company’s stock price fell sharply on competitive concerns after Pfizer’s TTR amyloid cardiomyopathy study was successful.

We believe Alnylam’s mechanism is far superior and will ultimately win majority market share. As we also remain optimistic about Alnylam’s attractive siRNA platform and long-term outlook, we used the price drop as an opportunity to buy additional shares of the stock.

Biopharma mid-cap holding Incyte was the third-largest relative detractor. In April, the company announced negative results from the Phase 3 trial that tested a combination of its IDO inhibitor epacadostat and Merck’s cancer drug Keytruda. Although this news was disappointing and removes a significant opportunity for value creation, we still believe the stock price does not fully discount Incyte’s currently approved products and continue to hold a position.

The fund’s positioning

At the end of the period, we held about 26% of the fund’s assets in non-U.S. investments, a level that has remained fairly stable over recent years. Our non-U.S. holdings are primarily domiciled in Japan, the United Kingdom, Switzerland, Belgium, and Israel, but many of them operate globally. We believe this strategy provides diversification for shareholders over the long term.

The fund consisted of 87 companies across all subsectors of health care. This figure was up from a year ago, when we held 75 equity names, because we took advantage of valuation opportunities to initiate some new positions, including a number of emerging-market stocks and biopharma mid-cap stocks.

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The fund is more concentrated than the index: As of July 31, its ten largest holdings represented 42% of its assets, while the benchmark’s ten largest positions represented 35% of the index.

We seek to invest in companies that look to provide solutions to the challenges facing the health care delivery system globally by shifting focus from volumes to value. Over the long term, the tailwinds of innovation, an aging population, and the globalization of demand for cutting-edge, developed-market health care should continue to drive growth. And we believe that we are favorably positioned to capitalize on this.

A core tenet of our investment philosophy is the importance of using a longer-term horizon to evaluate secular themes and health care trends, as well as individual companies, on a global scale. This should enable our team to identify pockets of opportunity in health care that are best positioned to create value and generate sustainable, innovation-driven, differentiated growth. We will remain diversified across subsectors and regions, focused on the long haul, and positioned in what we believe to be the most attractive health care stocks as we seek to generate strong, risk-adjusted returns.

As always, we thank you for your continued confidence and support as an investor in Vanguard Health Care Fund.

Jean M. Hynes, CFA
Senior Managing Director and
Portfolio Manager

Wellington Management Company llp

August 16, 2018

 

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Health Care Fund

Fund Profile
As of July 31, 2018

 

 

 

 

1 The expense ratios shown are from the prospectus dated May 25, 2018, and represent estimated costs for the current fiscal year. For the six
months ended July 31, 2018, the annualized expense ratios were 0.34% for Investor Shares and 0.29% for Admiral Shares.

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Health Care Fund

Sector categories are based on the Global Industry Classification
Standard (“GICS”), except for the “Other” category (if applicable),
which includes securities that have not been provided a GICS
classification as of the effective reporting period.

 

 

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Health Care 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, 2008, Through July 31, 2018

For a benchmark description, see the Glossary.
Note: For 2019, performance data reflect the six months ended July 31, 2018.

Average Annual Total Returns: Periods Ended June 30, 2018
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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Health Care Fund

Financial Statements (unaudited)

Statement of Net Assets
As of July 31, 2018

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).

 

10

 

Health Care Fund

 

11

 

Health Care Fund

 

12

 

Health Care Fund

• See Note A in Notes to Financial Statements.
* Non-income-producing security.
^ Includes partial security positions on loan to broker-dealers.
The total value of securities on loan is $22,340,000.
1 Considered an affiliated company of the fund as the fund
owns more than 5% of the outstanding voting securities of
such company.
2 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, 2018, the value of this security
represented 0.1% of net assets.
3 Affiliated money market fund available only to Vanguard
funds and certain trusts and accounts managed by Vanguard.
Rate shown is the 7-day yield.
4 Includes $22,513,000 of collateral received for securities
on loan, of which $22,508,000 is held in Vanguard Market
Liquidity Fund and $5,000 is held in cash.
5 Security exempt from registration under Section 4(2) of
the Securities Act of 1933. Such securities may be sold in
transactions exempt from registration only to dealers in that
program or other “accredited investors.” At July 31, 2018,
the aggregate value of these securities was $95,131,000,
representing 0.2% of net assets.
ADR—American Depositary Receipt.
CVR—Contingent Value Rights.

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

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Health Care Fund

Statement of Operations

 

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

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Health Care Fund

Statement of Changes in Net Assets

 

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

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Health Care Fund

Financial Highlights

The expense ratio, net investment 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 account service fees that may have applied in the periods shown. Fund prospectuses provide
information about any applicable account service fees.
3 Includes performance-based investment advisory fee increases (decreases) of 0.01% for the period ended July 31, 2018, 0.04%
for fiscal 2018, 0.04% for fiscal 2017, and 0.02% for fiscal 2016. Performance-based investment advisory fees did not apply before
fiscal 2016.

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

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Health Care Fund

Financial Highlights

 

The expense ratio, net investment 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 account service fees that may have applied in the periods shown. Fund prospectuses provide
information about any applicable account service fees.
3 Includes performance-based investment advisory fee increases (decreases) of 0.01% for the period ended July 31, 2018, 0.04%
for fiscal 2018, 0.04% for fiscal 2017, and 0.02% for fiscal 2016. Performance-based investment advisory fees did not apply before
fiscal 2016.

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

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Health Care Fund

Notes to Financial Statements

Vanguard Health Care 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. 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.

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Health Care Fund

4. Federal Income Taxes: The fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Management has analyzed the fund’s tax positions taken for all open federal income tax years (January 31, 2015–2018), and for the period ended July 31, 2018, and has concluded that no provision for federal income tax is required in the fund’s financial statements. 5. Distributions: Distributions to shareholders are recorded on the ex-dividend date.

6. Securities Lending: To earn additional income, the fund 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 before the opening of the market 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 event 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 Assets and Liabilities 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.

7. 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 July 31, 2018, or at any time during the period then ended.

8. Other: Dividend income is recorded on the ex-dividend date. 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.

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Health Care Fund

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), shareholder reporting, and the proxy. 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 the fund for a fee calculated at an annual percentage rate of average net assets. The basic fee is subject to quarterly adjustments based on the fund’s performance relative to the MSCI ACWI Health Care Index for the preceding three years. For the six months ended July 31, 2018, the investment advisory fee represented an effective annual basic rate of 0.15% of the fund’s average net assets before an increase of $1,485,000 (0.01%) 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 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 Assets and Liabilities. All other costs of operations payable to Vanguard are generally settled twice a month.

Upon the request of Vanguard, the fund may invest up to 0.40% of its net assets as capital in Vanguard. At July 31, 2018, the fund had contributed to Vanguard capital in the amount of $2,405,000, representing 0.01% of the fund’s net assets and 0.96% of Vanguard’s capitalization. The fund’s trustees and officers are also directors and employees, respectively, of Vanguard.

D. 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). Any investments valued with significant unobservable inputs are noted
on the Statement of Net Assets.

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Health Care Fund

The following table summarizes the market value of the fund’s investments as of July 31, 2018, based on the inputs used to value them:

 

E. 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.

At July 31, 2018, the cost of investment securities for tax purposes was $28,740,722,000. Net unrealized appreciation of investment securities for tax purposes was $19,062,090,000, consisting of unrealized gains of $20,037,888,000 on securities that had risen in value since their purchase and $975,798,000 in unrealized losses on securities that had fallen in value since their purchase.

F. During the six months ended July 31, 2018, the fund purchased $2,377,712,000 of investment securities and sold $3,978,384,000 of investment securities, other than temporary cash investments.

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

 

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Health Care Fund

H. Certain of the fund’s investments are in companies that are considered to be affiliated companies of the fund because the fund owns more than 5% of the outstanding voting securities of the company or the issuer is another member of The Vanguard Group. Transactions during the period in securities of these companies were as follows:

 

1 Not applicable—at July 31, 2018, the security was still held, but the issuer was not an affiliated company of the fund.
2 Not applicable—at January 31, 2018, the security was not an affiliated company of the fund.
3 Not applicable—purchases and sales are for temporary cash investment purposes.

I. Management has determined that no events or transactions occurred subsequent to July 31, 2018, that would require recognition or disclosure in these financial statements.

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