Vanguard Inflation-Protected Securities Fund

Transcription

1 Annual Report December 31, 2016 Vanguard Inflation-Protected Securities Fund

2 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. Contents Your Fund s Performance at a Glance Chairman s Perspective Advisor s Report Fund Profile Performance Summary Financial Statements About Your Fund s Expenses Glossary 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.

3 Your Fund s Performance at a Glance For the year ended December 31, 2016, Vanguard Inflation-Protected Securities Fund returned 4.52% for Investor Shares. This was slightly behind its benchmark and its peerfunds average. Investor Shares 30-day SEC yield began the year at 0.47% and ended at 0.07%. The U.S. bond market recorded positive returns. Prices rose, then retreated toward year s end as investors anticipated faster economic growth, higher inflation, and higher interest rates. Treasuries and mortgage-backed securities underperformed investmentgrade corporate bonds. A measure of expected inflation over the next five years, the gap between nominal Treasury and TIPS yields, widened from 1.26% to 2.04%. Distributions were withheld in March and September so that sufficient income was available for June and December distributions. Portions of the latter distribution were later reclassified as a long-term capital gain as well as a return of capital. Total Returns: Fiscal Year Ended December 31, Day SEC Yield Income Returns Capital Returns Total Returns Vanguard Inflation-Protected Securities Fund Investor Shares 0.07% 3.23% 1.29% 4.52% Admiral Shares Institutional Shares Bloomberg Barclays U.S. Treasury Inflation Protected Securities Index 4.68 Inflation-Protected Bond Funds Average 4.70 Inflation-Protected Bond Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. Admiral Shares carry lower expenses and are available to investors who meet certain account-balance requirements. Institutional Shares are available to certain institutional investors who meet specific administrative, service, and account-size criteria. Total Returns: Ten Years Ended December 31, 2016 Average Annual Return Inflation-Protected Securities Fund Investor Shares 4.11% Bloomberg Barclays U.S. Treasury Inflation Protected Securities Index 4.36 Inflation-Protected Bond Funds Average 3.39 Inflation-Protected Bond Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. 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. 1

4 Expense Ratios Your Fund Compared With Its Peer Group Investor Shares Admiral Shares Institutional Shares Peer Group Average Inflation-Protected Securities Fund 0.20% 0.10% 0.07% 0.75% The fund expense ratios shown are from the prospectus dated April 26, 2016, and represent estimated costs for the current fiscal year. For the fiscal year ended December 31, 2016, the fund s expense ratios were 0.20% for Investor Shares, 0.10% for Admiral Shares, and 0.07% for Institutional Shares. The peer-group expense ratio is derived from data provided by Lipper, a Thomson Reuters Company, and captures information through year-end Peer group: Inflation-Protected Bond Funds. 2

5 Chairman s Perspective Dear Shareholder, If you re like most investors, a big question on your mind is: What s in store for the markets and the economy in 2017? Bill McNabb Chairman and Chief Executive Officer At Vanguard, we re just as curious about the immediate future. But our curiosity is tempered by our belief that forecasts should give a range of possible outcomes, not pinpoint predictions. After all, there are bound to be occurrences the experts won t see coming. What really matters for investors In 2016, we saw two cases in point: The United Kingdom s June vote to exit the European Union and the November election of Donald Trump as U.S. president. Both unexpected outcomes triggered swift market reactions. But despite some short-term volatility, the markets 12-month performance as of December 31, 2016, proved to be less dramatic. U.S. stocks posted healthy returns, and U.S. bonds provided returns close to their long-term averages. International stocks and bonds also advanced, although returns for U.S. investors were reduced by the strength of the U.S. dollar. The surprises of 2016 remind us to be skeptical of overly precise short-term predictions about At the cusp of a new year, market prognosticators forecast where the Standard & Poor s 500 Index or the yield on the 10-year Treasury note will end up in 12 months. Such predictions can be attention-getting. They can also be dead wrong. 3

6 Investors are better off taking note of long-term trends that stand to influence our economies and markets. We re watching these trends closely, and we discuss our latest assessment in our 2017 economic and market outlook, which you can read at vanguard.com/research. Our global economic outlook: Expect stabilization, not stagnation One phenomenon in particular that we re watching is the low-growth, low-interestrate environment that has marked the global economy since the financial crisis. We don t think this economic backdrop is simply the result of cyclically weak demand or long-term stagnation. Instead, certain structural forces are contributing: Falling technology costs are restraining the amounts businesses are spending on capital investment, an aging population is weighing on growth in the developed world, and the free movement of capital and products across the globe has restrained prices and wages. In the near term, these forces will continue to dampen growth, inflation, and interest rates. They also make it unlikely that further monetary stimulus from central banks will do much to spur growth. I realize this all may sound gloomy, but that s not how we see it. We expect global growth to stabilize at more modest levels, not stagnate. The world isn t headed for Japanese-style deflation, in which a widespread sustained drop in prices puts economic activity into hibernation. Market Barometer Average Annual Total Returns Periods Ended December 31, 2016 One Three Five Year Years Years Stocks Russell 1000 Index (Large-caps) 12.05% 8.59% 14.69% Russell 2000 Index (Small-caps) Russell 3000 Index (Broad U.S. market) FTSE All-World ex US Index (International) Bonds Bloomberg Barclays U.S. Aggregate Bond Index (Broad taxable market) 2.65% 3.03% 2.23% Bloomberg Barclays Municipal Bond Index (Broad tax-exempt market) Citigroup Three-Month U.S. Treasury Bill Index CPI Consumer Price Index 2.07% 1.18% 1.36% 4

7 In fact, we believe that global growth could pick up modestly over time. Our expectation is based on a potential rebound in productivity as new digital technologies are used more effectively. We also anticipate a slight recovery in the labor force as the baby boom generation finishes its transition to retirement, nudging up demand for workers. Put expansion in perspective Looking to the United States, the world s largest economy remains firmly on a longterm-growth path of about 2% per year. That s lower than the historical average of 3.25% since We see such growth at this level as fundamentally sound, rather than abnormally low. Our evaluation takes into account lower U.S. population growth and the reality that the economic expansion from the 1980s until the financial crisis was fueled by debt, distorting the numbers. Turning to prices, we think that core U.S. inflation should modestly exceed 2% in That, in turn, will support further interest rate hikes by the Federal Reserve, similar to the one at the end of We expect the Fed to raise rates in 2017 before taking an extended pause, and we see the federal funds rate staying below 2% through at least Prepare for muted returns And what about prospects for the markets? Vanguard s outlook for global stocks and bonds remains the most guarded in ten years, given fairly high stock valuations Expect more modest returns, rely on time-tested principles In Vanguard s economic and market outlook for 2017, Global Chief Economist Joseph Davis and his team offer a projection of more modest returns from the global stock and bond markets. They caution that, over the next decade, returns for a balanced portfolio are likely to be moderately below long-run historical averages. The team s simulations indicate that for the decade ending in 2026, the average annualized return of a 60% stock/40% bond portfolio is likely to be centered in the 3% 5% range after inflation. That s below the actual average after-inflation return of 6% for the same portfolio for the nine decades since Ultimately, our global market outlook points toward a somewhat more challenging environment, yet one in which, over time, investors with an appropriate level of discipline, diversification, and patience are likely to be rewarded with reasonable inflation-adjusted returns. For more information about our expectations and the probability of various outcomes, see 2017 Economic and Market Outlook: Stabilization, Not Stagnation, available at vanguard.com/research. IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations as of September 30, Results from the model may vary with each use and over time. For more information, see the note at the end of this letter. 5

8 and the low-interest-rate environment. We don t expect global bond yields to increase materially from year-end 2016 levels. Our outlook for global equities is annualized returns of 5% 8% over the next decade. This outlook isn t bearish, but is actually fairly positive when you take into account the current low-rate environment. (See the box titled Expect more modest returns, rely on time-tested principles for more.) Focus on the four keys to investment success Significant trends often happen gradually. Like shifting tides, they re sometimes barely noticeable at first but ultimately can change the landscape entirely. Other times, apparent trends can end up receding before they have much of a long-term impact. Given the future s inherent unpredictability, it s not reasonable to expect a surefire blockbuster revelation from any prognosticator or investment firm. What to conclude, then? No matter what scenario plays out, we believe investors have the best chance for success if they stay focused on what they can control: their goals, asset allocation, and investment costs, along with the discipline to stick to a plan. As Tim Buckley, our chief investment officer, likes to say, this can be easy to say but harder to do, especially in times of uncertainty. Investors who can stay focused on those four keys will find themselves well-positioned to weather any market. As always, thank you for investing with Vanguard. Sincerely, F. William McNabb III Chairman and Chief Executive Officer January 16, IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time. The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based. The VCMM is a proprietary financial simulation tool developed and maintained by Vanguard s Investment Strategy Group. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.

9 Advisor s Report For the fiscal year ended December 31, 2016, Investor Shares of Vanguard Inflation- Protected Securities Fund returned 4.52%. The fund s result was slightly less than the 4.68% return of its benchmark, the Bloomberg Barclays U.S. Treasury Inflation Protected Securities Index. The fund s return also slightly trailed the 4.70% average return of peer-group funds. The investment environment After subpar gross domestic product readings in the first half of 2016, the U.S. economy regained some momentum. The annualized inflation-adjusted reading rose 3.5% in the third quarter as consumer spending remained strong and inventory investment rose for the first time since Net exports also rose as the year progressed. Preliminary fourth-quarter GDP figures were not available at the time of this writing. Inflation measures showed that price gains are meeting the Federal Reserve s targeted range of about 2%. The annual change in the Consumer Price Index, which stood at 0.7% in December 2015, rose to 2.1%. The more stable core CPI, which excludes food and energy items, didn t move much during the year, ending the period at 2.2%. Another measure, the core personal consumption expenditures index, is watched closely by the Fed to help set rate policy. That metric, which has been below CPI readings for some time, was up only 1.4% for the 12 months ended November 30, 2016, the latest figure available. After choosing to hold its federal funds rate steady through 2016, Fed policymakers in December finally did raise the rate by Yields of U.S. Treasury Inflation-Protected Securities (Real Yields) December 31, June 30, December 31, Maturity years 0.01% 0.90% 0.54% 3 years Years Years Years Years Years Source: Vanguard. 7

10 0.25 basis point to a range of 0.50% to 0.75%. This hike was only the second in more than a decade. The Fed s decision, which was widely expected, reaffirms its confidence in the strength of the U.S. economy, which is in the midst of one of its longest expansions. The labor market is essentially at full employment, vehicle sales are hovering at all-time highs, and the housing market has largely recovered from its bust. Meanwhile, energy and commodity prices rebounded enough to calm recession and deflation fears that were present a year ago. Based on its statement after its December meeting, and its latest projections, the Fed plans a gradual increase in rates over the next couple of years. It expects three quarter-percentage-point rate increases in 2017 and three each in 2018 and 2019 before the rate levels off at a long-run normal 3.0%. Management of the portfolio The U.S. Treasury uses the non-seasonally adjusted CPI for Urban Consumers (CPI-U NSA) to govern the inflation adjustments made for Treasury Inflation-Protected Securities (TIPS). This measure rose six straight months through June for the first time in two years, with the final four months in the 0.3% to 0.5% range. As often happens, changes in the CPI-U NSA were muted in the second half of the year, with two months registering negative readings. In the TIPS market, the 12-month period showed two distinct phases. During the first six months, the real yield curve sank across the board as yields fell along with those in the nominal Treasury market and in many other international bond markets. Worries about lackluster economic growth and disinflation prompted several major central banks to boost monetary accommodation. Some major bond markets even pushed sovereign bond yields into negative territory. But in the second half of the year, and particularly after the U.S. election, optimism grew about U.S. economic prospects. The shift in sentiment was reflected by the rotation of assets from bonds to stocks. TIPS real yields bounced back up, although they didn t reach their January 1, 2016, starting point. The 2-year TIPS fell from 0.01% to 0.90%, then rose to 0.54%. The rebound was more noticeable for the 10-year TIPS, whose yield went from 0.85% down to 0.16%, then rose to 0.62%. Not surprisingly, inflation expectations rose along with market confidence. The break-even inflation (BEI) rate, which is the difference between nominal Treasury and TIPS yields, rose during the year, signaling an expectation that inflation will accelerate. Still, the BEIs across the maturity spectrum were not unusually elevated by historical standards. For example, the 2-year BEI rose from 1.08% at the end of 2015 to 1.73%. The 5-year BEI rose from 1.26% to 2.04%, while the 10-year BEI rose from 1.45% to 1.83%. 8

11 As inflation expectations increased, TIPS remained attractive, so despite the yield rebound in the latter half of the year, over the 12-month period their prices rose and their yields fell. The fund s Investor Shares 30-day SEC yield began the fiscal year at 0.47%, sank to 0.28% in July, but ended the period at 0.07%. Thus, the BEI movements were less the result of changes in TIPS yields, which didn t rise in the second half of the year, as much as the result of rising yields for nominal Treasuries. The bellwether 10-year U.S. Treasury yield, which began the year at 2.30%, sank below 1.40% in July, but rose quickly during the fourth quarter to end the year at 2.45%. In light of these market crosscurrents, and based on our expectation of a rise in inflation and interest rates, we continue to modestly overweight longer-term TIPS. We also sold most of the nominal Treasuries in our portfolio and added more TIPS. We withheld distributions in March and September to make sure we had sufficient income for June and December distributions. We were successful, as sufficient income was generated from fund holdings through inflation adjustments triggered by monthly changes in the CPI-U NSA. These monthly changes can be volatile, which contributed to a recalculation of the December distribution after it was made. Part of the distribution was reclassified as a long-term capital gain, and another portion was classified as a return of capital. Outlook Absent an unexpected external shock, the U.S. economy looks to continue its steady growth, with real GDP possibly rising as much as 3% in With the labor market achieving the Fed s full employment target, the pace of annual wage increases should continue to improve, perhaps as high as in the 3% 4% range, as competition for labor increases. This will keep upward pressure on inflation in the short term, but not to the point of overheating. We expect inflation to average in the 2.2% 2.5% range by spring. Longer term, the continued strength of the U.S. dollar should restrain import prices. Also, even though interest rates rose sharply in the fourth quarter, the cost of borrowing should not get out of hand. Other developed economies are still striving to boost their own economies and inflation with ultra-low rates, so the U.S. bond market s yields remain very attractive to international investors. We re encouraged by the Fed s decision to continue the process of normalizing rates, which have been near zero since We expect the federal funds rate to increase to 1.25% 1.5% by the end of Nonetheless, we think the Fed will maintain its dovish tightening 9

12 approach, given the anti-inflationary forces still at work in the global economy. In fact, we will not be surprised to see the fed funds rate remain below 2% through at least Within the TIPS market, rising demand for TIPS inflation protection could be dampened by an increase in supply as the U.S. Treasury issues more new TIPS (and nominals) to fund increased government spending. Given the uncertainties around federal fiscal policy, trade policy, and geopolitical concerns, we are being very tactical in our management of the portfolio. We expect BEIs to firm along with inflation, but we remain cognizant of the winds of change that could negatively impact our outlook. Gemma Wright-Casparius, Principal Vanguard Fixed Income Group January 24,

13 Inflation-Protected Securities Fund Fund Profile As of December 31, 2016 Share-Class Characteristics Financial Attributes Investor Shares Admiral Shares Institutional Shares Ticker Symbol VIPSX VAIPX VIPIX Expense Ratio1 0.20% 0.10% 0.07% 30-Day SEC Yield % 0.17% 0.23% Bloomberg Barclays Fund Inflation Protected Securities Index Bloomberg Barclays US Aggregate Bond Index Number of Bonds ,054 Yield to Maturity (before expenses) 2.3% 2.2% 2.6% Average Coupon 0.8% 0.8% 3.1% Average Duration 7.9 years 7.8 years 5.9 years Average Effective Maturity 8.5 years 8.3 years 8.1 years Short-Term Reserves 0.3% Sector Diversification (% of portfolio) Treasury/Agency 99.6% Other 0.4 The agency and mortgage-backed securities sectors may include issues from government-sponsored enterprises; such issues are generally not backed by the full faith and credit of the U.S. government. Volatility Measures Bloomberg Barclays Inflation Protected Securities Index Bloomberg Barclays US Aggregate Bond Index R-Squared Beta These measures show the degree and timing of the fund s fluctuations compared with the indexes over 36 months. Distribution by Effective Maturity (% of portfolio) Under 1 Year 0.4% 1-3 Years Years Years Years Years 10.6 Distribution by Credit Quality (% of portfolio) U.S. Government 99.6% Aaa 0.4 Credit-quality ratings are obtained from Moody's and S&P, and the higher rating for each issue is shown. "Not Rated" is used to classify securities for which a rating is not available. Not rated securities include a fund's investment in Vanguard Market Liquidity Fund or Vanguard Municipal Cash Management Fund, each of which invests in high-quality money market instruments and may serve as a cash management vehicle for the Vanguard funds, trusts, and accounts. For more information about these ratings, see the Glossary entry for Credit Quality. 1 The expense ratios shown are from the prospectus dated April 26, 2016, and represent estimated costs for the current fiscal year. For the fiscal year ended December 31, 2016, the expense ratios were 0.20% for Investor Shares, 0.10% for Admiral Shares, and 0.07% for Institutional Shares. 2 Yields of inflation-protected securities tend to be lower than those of nominal bonds, because the former do not incorporate market expectations about inflation. The principal amounts and thus the interest payments of inflation-protected securities are adjusted over time to reflect inflation. 11

14 Inflation-Protected Securities Fund Investment Focus Average Maturity Short Med. Long Credit Quality Treasury/ Agency Investment-Grade Corporate Below Investment-Grade 12

15 Inflation-Protected Securities 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: December 31, 2006, Through December 31, 2016 Initial Investment of $10,000 $18,000 14, ,000 Average Annual Total Returns Periods Ended December 31, 2016 One Year Five Years Ten Years Final Value of a $10,000 Investment Inflation-Protected Securities Fund Investor Shares 4.52% 0.71% 4.11% $14,963 Bloomberg Barclays U.S. Treasury Inflation Protected Securities Index ,329 Inflation-Protected Bond Funds Average ,950 Bloomberg Barclays U.S. Aggregate Bond Index ,300 Inflation-Protected Bond Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. One Year Five Years Ten Years Final Value of a $50,000 Investment Inflation-Protected Securities Fund Admiral Shares 4.62% 0.82% 4.22% $75,588 Bloomberg Barclays U.S. Treasury Inflation Protected Securities Index ,644 Bloomberg Barclays U.S. Aggregate Bond Index ,502 See Financial Highlights for dividend and capital gains information. 13

16 Inflation-Protected Securities Fund Average Annual Total Returns Periods Ended December 31, 2016 One Year Five Years Ten Years Final Value of a $5,000,000 Investment Inflation-Protected Securities Fund Institutional Shares 4.63% 0.85% 4.26% $7,588,019 Bloomberg Barclays U.S. Treasury Inflation Protected Securities Index ,664,369 Bloomberg Barclays U.S. Aggregate Bond Index ,650,215 Fiscal-Year Total Returns (%): December 31, 2006, Through December 31, 2016 Bloomberg Barclays Inflation Protected Securities Investor Shares Index Fiscal Year Income Returns Capital Returns Total Returns Total Returns % 5.69% 11.59% 11.63%

17 Inflation-Protected Securities Fund Financial Statements Statement of Net Assets As of December 31, 2016 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). Face Market Maturity Amount Value Coupon Date ($000) ($000) U.S. Government and Agency Obligations (99.5%) U.S. Government Securities (99.5%) United States Treasury Inflation Indexed Bonds 0.125% 4/15/18 999,721 1,054,576 United States Treasury Inflation Indexed Bonds 1.375% 7/15/18 275, ,173 United States Treasury Inflation Indexed Bonds 2.125% 1/15/19 280, ,811 United States Treasury Inflation Indexed Bonds 0.125% 4/15/19 1,268,580 1,324,841 United States Treasury Inflation Indexed Bonds 1.875% 7/15/19 342, ,502 United States Treasury Inflation Indexed Bonds 1.375% 1/15/20 395, ,862 United States Treasury Inflation Indexed Bonds 0.125% 4/15/20 1,085,200 1,131,557 United States Treasury Inflation Indexed Bonds 1.250% 7/15/20 641, ,368 United States Treasury Inflation Indexed Bonds 1.125% 1/15/21 730, ,704 United States Treasury Inflation Indexed Bonds 0.125% 4/15/21 1,145,821 1,175,214 United States Treasury Inflation Indexed Bonds 0.625% 7/15/21 796, ,427 United States Treasury Inflation Indexed Bonds 0.125% 1/15/22 937,671 1,002,704 United States Treasury Inflation Indexed Bonds 0.125% 7/15/22 919, ,997 United States Treasury Inflation Indexed Bonds 0.125% 1/15/23 931, ,562 United States Treasury Inflation Indexed Bonds 0.375% 7/15/23 829, ,209 United States Treasury Inflation Indexed Bonds 0.625% 1/15/24 931, ,903 United States Treasury Inflation Indexed Bonds 0.125% 7/15/24 1,038,771 1,038,010 United States Treasury Inflation Indexed Bonds 0.250% 1/15/25 968, ,776 1 United States Treasury Inflation Indexed Bonds 2.375% 1/15/25 486, ,746 United States Treasury Inflation Indexed Bonds 0.375% 7/15/25 931, ,483 United States Treasury Inflation Indexed Bonds 0.625% 1/15/26 1,192,943 1,222,719 United States Treasury Inflation Indexed Bonds 2.000% 1/15/26 374, ,436 United States Treasury Inflation Indexed Bonds 0.125% 7/15/26 1,115,529 1,086,650 United States Treasury Inflation Indexed Bonds 2.375% 1/15/27 393, ,215 United States Treasury Inflation Indexed Bonds 1.750% 1/15/28 320, ,870 United States Treasury Inflation Indexed Bonds 3.625% 4/15/28 207, ,421 United States Treasury Inflation Indexed Bonds 2.500% 1/15/29 317, ,247 United States Treasury Inflation Indexed Bonds 3.875% 4/15/29 256, ,667 United States Treasury Inflation Indexed Bonds 3.375% 4/15/32 106, ,310 United States Treasury Inflation Indexed Bonds 2.125% 2/15/40 174, ,590 United States Treasury Inflation Indexed Bonds 2.125% 2/15/41 225, ,983 United States Treasury Inflation Indexed Bonds 0.750% 2/15/42 434, ,607 United States Treasury Inflation Indexed Bonds 0.625% 2/15/43 304, ,835 United States Treasury Inflation Indexed Bonds 1.375% 2/15/44 478, ,612 United States Treasury Inflation Indexed Bonds 0.750% 2/15/45 523, ,859 United States Treasury Inflation Indexed Bonds 1.000% 2/15/46 389, ,909 Total U.S. Government and Agency Obligations (Cost $24,526,844) 25,215,355 15

18 Inflation-Protected Securities Fund Market Value Coupon Shares ($000) Temporary Cash Investment (0.3%) Money Market Fund (0.3%) 2 Vanguard Market Liquidity Fund (Cost $81,206) 0.823% 812,000 81,208 Total Investments (99.8%) (Cost $24,608,050) 25,296,563 Expiration Date Contracts Liability for Options Written (0.0%) Call Options on 10-year U.S. Treasury Note Futures Contracts, Strike Price $ /27/17 92 (76) Call Options on 10-year U.S. Treasury Note Futures Contracts, Strike Price $ /27/ (11) Call Options on 10-year U.S. Treasury Note Futures Contracts, Strike Price $ /27/17 92 (9) Call Options on 10-year U.S. Treasury Note Futures Contracts, Strike Price $ /27/17 91 (4) Put Options on 10-year U.S. Treasury Note Futures Contracts, Strike Price $ /27/ (63) Put Options on 10-year U.S. Treasury Note Futures Contracts, Strike Price $ /27/17 91 (50) Put Options on 10-year U.S. Treasury Note Futures Contracts, Strike Price $ /27/ (46) Put Options on 10-year U.S. Treasury Note Futures Contracts, Strike Price $ /27/ (41) Put Options on 10-year U.S. Treasury Note Futures Contracts, Strike Price $ /27/17 92 (3) Put Options on 10-year U.S. Treasury Note Futures Contracts, Strike Price $ /24/17 2,236 (734) Total Liability for Options Written (Premiums Received $2,230) (1,037) Amount ($000) Other Assets and Liabilities (0.2%) Other Assets Investment in Vanguard 1,901 Receivables for Accrued Income 78,024 Receivables for Capital Shares Issued 62,093 Other Assets 806 Total Other Assets 142,824 Liabilities Payables for Investment Securities Purchased (84) Payables for Capital Shares Redeemed (66,097) Payables to Vanguard (30,695) Other Liabilities (3,758) Total Liabilities (100,634) Net Assets (100%) 25,337,716 16

19 Inflation-Protected Securities Fund At December 31, 2016, net assets consisted of: Amount ($000) Paid-in Capital 24,679,556 Overdistributed Net Investment Income (38,465) Accumulated Net Realized Gains 6,018 Unrealized Appreciation (Depreciation) Investment Securities 688,513 Futures Contracts 901 Options on Futures Contracts 1,193 Net Assets 25,337,716 Investor Shares Net Assets Applicable to 346,227,995 outstanding $.001 par value shares of beneficial interest (unlimited authorization) 4,495,519 Net Asset Value Per Share Investor Shares $12.98 Admiral Shares Net Assets Applicable to 478,960,739 outstanding $.001 par value shares of beneficial interest (unlimited authorization) 12,204,925 Net Asset Value Per Share Admiral Shares $25.48 Institutional Shares Net Assets Applicable to 832,047,351 outstanding $.001 par value shares of beneficial interest (unlimited authorization) 8,637,272 Net Asset Value Per Share Institutional Shares $10.38 See Note A in Notes to Financial Statements. 1 Securities with a value of $9,920,000 have been segregated as initial margin for open futures contracts. 2 Affiliated money market fund available only to Vanguard funds and certain trusts and accounts managed by Vanguard. Rate shown is the 7-day yield. See accompanying Notes, which are an integral part of the Financial Statements. 17

20 Inflation-Protected Securities Fund Statement of Operations Year Ended December 31, 2016 ($000) Investment Income Income Interest 1 530,984 Total Income 530,984 Expenses The Vanguard Group Note B Investment Advisory Services 2,562 Management and Administrative Investor Shares 7,560 Management and Administrative Admiral Shares 8,485 Management and Administrative Institutional Shares 4,222 Marketing and Distribution Investor Shares 936 Marketing and Distribution Admiral Shares 1,126 Marketing and Distribution Institutional Shares 218 Custodian Fees 127 Auditing Fees 41 Shareholders Reports Investor Shares 129 Shareholders Reports Admiral Shares 140 Shareholders Reports Institutional Shares 112 Trustees Fees and Expenses 20 Total Expenses 25,678 Net Investment Income 505,306 Realized Net Gain (Loss) Investment Securities Sold 1 54,271 Futures Contracts (255) Options on Futures Contracts 2,105 Realized Net Gain (Loss) 56,121 Change in Unrealized Appreciation (Depreciation) Investment Securities 462,684 Futures Contracts 1,197 Options on Futures Contracts 1,094 Change in Unrealized Appreciation (Depreciation) 464,975 Net Increase (Decrease) in Net Assets Resulting from Operations 1,026,402 1 Interest income and realized net gain (loss) from an affiliated company of the fund were $1,004,000 and $8,000, respectively. See accompanying Notes, which are an integral part of the Financial Statements. 18

21 Inflation-Protected Securities Fund Statement of Changes in Net Assets Year Ended December 31, ($000) ($000) Increase (Decrease) in Net Assets Operations Net Investment Income 505, ,122 Realized Net Gain (Loss) 56,121 42,806 Change in Unrealized Appreciation (Depreciation) 464,975 (649,145) Net Increase (Decrease) in Net Assets Resulting from Operations 1,026,402 (407,217) Distributions Net Investment Income Investor Shares (89,680) (36,231) Admiral Shares (251,324) (91,547) Institutional Shares (176,121) (67,708) Realized Capital Gain 1 Investor Shares (5,713) (579) Admiral Shares (16,005) (1,124) Institutional Shares (11,234) (933) Return of Capital Investor Shares (52,119) Admiral Shares (146,011) Institutional Shares (102,484) Total Distributions (850,691) (198,122) Capital Share Transactions Investor Shares (315,211) (734,224) Admiral Shares 1,609,525 29,952 Institutional Shares 1,117,521 (772,077) Net Increase (Decrease) from Capital Share Transactions 2,411,835 (1,476,349) Total Increase (Decrease) 2,587,546 (2,081,688) Net Assets Beginning of Period 22,750,170 24,831,858 End of Period 2 25,337,716 22,750,170 1 Includes fiscal 2016 and 2015 short-term gain distributions totaling $0 and $0, respectively. Short-term gain distributions are treated as ordinary income dividends for tax purposes. 2 Net Assets End of Period includes undistributed (overdistributed) net investment income of ($38,465,000) and ($27,370,000). See accompanying Notes, which are an integral part of the Financial Statements. 19

22 Inflation-Protected Securities Fund Financial Highlights Investor Shares For a Share Outstanding Year Ended December 31, Throughout Each Period Net Asset Value, Beginning of Period $12.84 $13.18 $12.98 $14.53 $14.11 Investment Operations Net Investment Income Net Realized and Unrealized Gain (Loss) on Investments.315 (.339).273 (1.499).586 Total from Investment Operations.578 (.241).497 (1.289).953 Distributions Dividends from Net Investment Income (.266) (.098) (.281) (.216) (.366) Distributions from Realized Capital Gains (.017) (.001) (.016) (.045) (.167) Return of Capital (.155) Total Distributions (.438) (.099) (.297) (.261) (.533) Net Asset Value, End of Period $12.98 $12.84 $13.18 $12.98 $14.53 Total Return % -1.83% 3.83% -8.92% 6.78% Ratios/Supplemental Data Net Assets, End of Period (Millions) $4,496 $4,746 $5,604 $6,577 $16,075 Ratio of Total Expenses to Average Net Assets 0.20% 0.20% 0.20% 0.20% 0.20% Ratio of Net Investment Income to Average Net Assets 1.99% 0.72% 2.01% 1.33% 2.55% Portfolio Turnover Rate 2 27% 43% 39% 44% 33% 1 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. 2 Excludes the value of portfolio securities received or delivered as a result of in-kind purchases or redemptions of the fund s capital shares. 20 See accompanying Notes, which are an integral part of the Financial Statements.

23 Inflation-Protected Securities Fund Financial Highlights Admiral Shares For a Share Outstanding Year Ended December 31, Throughout Each Period Net Asset Value, Beginning of Period $25.21 $25.87 $25.47 $28.54 $27.71 Investment Operations Net Investment Income Net Realized and Unrealized Gain (Loss) on Investments.615 (.658).544 (2.965) Total from Investment Operations (.437) (2.516) Distributions Dividends from Net Investment Income (.541) (.220) (.581) (.465) (.747) Distributions from Realized Capital Gains (.034) (.003) (.031) (.089) (.328) Return of Capital (.314) Total Distributions (.889) (.223) (.612) (.554) (1.075) Net Asset Value, End of Period $25.48 $25.21 $25.87 $25.47 $28.54 Total Return % -1.69% 3.97% -8.86% 6.90% Ratios/Supplemental Data Net Assets, End of Period (Millions) $12,205 $10,533 $10,778 $11,005 $16,011 Ratio of Total Expenses to Average Net Assets 0.10% 0.10% 0.10% 0.10% 0.10% Ratio of Net Investment Income to Average Net Assets 2.09% 0.82% 2.11% 1.43% 2.65% Portfolio Turnover Rate 2 27% 43% 39% 44% 33% 1 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. 2 Excludes the value of portfolio securities received or delivered as a result of in-kind purchases or redemptions of the fund s capital shares. See accompanying Notes, which are an integral part of the Financial Statements. 21

24 Inflation-Protected Securities Fund Financial Highlights Institutional Shares For a Share Outstanding Year Ended December 31, Throughout Each Period Net Asset Value, Beginning of Period $10.27 $10.54 $10.37 $11.62 $11.29 Investment Operations Net Investment Income Net Realized and Unrealized Gain (Loss) on Investments.250 (.269).229 (1.208).463 Total from Investment Operations.474 (.176).422 (1.021).773 Distributions Dividends from Net Investment Income (.221) (.093) (.239) (.193) (.309) Distributions from Realized Capital Gains (.014) (.001) (.013) (.036) (.134) Return of Capital (.129) Total Distributions (.364) (.094) (.252) (.229) (.443) Net Asset Value, End of Period $10.38 $10.27 $10.54 $10.37 $11.62 Total Return 4.63% -1.67% 4.07% -8.83% 6.87% Ratios/Supplemental Data Net Assets, End of Period (Millions) $8,637 $7,471 $8,449 $8,919 $12,491 Ratio of Total Expenses to Average Net Assets 0.07% 0.07% 0.07% 0.07% 0.07% Ratio of Net Investment Income to Average Net Assets 2.12% 0.85% 2.14% 1.46% 2.68% Portfolio Turnover Rate 1 27% 43% 39% 44% 33% 1 Excludes the value of portfolio securities received or delivered as a result of in-kind purchases or redemptions of the fund s capital shares. 22 See accompanying Notes, which are an integral part of the Financial Statements.

25 Inflation-Protected Securities Fund Notes to Financial Statements Vanguard Inflation-Protected Securities Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund offers three classes of shares: Investor Shares, Admiral Shares, and Institutional Shares. Investor Shares are available to any investor who meets the fund s minimum purchase requirements. Admiral Shares and Institutional 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. Bonds and 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. Investments in Vanguard Market Liquidity Fund are valued at that fund s net asset value. 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 by methods deemed by the board of trustees to represent fair value. 2. Futures and Options: The fund uses futures contracts and options on futures contracts to invest in fixed income asset classes with greater efficiency and lower cost than is possible through direct investment, to add value when these instruments are attractively priced, or to adjust sensitivity to changes in interest rates. The primary risks associated with the use of futures contracts are imperfect correlation between changes in market values of bonds held by the fund and the prices of futures contracts, and the possibility of an illiquid market. The primary risk associated with purchasing options is that interest rates move in such a way that the option is out-of-the-money, the position is worthless at expiration, and the fund loses the premium paid. The primary risk associated with writing options is that interest rates move in such a way that the option is in-the-money, the counterparty exercises the option, and the fund loses an amount equal to the market value of the option written less the premium received. Counterparty risk involving futures and exchange-traded options is mitigated because a regulated clearinghouse is the counterparty instead of the clearing broker. To further mitigate counterparty risk, the fund trades futures and options 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. 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 December 31, 2016, the fund s average investments in long and short futures contracts represented 4% and 3% of net assets, respectively, based on the average of aggregate settlement values at each quarter-end during the period. Options on futures contracts are also valued at their quoted daily settlement prices. The premium paid for a purchased option is recorded in the Statement of Net Assets as an asset that is subsequently adjusted daily to the current market value of the option purchased. The premium received for a written option is recorded in the Statement of Net Assets as an asset with an equal liability that is subsequently 23

26 Inflation-Protected Securities Fund 24 adjusted daily to the current market value of the option written. Fluctuations in the value of the options are recorded in the Statement of Operations as unrealized appreciation (depreciation) until expired, closed, or exercised, at which time realized gains (losses) are recognized. During the year ended December 31, 2016, the fund s average value of investments in options purchased and options written each represented less than 1% of net assets, respectively, based on the average market values at each quarter-end during the period. 3. 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 (December 31, ), and has concluded that no provision for federal income tax is required in the fund s financial statements. 4. Distributions: Distributions to shareholders are recorded on the ex-dividend date. 5. 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 December 31, 2016, or at any time during the period then ended. 6. Other: 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. Inflation adjustments to the face amount of inflation-indexed securities are included in interest income. 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. 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.