Vanguard U.S. Stock Index Funds Small-Capitalization Portfolios

Transcription

1 Annual Report December 31, 2016 Vanguard U.S. Stock Index Funds Small-Capitalization Portfolios Vanguard Small-Cap Index Fund Vanguard Small-Cap Growth Index Fund Vanguard Small-Cap Value Index 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 Small-Cap Index Fund Small-Cap Growth Index Fund Small-Cap Value Index Fund Your Fund s After-Tax Returns 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 12 months ended December 31, 2016, returns for the three Vanguard smallcapitalization U.S. index funds ranged from nearly 25% for Vanguard Small-Cap Value Index Fund to about 11% for Vanguard Small-Cap Growth Index Fund. Vanguard Small- Cap Index Fund, which contains both growth and value stocks, returned about 18%. All three funds closely tracked their target indexes. The Small-Cap Index Fund and Small-Cap Value Index Fund trailed the average return of their peers, while the Small-Cap Growth Index Fund surpassed the average return of its peers. Small-cap stocks outperformed their large- and mid-cap counterparts, and value stocks outpaced growth stocks. Financial and industrial stocks were top contributors for all three funds. The basic materials sector recorded the highest returns for the funds, which saw negative results from health care. Over the past decade, the funds posted returns in line with their benchmark indexes and ahead of their peer averages. Total Returns: Fiscal Year Ended December 31, 2016 Total Returns Vanguard Small-Cap Index Fund Investor Shares 18.17% ETF Shares Market Price Net Asset Value Admiral Shares Institutional Shares Institutional Plus Shares CRSP US Small Cap Index Small-Cap Core Funds Average Small-Cap Core Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. 1

4 Total Returns Vanguard Small-Cap Growth Index Fund Investor Shares 10.61% ETF Shares Market Price Net Asset Value Admiral Shares Institutional Shares CRSP US Small Cap Growth Index Small-Cap Growth Funds Average 9.75 Small-Cap Growth Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. Vanguard Small-Cap Value Index Fund Investor Shares 24.65% ETF Shares Market Price Net Asset Value Admiral Shares Institutional Shares CRSP US Small Cap Value Index Small-Cap Value Funds Average Small-Cap Value 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 and Institutional Plus Shares are available to certain institutional investors who meet specific administrative, service, and account-size criteria. The Vanguard ETF Shares shown are traded on the NYSE Arca exchange and are available only through brokers. The table provides ETF returns based on both the NYSE Arca market price and the net asset value for a share. U.S. Pat. Nos. 6,879,964; 7,337,138; 7,720,749; 7,925,573; 8,090,646; and 8,417,623. For the ETF Shares, the market price is determined by the midpoint of the bid-offer spread as of the closing time of the New York Stock Exchange (generally 4 p.m., Eastern time). The net asset value is also determined as of the NYSE closing time. For more information about how the ETF Shares' market prices have compared with their net asset value, visit vanguard.com, select your ETF, and then select the Price and Performance tab. The ETF premium/discount analysis there shows the percentages of days on which the ETF Shares' market price was above or below the NAV. Total Returns: Ten Years Ended December 31, 2016 Average Annual Return Small-Cap Index Fund Investor Shares 8.04% Spliced Small-Cap Index 8.10 Small-Cap Core Funds Average 6.33 For a benchmark description, see the Glossary. Small-Cap Core Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. 2

5 Average Annual Return Small-Cap Growth Index Fund Investor Shares 8.09% Spliced Small-Cap Growth Index 8.11 Small-Cap Growth Funds Average 6.32 For a benchmark description, see the Glossary. Small-Cap Growth Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. Small-Cap Value Index Fund Investor Shares 7.63% Spliced Small-Cap Value Index 7.76 Small-Cap Value Funds Average 6.61 For a benchmark description, see the Glossary. Small-Cap Value 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. Expense Ratios Your Fund Compared With Its Peer Group Investor Shares ETF Shares Admiral Shares Institutional Shares Institutional Plus Shares Peer Group Average Small-Cap Index Fund 0.20% 0.08% 0.08% 0.07% 0.05% 1.25% Small-Cap Growth Index Fund Small-Cap Value Index Fund The fund expense ratios shown are from the prospectus dated April 27, 2016, and represent estimated costs for the current fiscal year. For the fiscal year ended December 31, 2016, the funds expense ratios were: for the Small-Cap Index Fund, 0.18% for Investor Shares, 0.06% for ETF Shares, 0.06% for Admiral Shares, 0.05% for Institutional Shares, and 0.04% for Institutional Plus Shares; for the Small-Cap Growth Index Fund, 0.19% for Investor Shares, 0.07% for ETF Shares, 0.07% for Admiral Shares, and 0.06% for Institutional Shares; and for the Small-Cap Value Index Fund, 0.19% for Investor Shares, 0.07% for ETF Shares, 0.07% for Admiral Shares, and 0.06% for Institutional Shares. The peer-group expense ratios are derived from data provided by Lipper, a Thomson Reuters Company, and capture information through year-end Peer groups: For the Small-Cap Index Fund, Small-Cap Core Funds; for the Small-Cap Growth Index Fund, Small-Cap Growth Funds; and for the Small-Cap Value Index Fund, Small-Cap Value Funds. 3

6 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. 4

7 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% 5

8 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. 6 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.

9 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, 2017 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. 7

10 Small-Cap Index Fund Fund Profile As of December 31, 2016 Share-Class Characteristics Investor Shares ETF Shares Admiral Shares Institutional Shares Institutional Plus Shares Ticker Symbol NAESX VB VSMAX VSCIX VSCPX Expense Ratio1 0.20% 0.08% 0.08% 0.07% 0.05% 30-Day SEC Yield 1.37% 1.49% 1.49% 1.50% 1.49% Portfolio Characteristics DJ U.S. Fund CRSP US Small Cap Index Total Market FA Index Number of Stocks 1,438 1,430 3,833 Median Market Cap $3.5B $3.5B $54.1B Price/Earnings Ratio 31.5x 31.7x 24.4x Price/Book Ratio 2.4x 2.5x 2.8x Return on Equity 11.0% 11.0% 16.5% Earnings Growth Rate 9.7% 9.7% 8.2% Dividend Yield 1.5% 1.5% 2.0% Foreign Holdings 0.0% 0.0% 0.0% Turnover Rate 14% Short-Term Reserves 0.1% Sector Diversification (% of equity exposure) DJ CRSP US U.S. Total Fund Small Cap Index Market FA Index Basic Materials 4.4% 4.5% 2.6% Consumer Goods Consumer Services Financials Health Care Industrials Oil & Gas Technology Telecommunications Utilities Volatility Measures CRSP US Small Cap Index DJ U.S. Total Market FA Index R-Squared Beta These measures show the degree and timing of the fund s fluctuations compared with the indexes over 36 months. Ten Largest Holdings (% of total net assets) Targa Resources Corp. Diamondback Energy Inc. Exploration & Production 0.3% Exploration & Production 0.3 SVB Financial Group Banks 0.3 Advanced Micro Devices Inc. Semiconductors 0.3 Huntington Ingalls Industries Inc. Defense 0.3 HD Supply Holdings Inc. Industrial Suppliers 0.3 CDW Corp. Computer Services 0.3 Steel Dynamics Inc. Iron & Steel 0.3 Newfield Exploration Co. Exploration & Production 0.3 Packaging Corp. of America Containers & Packaging 0.3 Top Ten 3.0% The holdings listed exclude any temporary cash investments and equity index products. 1 The expense ratios shown are from the prospectus dated April 27, 2016, and represent estimated costs for the current fiscal year. For the fiscal year ended December 31, 2016, the expense ratios were 0.18% for Investor Shares, 0.06% for ETF Shares, 0.06% for Admiral Shares, 0.05% for Institutional Shares, and 0.04% for Institutional Plus Shares. 8

11 Small-Cap Index Fund Investment Focus Style Value Blend Growth Market Cap Large Medium Small 9

12 Small-Cap Index 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 $28,000 21, ,000 Average Annual Total Returns Periods Ended December 31, 2016 One Year Five Years Ten Years Final Value of a $10,000 Investment Small-Cap Index Fund*Investor Shares 18.17% 14.68% 8.04% $21,672 Spliced Small-Cap Index ,797 Small-Cap Core Funds Average ,474 Dow Jones U.S. Total Stock Market Float Adjusted Index ,003 For a benchmark description, see the Glossary. Small-Cap Core Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. One Year Five Years Ten Years Final Value of a $10,000 Investment Small-Cap Index Fund ETF Shares Net Asset Value 18.31% 14.83% 8.18% $21,958 Spliced Small-Cap Index ,797 Dow Jones U.S. Total Stock Market Float Adjusted Index , See Financial Highlights for dividend and capital gains information.

13 Small-Cap Index Fund Average Annual Total Returns Periods Ended December 31, 2016 One Year Five Years Ten Years Final Value of a $10,000 Investment Small-Cap Index Fund Admiral Shares 18.30% 14.83% 8.18% $21,951 Spliced Small-Cap Index ,797 Dow Jones U.S. Total Stock Market Float Adjusted Index ,003 One Year Five Years Ten Years Final Value of a $5,000,000 Investment Small-Cap Index Fund Institutional Shares 18.32% 14.85% 8.21% $11,007,326 Spliced Small-Cap Index ,898,613 Dow Jones U.S. Total Stock Market Float Adjusted Index ,001,613 One Year Five Years Since Inception (12/17/2010) Final Value of a $100,000,000 Investment Small-Cap Index Fund Institutional Plus Shares 18.33% 14.87% 11.82% $196,296,197 Spliced Small-Cap Index ,571,781 Dow Jones U.S. Total Stock Market Float Adjusted Index ,055,560 "Since Inception" performance is calculated from the Institutional Plus Shares inception date for both the fund and its comparative standards. Cumulative Returns of ETF Shares: December 31, 2006, Through December 31, 2016 One Year Five Years Ten Years Small-Cap Index Fund ETF Shares Market Price 18.35% 99.81% % Small-Cap Index Fund ETF Shares Net Asset Value Spliced Small-Cap Index

14 Small-Cap Index Fund Fiscal-Year Total Returns (%): December 31, 2006, Through December 31, Small-Cap Index Fund Investor Shares Spliced Small-Cap Index For a benchmark description, see the Glossary. 12

15 Small-Cap Index Fund Financial Statements Statement of Net Assets Investments Summary As of December 31, 2016 This Statement summarizes the fund s holdings by asset type. Details are reported for each of the fund s 50 largest individual holdings and for investments that, in total for any issuer, represent more than 1% of the fund s net assets. The total value of smaller holdings is reported as a single amount within each category. 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 complete listing of the fund s holdings is available electronically on vanguard.com and on the Securities and Exchange Commission s website (sec.gov), or you can have it mailed to you without charge by calling For the first and third fiscal quarters, the fund files the lists with the SEC on Form N-Q. Shareholders can look up the fund s Forms N-Q on the SEC s website. 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). Market Percentage Value of Net Shares Assets Common Stocks Basic Materials Steel Dynamics Inc. 5,172, , % RPM International Inc. 2,979, , % Basic Materials Other 2,702, % 3,047, % Consumer Goods * Middleby Corp. 1,284, , % Leggett & Platt Inc. 2,985, , % Pinnacle Foods Inc. 2,636, , % Consumer Goods Other 4,366, % 4,818, % Consumer Services Domino s Pizza Inc. 1,073, , % * JetBlue Airways Corp. 7,229, , % Consumer Services Other 7,941, % 8,274, % Financials * SVB Financial Group 1,163, , % * Signature Bank 1,158, , % East West Bancorp Inc. 3,219, , % Regency Centers Corp. 2,333, , % Apartment Investment & Management Co. 3,503, , % Kilroy Realty Corp. 2,060, , % American Campus Communities Inc. 2,949, , % PacWest Bancorp 2,685, , % National Retail Properties Inc. 3,285, , % WP Carey Inc. 2,373, , % American Financial Group Inc. 1,551, , % ^ Omega Healthcare Investors Inc. 4,357, , % Financials Other 17,002, % 18,862, % 13

16 Small-Cap Index Fund Market Percentage Value of Net Shares Assets Health Care Teleflex Inc. 983, , % * Align Technology Inc. 1,601, , % * MEDNAX Inc. 2,090, , % West Pharmaceutical Services Inc. 1,634, , % Health Care Other 5,478, % 6,069, % Industrials Huntington Ingalls Industries Inc. 1,035, , % * HD Supply Holdings Inc. 4,479, , % Packaging Corp. of America 2,104, , % Broadridge Financial Solutions Inc. 2,661, , % Valspar Corp. 1,594, , % Carlisle Cos. Inc. 1,440, , % Spirit AeroSystems Holdings Inc. Class A 2,717, , % AO Smith Corp. 3,298, , % Jack Henry & Associates Inc. 1,744, , % IDEX Corp. 1,702, , % Lennox International Inc. 913, , % * Keysight Technologies Inc. 3,795, , % Allegion plc 2,144, , % * CoStar Group Inc. 727, , % Industrials Other 11,464, % 13,700, % Oil & Gas Targa Resources Corp. 3,836, , % * Diamondback Energy Inc. 1,977, , % * Newfield Exploration Co. 4,441, , % *,^ Chesapeake Energy Corp. 19,816, , % Oil & Gas Other 2,987, % 3,721, % 1Other 5, % Technology * Advanced Micro Devices Inc. 17,593, , % CDW Corp. 3,587, , % Leidos Holdings Inc. 3,357, , % * Cadence Design Systems Inc. 6,402, , % * CommScope Holding Co. Inc. 4,306, , % * Microsemi Corp. 2,560, , % Technology Other 6,900, % 7,918, % Telecommunications 291, % Utilities Westar Energy Inc. Class A 3,166, , % UGI Corp. 3,866, , % Atmos Energy Corp. 2,322, , % Utilities Other 1,930, % 2,459, % Total Common Stocks (Cost $53,367,847) 69,169, % 2 14

17 Small-Cap Index Fund Market Percentage Value of Net Coupon Shares Assets Temporary Cash Investments Money Market Fund 3,4 Vanguard Market Liquidity Fund 0.823% 10,945,278 1,094, % 5,6U.S. Government and Agency Obligations 17, % Total Temporary Cash Investments (Cost $1,112,320) 1,112, % 2 Total Investments (Cost $54,480,167) 70,281, % Amount Other Assets and Liabilities Other Assets Investment in Vanguard 5,075 Receivables for Investment Securities Sold 195,062 Receivables for Accrued Income 111,525 Receivables for Capital Shares Issued 78,345 Other Assets 5 1,830 Total Other Assets 391, % Liabilities Payables for Investment Securities Purchased (19,842) Collateral for Securities on Loan (734,518) Payables for Capital Shares Redeemed (438,316) Payables to Vanguard (34,940) Other Liabilities (4,150) Total Liabilities (1,231,766) (1.8%) Net Assets 69,441, % At December 31, 2016, net assets consisted of: Amount Paid-in Capital 56,118,572 Overdistributed Net Investment Income (23,248) Accumulated Net Realized Losses (2,449,384) Unrealized Appreciation (Depreciation) Investment Securities 15,801,391 Futures Contracts (5,181) Swap Contracts (521) Net Assets 69,441,629 Investor Shares Net Assets Applicable to 71,269,277 outstanding $.001 par value shares of beneficial interest (unlimited authorization) 4,400,726 Net Asset Value Per Share Investor Shares $

18 Small-Cap Index Fund Amount ETF Shares Net Assets Applicable to 125,313,816 outstanding $.001 par value shares of beneficial interest (unlimited authorization) 16,152,927 Net Asset Value Per Share ETF Shares $ Admiral Shares Net Assets Applicable to 449,721,155 outstanding $.001 par value shares of beneficial interest (unlimited authorization) 27,778,167 Net Asset Value Per Share Admiral Shares $61.77 Institutional Shares Net Assets Applicable to 210,958,628 outstanding $.001 par value shares of beneficial interest (unlimited authorization) 13,029,882 Net Asset Value Per Share Institutional Shares $61.77 Institutional Plus Shares Net Assets Applicable to 45,322,224 outstanding $.001 par value shares of beneficial interest (unlimited authorization) 8,079,927 Net Asset Value Per Share Institutional Plus Shares $ 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 $689,588,000. Represents the aggregate value, by category, of securities that are not among the 50 largest holdings and, in total for any issuer, represent 1% or less of net assets. 1 Other represents securities that are not classified by the fund s benchmark index. 2 The fund invests a portion of its cash reserves in equity markets through the use of index futures contracts and swap contracts. After giving effect to futures and swap investments, the fund s effective common stock and temporary cash investment positions represent 100.1% and 1.1%, respectively, 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 $734,518,000 of collateral received for securities on loan. 5 Securities with a value of $15,290,000 and cash of $1,823,000, have been segregated as initial margin for open futures contracts. 6 Securities with a value of 1,572,000 have been segregated as collateral for open over-the-counter swap contracts. See accompanying Notes, which are an integral part of the Financial Statements.

19 Small-Cap Index Fund Statement of Operations Year Ended December 31, 2016 Investment Income Income Dividends 964,753 Interest 1 1,692 Securities Lending Net 51,566 Total Income 1,018,011 Expenses The Vanguard Group Note B Investment Advisory Services 4,715 Management and Administrative Investor Shares 5,940 Management and Administrative ETF Shares 4,909 Management and Administrative Admiral Shares 8,947 Management and Administrative Institutional Shares 3,926 Management and Administrative Institutional Plus Shares 1,946 Marketing and Distribution Investor Shares 875 Marketing and Distribution ETF Shares 815 Marketing and Distribution Admiral Shares 2,522 Marketing and Distribution Institutional Shares 273 Marketing and Distribution Institutional Plus Shares 98 Custodian Fees 1,422 Auditing Fees 44 Shareholders Reports Investor Shares 89 Shareholders Reports ETF Shares 663 Shareholders Reports Admiral Shares 207 Shareholders Reports Institutional Shares 155 Shareholders Reports Institutional Plus Shares 71 Trustees Fees and Expenses 45 Total Expenses 37,662 Net Investment Income 980,349 Realized Net Gain (Loss) 1 Investment Securities Sold 1,309,386 Futures Contracts 44,048 Swap Contracts 23,815 Realized Net Gain (Loss) 1,377,249 Change in Unrealized Appreciation (Depreciation) Investment Securities 7,977,668 Futures Contracts (7,312) Swap Contracts (1,829) Change in Unrealized Appreciation (Depreciation) 7,968,527 Net Increase (Decrease) in Net Assets Resulting from Operations 10,326,125 1 Interest income, and realized net gain (loss) from affiliated companies of the fund were $1,633,000 and $14,000, respectively. See accompanying Notes, which are an integral part of the Financial Statements. 17

20 Small-Cap Index Fund Statement of Changes in Net Assets Year Ended December 31, Increase (Decrease) in Net Assets Operations Net Investment Income 980, ,370 Realized Net Gain (Loss) 1,377,249 2,704,498 Change in Unrealized Appreciation (Depreciation) 7,968,527 (5,655,783) Net Increase (Decrease) in Net Assets Resulting from Operations 10,326,125 (2,160,915) Distributions Net Investment Income Investor Shares (62,250) (55,298) ETF Shares (227,380) (164,546) Admiral Shares (399,294) (309,236) Institutional Shares (189,498) (148,089) Institutional Plus Shares (120,494) (101,667) Realized Capital Gain Investor Shares ETF Shares Admiral Shares Institutional Shares Institutional Plus Shares Total Distributions (998,916) (778,836) Capital Share Transactions Investor Shares (288,011) (344,117) ETF Shares 2,612,289 2,265,366 Admiral Shares 2,568,322 2,571,958 Institutional Shares 1,232, ,267 Institutional Plus Shares 52,625 1,305,476 Net Increase (Decrease) from Capital Share Transactions 6,177,279 6,403,950 Total Increase (Decrease) 15,504,488 3,464,199 Net Assets Beginning of Period 53,937,141 50,472,942 End of Period 1 69,441,629 53,937,141 1 Net Assets End of Period includes undistributed (overdistributed) net investment income of ($23,248,000) and ($28,872,000). 18 See accompanying Notes, which are an integral part of the Financial Statements.

21 Small-Cap Index Fund Financial Highlights Investor Shares For a Share Outstanding Year Ended December 31, Throughout Each Period Net Asset Value, Beginning of Period $53.03 $55.86 $52.69 $38.74 $33.38 Investment Operations Net Investment Income Net Realized and Unrealized Gain (Loss) on Investments (2.840) Total from Investment Operations (2.113) Distributions Dividends from Net Investment Income (.857) (.717) (.708) (.617) (.662) Distributions from Realized Capital Gains Total Distributions (.857) (.717) (.708) (.617) (.662) Net Asset Value, End of Period $61.75 $53.03 $55.86 $52.69 $38.74 Total Return % -3.78% 7.37% 37.62% 18.04% Ratios/Supplemental Data Net Assets, End of Period (Millions) $4,401 $4,058 $4,606 $5,041 $3,813 Ratio of Total Expenses to Average Net Assets 0.18% 0.20% 0.23% 0.24% 0.24% Ratio of Net Investment Income to Average Net Assets 1.55% 1.33% 1.40% 1.39% 1.82% Portfolio Turnover Rate 2 14% 11% 10% 29% 14% 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, including ETF Creation Units. See accompanying Notes, which are an integral part of the Financial Statements. 19

22 Small-Cap Index Fund Financial Highlights ETF Shares For a Share Outstanding Year Ended December 31, Throughout Each Period Net Asset Value, Beginning of Period $ $ $ $80.89 $69.70 Investment Operations Net Investment Income Net Realized and Unrealized Gain (Loss) on Investments (5.931) Total from Investment Operations (4.263) Distributions Dividends from Net Investment Income (1.930) (1.637) (1.673) (1.439) (1.504) Distributions from Realized Capital Gains Total Distributions (1.930) (1.637) (1.673) (1.439) (1.504) Net Asset Value, End of Period $ $ $ $ $80.89 Total Return 18.31% -3.65% 7.51% 37.80% 18.22% Ratios/Supplemental Data Net Assets, End of Period (Millions) $16,153 $11,478 $9,833 $8,217 $4,691 Ratio of Total Expenses to Average Net Assets 0.06% 0.08% 0.09% 0.09% 0.10% Ratio of Net Investment Income to Average Net Assets 1.67% 1.45% 1.54% 1.54% 1.96% Portfolio Turnover Rate 1 14% 11% 10% 29% 14% 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, including ETF Creation Units. 20 See accompanying Notes, which are an integral part of the Financial Statements.

23 Small-Cap Index Fund Financial Highlights Admiral Shares For a Share Outstanding Year Ended December 31, Throughout Each Period Net Asset Value, Beginning of Period $53.05 $55.87 $52.72 $38.76 $33.39 Investment Operations Net Investment Income Net Realized and Unrealized Gain (Loss) on Investments (2.833) Total from Investment Operations (2.036) Distributions Dividends from Net Investment Income (.923) (.784) (.800) (.689) (.719) Distributions from Realized Capital Gains Total Distributions (.923) (.784) (.800) (.689) (.719) Net Asset Value, End of Period $61.77 $53.05 $55.87 $52.72 $38.76 Total Return % -3.64% 7.50% 37.81% 18.24% Ratios/Supplemental Data Net Assets, End of Period (Millions) $27,778 $21,441 $20,034 $10,126 $6,541 Ratio of Total Expenses to Average Net Assets 0.06% 0.08% 0.09% 0.09% 0.10% Ratio of Net Investment Income to Average Net Assets 1.67% 1.45% 1.54% 1.54% 1.96% Portfolio Turnover Rate 2 14% 11% 10% 29% 14% 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, including ETF Creation Units. See accompanying Notes, which are an integral part of the Financial Statements. 21

24 Small-Cap Index Fund Financial Highlights Institutional Shares For a Share Outstanding Year Ended December 31, Throughout Each Period Net Asset Value, Beginning of Period $53.05 $55.87 $52.71 $38.76 $33.39 Investment Operations Net Investment Income Net Realized and Unrealized Gain (Loss) on Investments (2.834) Total from Investment Operations (2.031) Distributions Dividends from Net Investment Income (.929) (.789) (.805) (.693) (.726) Distributions from Realized Capital Gains Total Distributions (.929) (.789) (.805) (.693) (.726) Net Asset Value, End of Period $61.77 $53.05 $55.87 $52.71 $38.76 Total Return 18.32% -3.63% 7.53% 37.80% 18.26% Ratios/Supplemental Data Net Assets, End of Period (Millions) $13,030 $10,036 $9,975 $9,185 $5,955 Ratio of Total Expenses to Average Net Assets 0.05% 0.07% 0.08% 0.08% 0.08% Ratio of Net Investment Income to Average Net Assets 1.68% 1.46% 1.55% 1.55% 1.98% Portfolio Turnover Rate 1 14% 11% 10% 29% 14% 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, including ETF Creation Units. 22 See accompanying Notes, which are an integral part of the Financial Statements.

25 Small-Cap Index Fund Financial Highlights Institutional Plus Shares For a Share Outstanding Year Ended December 31, Throughout Each Period Net Asset Value, Beginning of Period $ $ $ $ $96.37 Investment Operations Net Investment Income Net Realized and Unrealized Gain (Loss) on Investments (8.203) Total from Investment Operations (5.850) Distributions Dividends from Net Investment Income (2.703) (2.310) (2.357) (2.028) (2.120) Distributions from Realized Capital Gains Total Distributions (2.703) (2.310) (2.357) (2.028) (2.120) Net Asset Value, End of Period $ $ $ $ $ Total Return 18.33% -3.62% 7.55% 37.85% 18.29% Ratios/Supplemental Data Net Assets, End of Period (Millions) $8,080 $6,925 $6,024 $4,323 $2,435 Ratio of Total Expenses to Average Net Assets 0.04% 0.05% 0.06% 0.06% 0.06% Ratio of Net Investment Income to Average Net Assets 1.69% 1.48% 1.57% 1.57% 2.00% Portfolio Turnover Rate 1 14% 11% 10% 29% 14% 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, including ETF Creation Units. See accompanying Notes, which are an integral part of the Financial Statements. 23

26 Small-Cap Index Fund Notes to Financial Statements Vanguard Small-Cap Index Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund offers five classes of shares: Investor Shares, ETF Shares, Admiral Shares, Institutional Shares, and Institutional Plus Shares. Investor Shares are available to any investor who meets the fund s minimum purchase requirements. ETF Shares are listed for trading on NYSE Arca; they can be purchased and sold through a broker. Admiral Shares, Institutional Shares, and Institutional Plus 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 materially 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. 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. Futures Contracts: The fund uses index futures contracts to a limited extent, with the objectives of maintaining full exposure to the stock market, enhancing returns, maintaining liquidity, and minimizing transaction costs. The fund may purchase futures contracts to immediately invest incoming cash in the market, or sell futures in response to cash outflows, thereby simulating a fully invested position in the underlying index while maintaining a cash balance for liquidity. The fund may seek to enhance returns by using futures contracts instead of the underlying securities when futures are believed to be priced more attractively than the underlying securities. The primary risks associated with the use of futures contracts are imperfect correlation between changes in market values of stocks held by the fund and the prices of futures contracts, and the possibility of an illiquid market. Counterparty risk involving futures is mitigated because a regulated clearinghouse is the counterparty instead of the clearing broker. To further mitigate counterparty risk, the fund trades futures contracts on an exchange, monitors the financial strength of its clearing brokers and clearinghouse, and has entered into clearing agreements with its clearing brokers. The clearinghouse imposes initial margin requirements to secure the fund s performance and requires daily settlement of variation margin representing changes in the market value of each contract. 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 less than 1% and 0% of net assets, respectively, based on the average of aggregate settlement values at each quarter-end during the period. 24

27 Small-Cap Index Fund 3. Swap Contracts: The fund has entered into equity swap contracts to earn the total return on selected reference stocks in the fund s target index. Under the terms of the swaps, the fund receives the total return on the referenced stock (i.e., receiving the increase or paying the decrease in value of the selected reference stock and receiving the equivalent of any dividends in respect of the selected referenced stock) over a specified period of time, applied to a notional amount that represents the value of a designated number of shares of the selected reference stock at the beginning of the equity swap contract. The fund also pays a floating rate that is based on short-term interest rates, applied to the notional amount. At the same time, the fund invests an amount approximating the notional amount of the swap in high-quality temporary cash investments. The notional amounts of swap contracts are not recorded in the Statement of Net Assets. Swaps are valued daily based on market quotations received from independent pricing services or recognized dealers and the change in value is recorded in the Statement of Net Assets as an asset (liability) and in the Statement of Operations as unrealized appreciation (depreciation) until termination of the swap, at which time realized gain (loss) is recorded. A risk associated with all types of swaps is the possibility that a counterparty may default on its obligation to pay net amounts due to the fund. The fund s maximum amount subject to counterparty risk is the unrealized appreciation on the swap contract. The fund mitigates its counterparty risk by entering into swaps only with a diverse group of prequalified counterparties, monitoring their financial strength, entering into master netting arrangements with its counterparties, and requiring its counterparties to transfer collateral as security for their performance. In the absence of a default, the collateral pledged or received by the fund cannot be repledged, resold or rehypothecated. In the event of a counterparty s default (including bankruptcy), the fund may terminate any swap contracts with that counterparty, determine the net amount owed by either party in accordance with its master netting arrangements, and sell or retain any collateral held up to the net amount owed to the fund under the master netting arrangements. The swap contracts contain provisions whereby a counterparty may terminate open contracts if the fund net assets decline below a certain level, triggering a payment by the fund if the fund is in a net liability position at the time of the termination. The payment amount would be reduced by any collateral the fund has pledged. Any securities pledged as collateral for open contracts are noted in the Statement of Net Assets. The value of collateral received or pledged is compared daily to the value of the swap contracts exposure with each counterparty, and any difference, if in excess of a specified minimum transfer amount, is adjusted and settled within two business days. During the year ended December 31, 2016, the fund s average amounts of investments in total return swaps represented less than 1% of net assets, based on the average of notional amounts at each quarter-end during the period. 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 (December 31, ), 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 on the next business day. The fund further mitigates its counterparty risk by entering into securities lending transactions 25