Vanguard U.S. Government Bond Funds

Transcription

1 Annual Report January 31, 2018 Vanguard U.S. Government Bond Funds Vanguard Short-Term Treasury Fund Vanguard Short-Term Federal Fund Vanguard Intermediate-Term Treasury Fund Vanguard GNMA Fund Vanguard Long-Term Treasury Fund

2 Vanguard s Principles for Investing Success We want to give you the best chance of investment success. These principles, grounded in Vanguard s research and experience, can put you on the right path. Goals. Create clear, appropriate investment goals. Balance. Develop a suitable asset allocation using broadly diversified funds. Cost. Minimize cost. Discipline. Maintain perspective and long-term discipline. A single theme unites these principles: Focus on the things you can control. We believe there is no wiser course for any investor. Contents Your Fund s Performance at a Glance CEO s Perspective Advisors Report Results of Proxy Voting Short-Term Treasury Fund Short-Term Federal Fund Intermediate-Term Treasury Fund GNMA Fund Long-Term Treasury Fund 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: Nautical images have been part of Vanguard s rich heritage since its start in For an incoming ship, a lighthouse offers a beacon and safe path to shore. You can similarly depend on Vanguard to put you first and light the way as you strive to meet your financial goals. Our client focus and low costs, stemming from our unique ownership structure, assure that your interests are paramount.

3 Your Fund s Performance at a Glance For the 12 months ended January 31, 2018, the returns of the funds in this report ranged from 0.31% for both Vanguard Short-Term Treasury Fund and Vanguard Intermediate-Term Treasury Fund to 4.21% for Vanguard Long-Term Treasury Fund. (Returns cited are for Investor Shares.) Results versus their benchmark indexes and peer groups were mixed. Short-term interest rates moved significantly higher during the period as the Federal Reserve raised its federal funds target rate three times. Longer-term rates, which are driven more by expectations for growth and inflation down the road, moved less. Holding more shorter maturities proved a headwind for the Short-Term and Intermediate-Term Treasury Funds, whereas the Short-Term Federal Fund s overweighted allocation to agency debt helped. Yield curve positioning and duration worked against the Long-Term Treasury Fund. In the GNMA Fund, mortgage-related securities other than GNMAs added value. Total Returns: Fiscal Year Ended January 31, Day SEC Yield Income Returns Capital Returns Total Returns Vanguard Short-Term Treasury Fund Investor Shares 1.80% 1.19% -1.50% -0.31% Admiral Shares Bloomberg Barclays U.S. 1 5 Year Treasury Bond Index Short-Term U.S. Treasury Funds Average 0.34 Short-Term U.S. Treasury Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. Vanguard Short-Term Federal Fund Investor Shares 1.90% 1.32% -1.34% -0.02% Admiral Shares Bloomberg Barclays U.S. 1 5 Year Government Bond Index Short-Intermediate U.S. Government Funds Average Short-Intermediate U.S. Government Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. Vanguard Intermediate-Term Treasury Fund Investor Shares 2.22% 1.76% -2.07% -0.31% Admiral Shares Bloomberg Barclays U.S Year Treasury Bond Index 0.07 General U.S. Treasury Funds Average 1.73 General U.S. Treasury Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company.

4 30-Day SEC Yield Income Returns Capital Returns Total Returns Vanguard GNMA Fund Investor Shares 2.71% 2.66% -1.81% 0.85% Admiral Shares Bloomberg Barclays U.S. GNMA Bond Index 0.86 GNMA Funds Average 0.15 GNMA Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. Vanguard Long-Term Treasury Fund Investor Shares 2.68% 2.77% 1.44% 4.21% Admiral Shares Bloomberg Barclays U.S. Long Treasury Bond Index 4.62 General U.S. Treasury Funds Average 1.73 General U.S. Treasury 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. Total Returns: Ten Years Ended January 31, 2018 Average Annual Return Short-Term Treasury Fund Investor Shares 1.35% Bloomberg Barclays U.S. 1 5 Year Treasury Bond Index 1.76 Short-Term U.S. Treasury Funds Average 1.16 Short-Term U.S. Treasury Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. Short-Term Federal Fund Investor Shares 1.80% Bloomberg Barclays U.S. 1 5 Year Government Bond Index 1.79 Short-Intermediate U.S. Government Funds Average 1.59 Short-Intermediate U.S. Government Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. Intermediate-Term Treasury Fund Investor Shares 3.11% Bloomberg Barclays U.S Year Treasury Bond Index 3.71 General U.S. Treasury Funds Average 3.89 General U.S. Treasury Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. GNMA Fund Investor Shares 3.59% Bloomberg Barclays U.S. GNMA Bond Index 3.55 GNMA Funds Average 2.98 GNMA Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. 2

5 Average Annual Return Long-Term Treasury Fund Investor Shares 5.71% Bloomberg Barclays U.S. Long Treasury Bond Index 5.93 General U.S. Treasury Funds Average 3.89 General U.S. Treasury 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 Admiral Shares Peer Group Average Short-Term Treasury Fund 0.20% 0.10% 0.47% Short-Term Federal Fund Intermediate-Term Treasury Fund GNMA Fund Long-Term Treasury Fund The fund expense ratios shown are from the prospectus dated May 26, 2017, and represent estimated costs for the current fiscal year. For the fiscal year ended January 31, 2018, the funds expense ratios were: for the Short-Term Treasury Fund, 0.20% for Investor Shares and 0.10% for Admiral Shares; for the Short-Term Federal Fund, 0.20% for Investor Shares and 0.10% for Admiral Shares; for the Intermediate-Term Treasury Fund, 0.20% for Investor Shares and 0.10% for Admiral Shares; for the GNMA Fund, 0.21% for Investor Shares and 0.11% for Admiral Shares; and for the Long-Term Treasury Fund, 0.20% for Investor Shares and 0.10% for Admiral Shares. 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 Short-Term Treasury Fund, Short-Term U.S. Treasury Funds; for the Short-Term Federal Fund, Short-Intermediate U.S. Government Funds; for the Intermediate-Term Treasury Fund, General U.S. Treasury Funds; for the GNMA Fund, GNMA Funds; and for the Long-Term Treasury Fund, General U.S. Treasury Funds. 3

6 CEO s Perspective Dear Shareholder, When you start a new job, it s natural to reflect on both the past and the future. And so it is in my case, having begun my service as just the fourth chief executive in Vanguard s history. Tim Buckley President and Chief Executive Officer I feel extremely fortunate to have the chance to lead a company filled with people who come to work every day passionate about Vanguard s core purpose: to take a stand for all investors, to treat them fairly, and to give them the best chance for investment success. Making a real difference When I joined Vanguard in 1991, I found a mission-driven team focused on improving lives helping people retire more comfortably, put their children through college, and achieve financial security. I found a company with purpose in an industry ripe for improvement. It was clear, even early in my career, that the cards were stacked against most investors. Hidden fees, performancechasing, and poor advice were relentlessly eroding investors dreams. We knew Vanguard could be different and, as a result, could make a real difference. Over the past 25 years, for example, Vanguard has lowered our funds asset-weighted average expense ratio 4

7 from 0.31% to 0.12%. And over the past decade, 94% of our funds have beaten the average annual return of their peers. 1 Focused on your success Vanguard is built for Vanguard investors as a client-owned company, we focus solely on you, our fund shareholders. Everything we do is designed to give our clients the best chance for investment success. In my new role as CEO, I intend to keep this priority front and center. We re proud of what we ve achieved, but we re even more excited about what s to come. As I write this, we ve experienced a period of pronounced market volatility. Strong economic growth and budding signs of inflation have raised concerns about a more aggressive Federal Reserve. Although volatility can test investors nerves, we sometimes think of this as Vanguard weather a time when having a disciplined, low-cost, and long-term approach to investment management serves investors well. Market Barometer Average Annual Total Returns Periods Ended January 31, 2018 One Year Three Years Five Years Stocks Russell 1000 Index (Large-caps) 25.84% 14.28% 15.72% 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) 2.15% 1.14% 2.01% Bloomberg Barclays Municipal Bond Index (Broad tax-exempt market) Citigroup Three-Month U.S. Treasury Bill Index CPI Consumer Price Index 2.07% 1.98% 1.48% The performance data shown represent past performance, which is not a guarantee of future results. 1 For the ten-year period through December 31, 2017, 9 of 9 Vanguard money market funds, 56 of 60 bond funds, 21 of 22 balanced funds, and 131 of 140 stock funds, or 217 of 231 Vanguard funds, outperformed their peer-group averages. Sources: Vanguard, based on data from Lipper, a Thomson Reuters Company. 5

8 Steady, time-tested guidance Our guidance for investors, as always, is to stay the course, tune out the hyperbolic headlines, and focus on your goals and what you can control, such as costs and how much you save. This time-tested advice has served our clients well over the decades. Regardless of how the markets perform in the short term, I m incredibly optimistic about the future for our investors. We have a dedicated team serving you, and we will never stop striving to make Vanguard the best place for you to invest through our high-quality funds and services, advice and guidance to help you meet your financial goals, and an experience that makes you feel good about entrusting us with your hard-earned savings. Thank you for your continued loyalty. Sincerely, Mortimer J. Buckley President and Chief Executive Officer February 15,

9 Advisors Report For the Short-, Intermediate-, and Long-Term Treasury Funds and the Short-Term Federal Fund Interest rates mostly moved higher, with short-term rates rising the most. Returns for the four U.S. Government Bond Funds managed by Vanguard s Fixed Income Group ranged from 0.31% for Investor Shares of both Vanguard Short-Term Treasury Fund and Vanguard Intermediate-Term Treasury Fund to 4.32% for Admiral Shares of Vanguard Long-Term Treasury Fund. The Short-Term Federal Fund finished just ahead of its benchmark index; the other funds lagged theirs. The Short-Term Federal Fund and the Long-Term Treasury Fund outpaced the average returns of their peer groups, while the Short-Term Treasury Fund and the Intermediate-Term Treasury Fund underperformed theirs. With more movement at the short end of the yield curve, the 30-day SEC yield for Investor Shares of the Short-Term Treasury Fund gained the most, rising 81 basis points to 1.80%. Investor Shares of the Long-Term Treasury Fund rose the least, edging up only 4 basis points to 2.68%. (A basis point is one onehundredth of a percentage point.) Investment environment Anticipation of higher infrastructure spending, deregulation, and tax cuts under a new presidential administration contributed to strong stock market returns during the funds fiscal year. Although Yields of U.S. Treasury Securities January 31, January 31, Maturity years 1.21% 2.14% 3 years years years years Source: Vanguard. 7

10 political debates waylaid much of the administration s agenda, tax legislation ultimately passed in December The economy remained strong and inflation was subdued. Many stock market indexes reached record highs as companies posted strong profits. The Federal Reserve under Janet Yellen was also enthusiastic about the health of the U.S. economy. It raised short-term interest rates three times during the year, pushing its target range for the federal funds rate to 1.25% 1.5%. It also began to reduce the $4.5 trillion balance sheet it had amassed as part of a stimulus package during the recession. All were signals that the central bank was intent on normalizing monetary policy. The Fed s decisions were supported by solid economic readings. The U.S. economy made up for a sluggish start to the year with stronger growth later on. For 2017, gross domestic product grew at a rate of 2.3%, up from 1.5% in The unemployment rate continued to grind lower, hovering at 4.1% at the end of the fiscal year compared with 4.8% at the beginning. Wage growth remained softer than expected for much of the period, and inflation expectations drifted lower before ending the year on an upward track. Fed action contributed to a significant rise in short-term yields. The 2-year Treasury note rose 93 basis points to 2.14%, and the 5-year note rose 61 basis points to 2.52%. Longer-term yields, which are more affected by market expectations for growth and inflation, moved less. The yield of the bellwether 10-year Treasury note was lower than where it had started for a good part of the year but finished up 26 basis points at 2.71%. Management of the funds The Short-Term and Intermediate-Term Treasury Funds have a structurally short duration relative to their benchmarks. (Duration is a measure of a portfolio s sensitivity to interest rate changes.) Although that stance might have been expected to help the funds during this period of rising rates, it dampened their relative performance this time around as shorter rates rose more than longer ones. Bond fund managers often adjust the duration of their portfolios based on where they think the economy is headed and what that might mean for interest rates. However, duration calls are hard to consistently get right over time. We try to take advantage of a broader set of opportunities to generate alpha that are not correlated with duration calls. Our investment toolkit includes AAA-rated debt other than Treasuries such as mortgagebacked securities, other agency debt, and Treasury Inflation-Protected Securities (TIPS). Security selection plays a role as well: We use relative value metrics to identify individual bonds that offer attractive return potential. A tactical opportunity arose during the period, and we added mortgage-backed securities when they cheapened on the 8

11 prospect of the Fed s moving to unwind its balance sheet. We then reduced our exposure once their valuations recovered after the gradual pace of tapering was announced. We selectively purchased agency debt as well, which added some income to the funds. An overweighted allocation to these securities helped the Short-Term Federal Fund surpass its benchmark and the average return of its peer group. We also added Treasury inflationprotected securities to all four funds early in the period when medium-term inflation expectations seemed low. We then reduced that out-of-benchmark allocation as breakeven inflation widened toward our targeted valuation levels. Outlook The pace of productivity growth, demographic trends, and the impact of new technologies, among other things, pose long-term structural challenges. Nonetheless, the U.S. economy is on pace to break above its long-term potential and grow at around 2.5% in The unemployment rate has fallen to its lowest level since 2000 and is likely to move even lower. Although it s taken longer than expected, we ve seen some indications of late that the tight labor market is putting some upward pressure on wages. Along with stable and broader global growth, that may well lead to a cyclical upswing in inflation, a scenario the financial markets are now beginning to price in. Recent weakness in the U.S. dollar is also likely to bolster core inflation metrics, albeit moderately and over the course of the next year. However, our long-term outlook, which calls for tepid inflation, remains unchanged. That backdrop should justify the Fed, now under the chairmanship of Jerome Powell, in raising the federal funds rate to at least 2% by the end of The Fed will probably want to stick to the framework and timetable it has laid out for reductions in its balance sheet, barring unexpected economic data or unintended consequences from tapering in the bond market. Volatility has recently picked up from the very low levels we ve been experiencing for some time, bringing with it more opportunities to take advantage of price dislocations in the market. Rising inflation expectations seem to have been the trigger, but other potential developments could also fuel volatility. These include midterm elections, stalled or scuttled trade negotiations, and flare-ups in geopolitical tensions. In addition, as 2018 unfolds, we anticipate a convergence of monetary policy, with central banks adopting a less accommodative stance some raising rates, some planning to do so, and some reducing quantitative easing. 9

12 It s worth restating that investors should look beyond short-term volatility and adhere to their long-term investment strategies. And keep in mind the silver lining in higher rates for long-term investors coupon payments and proceeds from maturing bonds can be reinvested at higher rates. Whatever the markets may bring, our experienced team of portfolio managers and traders will continue to seek out opportunities to add to the funds performance. John Hollyer, CFA, Principal and Global Head of Fixed Income Group Gemma Wright-Casparius, Principal and Portfolio Manager Brian Quigley, Portfolio Manager Vanguard Fixed Income Group February 16, 2018 For the GNMA Fund For the 12 months ended January 31, 2018, Investor Shares of Vanguard GNMA Fund returned 0.85% and Admiral Shares returned 0.95%. The fund s benchmark index, the Bloomberg Barclays U.S. GNMA Bond Index, returned 0.86%. Investment environment Over the period, global fixed income markets generated solid gains. Escalating geopolitical tensions and serial disappointments in inflation data helped contain the increase in sovereign yields prompted by central bank policy normalization. U.S. political controversies in particular, the ongoing investigation into alleged involve ment by Russia in the 2016 presidential election led to a short-lived dip in risk assets. Elections in France and the United Kingdom presented potential sources of volatility but proved benign. Despite concerns about prospects for retailers, particularly in the United States, generally solid corporate earnings, strong global economic data, and continued demand for yield-producing assets supported credit markets and led to tighter spreads. Monetary policy continued down an incrementally more hawkish path. The Federal Reserve announced it would begin tapering its asset purchases in October, raised rates three times over the period, and projected an additional three hikes in At its October meeting, the European Central Bank announced a reduction in its monthly asset purchases to 30 billion from 60 billion beginning in January, but it extended the purchase program through September Strong growth and inflation data prompted the Bank of Canada to increase rates for the first time in seven years. The Bank of England raised interest rates for the first time in ten years. However, it tilted dovish at the press conference announcing the 10

13 move, noting that future rate hikes would depend on the stability of the Brexit transition. Developed-market government yields ended mixed as improving global economic data were balanced by subdued inflation readings. In the United States, the yield curve flattened. Front-end yields, heavily influenced by Fed monetary policy expectations, rose the most, while the 30-year Treasury yield declined. German bund yields increased along with improving growth prospects in the region. Longer-term U.K. yields fell amid Brexit uncertainty. Japanese government bond yields, anchored by the Bank of Japan s yield-targeting policy, were little changed. Absolute returns in most major fixed income spread sectors were positive. On an excess return basis, all of the major spread sectors posted positive returns, including securitized, high-yield, emergingmarket debt and investment-grade corporates, led by lower-rated sectors. The agency mortgage-backed securities (MBS) market returned 1.31% as measured by the Barclays MBS Fixed Rate Index, surpassing duration-equivalent Treasuries by 69 basis points (as measured by Wellington). Mortgages started the period with a cautious outlook amid concerns over the timing of the Federal Reserve s balance sheet tapering. However, increased clarity about the Fed s plan to gradually taper its MBS reinvestments helped provide stability to the sector. In September, the Fed announced it would officially begin its balance sheet normal ization process in October. Extremely low levels of volatility and generally range-bound 10-year Treasury yields helped MBS outperform for the balance of the year. The current coupon mortgage spread compressed to its tightest level since the announcement of quantitative easing in Within the MBS sector, conventionals (FHLMC, FNMA) bested GNMA passthroughs as the possibility of reduced banking regulations lowered demand for GNMAs. Thirty-year securities surpassed 15-year, and lower coupons did better than higher ones. GNMA securities returned 0.86% as measured by the Bloomberg Barclays U.S. GNMA Bond Index. They beat duration-equivalent Treasuries by 16 basis points (as measured by Wellington) but fell behind conventional mortgages. The fund s successes On average, the fund had an underweighted allocation to GNMAs, instead favoring conventionals, Fannie Mae multifamily Delegated Underwriting and Servicing (DUS) bonds, and agency collateralized mortgage obligations (CMOs). This positioning was beneficial as GNMAs lagged DUS bonds and agency CMOs on an excess return basis. The fund s tactical duration and yield curve position also helped relative performance. The fund s shortfalls Selection within 30-year GNMA securities detracted from relative results. 11

14 The fund s positioning Our overall MBS positioning, which includes agency pass-throughs, CMOs, and DUS bonds, is relatively neutral. Within that mix, we have underweighted agency pass-throughs in favor of DUS bonds, agency CMOs, and high-quality agency multifamily bonds with relatively stable cash flows and duration profiles. The underweighted allocation to passthroughs is primarily concentrated in 30-year GNMA 3.0% and 3.5% coupons. Although we do not see a significant near-term source of underperformance, historically tight spreads and ultra-low volatility leave us with a negative view of agency MBS pass-throughs. As a result, we have tilted our holdings toward other sectors with attractive income and less sensitivity to prepayments or a pickup in volatility. In fact, while we often maintain this bias toward stability, our MBS portfolios now have their lowest weighting in agency pass-throughs since the crisis. Mortgage spreads to Treasuries are historically tight during this time of steady economic growth, benign inflation, and low volatility. And tight valuations in competing spread sectors are creating demand for MBS as investors de-risk and shift into high-quality assets. However, we are not advocating underweighted allocations to all sectors of the agency MBS market. They are able to earn positive carry in a steady state environment, which often continues for longer than expected. Instead, we have shifted our portfolio to the more stable MBS sectors, positioning us for an increase in volatility without a significant sacrifice in income. The Fed has orchestrated a smooth balance-sheet exit so far, judging by the muted response from the agency MBS market. Still, the market may begin to price in the Fed s actions as its balance sheet begins to shrink more rapidly during Overall, we still expect a muted impact, with the potential for a modest spread-widening in agency MBS as tapering reinvestments progress. Since the Fed has been very transparent over the timing and measured pace of the plan, we expect the path to wider spreads will be very gradual and partially offset by the benefit of MBS income. We still expect MBS spreads to remain toward the tight end of their range relative to long-term history. We base this opinion on their favorable supply relative to U.S. Treasuries, lower leverage in the system, a more stable buyer base of long-term investors, a constrained mortgage credit environment, and lower refinancing risk. Michael F. Garrett Senior Managing Director and Fixed Income Portfolio Manager Wellington Management Company LLP February 16,

15 Results of Proxy Voting At a special meeting of shareholders on November 15, 2017, fund shareholders approved the following proposals: Proposal 1 Elect trustees for the fund.* The individuals listed in the table below were elected as trustees for the fund. All trustees with the exception of Ms. Mulligan, Ms. Raskin, and Mr. Buckley (each of whom already serves as a director of The Vanguard Group, Inc.) served as trustees to the funds prior to the shareholder meeting. Percentage Trustee For Withheld For Mortimer J. Buckley 13,797,659, ,742, % Emerson U. Fullwood 13,808,942, ,459, % Amy Gutmann 13,799,031, ,369, % JoAnn Heffernan Heisen 13,818,500, ,901, % F. Joseph Loughrey 13,816,747, ,654, % Mark Loughridge 13,824,483, ,918, % Scott C. Malpass 13,800,329, ,071, % F. William McNabb III 13,774,270, ,131, % Deanna Mulligan 13,816,630, ,771, % André F. Perold 13,628,951, ,450, % Sarah Bloom Raskin 13,806,213, ,188, % Peter F. Volanakis 13,807,988, ,413, % * Results are for all funds within the same trust. Proposal 2 Approve a manager-of-managers arrangement with third-party investment advisors. This arrangement enables the fund to enter into and materially amend investment advisory arrangements with third-party investment advisors, subject to the approval of the fund s board of trustees and certain conditions imposed by the Securities and Exchange Commission, while avoiding the costs and delays associated with obtaining future shareholder approval. Broker Percentage Vanguard Fund For Abstain Against Non-Votes For Intermediate-Term Treasury Fund 286,317,571 12,639,826 11,540,619 54,440, % Long-Term Treasury Fund 145,796,839 12,002,445 10,434,089 25,700, % Short-Term Federal Fund 272,373,176 7,741,900 5,487,483 63,981, % Short-Term Treasury Fund 344,126,370 12,115,520 11,319,781 84,922, % 13

16 Proposal 3 Approve a manager-of-managers arrangement with wholly owned subsidiaries of Vanguard. This arrangement enables Vanguard or the fund to enter into and materially amend investment advisory arrangements with wholly owned subsidiaries of Vanguard, subject to the approval of the fund s board of trustees and any conditions imposed by the Securities and Exchange Commission (SEC), while avoiding the costs and delays associated with obtaining future shareholder approval. The ability of the fund to operate in this manner is contingent upon the SEC s approval of a pending application for an order of exemption. Broker Percentage Vanguard Fund For Abstain Against Non-Votes For GNMA Fund 1,473,758,217 72,909,320 68,557, ,357, % Intermediate-Term Treasury Fund 288,856,662 11,475,169 10,166,185 54,440, % Long-Term Treasury Fund 148,713,118 11,341,973 8,178,282 25,700, % Short-Term Federal Fund 273,366,771 7,441,705 4,794,082 63,981, % Short-Term Treasury Fund 345,772,284 11,858,115 9,931,273 84,922, % Shareholders of Vanguard GNMA Fund, Vanguard Intermediate-Term Treasury Fund, Vanguard Long-Term Treasury Fund, and Vanguard Short-Term Treasury Fund did not approve the following proposal: Proposal 7 Institute transparent procedures to avoid holding investments in companies that, in management s judgment, substantially contribute to genocide or crimes against humanity, the most egregious violations of human rights. Such procedures may include time-limited engagement with problem companies if management believes that their behavior can be changed. The trustees recommended a vote against the proposal for the following reasons: (1) Vanguard is fully compliant with all applicable U.S. laws and regulations that prohibit the investment in any company owned or controlled by the government of Sudan; (2) the addition of further investment constraints is not in fund shareholders best interests if those constraints are unrelated to a fund s stated investment objective, policies, and strategies; and (3) divestment is an ineffective means to implement social change, as it often puts the shares into the hands of another owner with no direct impact to the company s capitalization. Broker Percentage Vanguard Fund For Abstain Against Non-Votes For GNMA Fund 352,003,560 98,040,853 1,165,180, ,357, % Intermediate-Term Treasury Fund 57,596,356 22,025, ,876,045 54,440, % Long-Term Treasury Fund 47,923,993 14,083, ,225,881 25,700, % Short-Term Treasury Fund 98,869,568 17,490, ,201,441 84,922, % 14

17 Short-Term Treasury Fund Fund Profile As of January 31, 2018 Share-Class Characteristics Investor Shares Admiral Shares Ticker Symbol VFISX VFIRX Expense Ratio % 0.10% 30-Day SEC Yield 1.80% 1.90% Financial Attributes Bloomberg Fund Barclays 1 5 Year Treasury Index Bloomberg Barclays Aggregate Bond Index Number of Bonds ,734 Yield to Maturity (before expenses) 2.3% 2.3% 3.0% Average Coupon 1.3% 1.8% 3.1% Average Duration 2.4 years 2.7 years 6.1 years Average Effective Maturity 2.0 years 2.8 years 8.3 years Short-Term Reserves 1.0% Sector Diversification (% of portfolio) Government Mortgage-Backed 0.6% Treasury/Agency 99.4 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 1 5 Year Treasury Index Bloomberg Barclays 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 11.6% 1-3 Years Years Years Years 0.3 Distribution by Credit Quality (% of portfolio) U.S. Government 99.1% Not Rated 0.9 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. Investment Focus Average Maturity Short Med. Long Credit Quality Treasury/ Agency Investment-Grade Corporate Below Investment-Grade 1 The expense ratios shown are from the prospectus dated May 26, 2017, and represent estimated costs for the current fiscal year. For the fiscal year ended January 31, 2018, the expense ratios were 0.20% for Investor Shares and 0.10% for Admiral Shares. 15

18 Short-Term Treasury Fund Performance Summary All of the returns in this report represent past performance, which is not a guarantee of future results that may be achieved by the fund. (Current performance may be lower or higher than the performance data cited. For performance data current to the most recent month-end, visit our website at vanguard.com/performance.) Note, too, that both investment returns and principal value can fluctuate widely, so an investor s shares, when sold, could be worth more or less than their original cost. The returns shown do not reflect taxes that a shareholder would pay on fund distributions or on the sale of fund shares. Cumulative Performance: January 31, 2008, Through January 31, 2018 Initial Investment of $10,000 $18,000 11, ,000 Average Annual Total Returns Periods Ended January 31, 2018 One Year Five Years Ten Years Final Value of a $10,000 Investment Short-Term Treasury Fund Investor Shares -0.31% 0.41% 1.35% $11,437 Bloomberg Barclays U.S. 1 5 Year Treasury Bond Index ,904 Short-Term U.S. Treasury Funds Average ,218 Bloomberg Barclays U.S. Aggregate Bond Index ,398 Short-Term U.S. Treasury 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 Short-Term Treasury Fund Admiral Shares -0.21% 0.51% 1.46% $57,774 Bloomberg Barclays U.S. 1 5 Year Treasury Bond Index ,519 Bloomberg Barclays U.S. Aggregate Bond Index ,990 See Financial Highlights for dividend and capital gains information. 16

19 Short-Term Treasury Fund Fiscal-Year Total Returns (%): January 31, 2008, Through January 31, 2018 Bloomberg Barclays 1 5 Year Treasury Investor Shares Index Fiscal Year Income Returns Capital Returns Total Returns Total Returns % 1.79% 4.49% 5.84% Average Annual Total Returns: Periods Ended December 31, 2017 This table presents returns through the latest calendar quarter rather than through the end of the fiscal period. Securities and Exchange Commission rules require that we provide this information. Ten Years Inception Date One Year Five Years Income Capital Total Investor Shares 10/28/ % 0.49% 1.03% 0.57% 1.60% Admiral Shares 2/13/

20 Short-Term Treasury Fund Financial Statements Statement of Net Assets As of January 31, 2018 The fund reports a complete list of its holdings in regulatory filings four times in each fiscal year, at the quarter-ends. For the second and fourth fiscal quarters, the lists appear in the fund s semiannual and annual reports to shareholders. For the first and third fiscal quarters, the fund files the lists with the Securities and Exchange Commission on Form N-Q. Shareholders can look up the fund s Forms N-Q on the SEC s website at sec.gov. Forms N-Q may also be reviewed and copied at the SEC s Public Reference Room (see the back cover of this report for further information). Face Market Maturity Amount Value Coupon Date ($000) ($000) U.S. Government and Agency Obligations (98.0%) U.S. Government Securities (90.2%) United States Treasury Inflation Indexed Bonds 0.125% 4/15/19 576, ,311 United States Treasury Note/Bond 1.250% 11/15/18 190, ,109 United States Treasury Note/Bond 1.250% 11/30/18 250, ,710 United States Treasury Note/Bond 1.250% 12/31/18 250, ,515 United States Treasury Note/Bond 1.250% 1/31/19 100,000 99,312 United States Treasury Note/Bond 1.500% 2/28/19 7,000 6,964 United States Treasury Note/Bond 1.625% 3/31/19 3,000 2,987 United States Treasury Note/Bond 0.750% 7/15/19 48,000 47,100 United States Treasury Note/Bond 1.375% 7/31/19 170, ,273 United States Treasury Note/Bond 1.000% 8/31/19 162, ,291 United States Treasury Note/Bond 1.250% 8/31/19 370, ,201 United States Treasury Note/Bond 1.625% 8/31/19 250, ,202 United States Treasury Note/Bond 0.875% 9/15/19 150, ,117 United States Treasury Note/Bond 1.375% 9/30/19 200, ,656 United States Treasury Note/Bond 1.750% 9/30/19 23,000 22,871 United States Treasury Note/Bond 1.000% 10/15/19 200, ,344 United States Treasury Note/Bond 1.500% 10/31/19 101,000 99,943 United States Treasury Note/Bond 1.500% 11/30/19 200, ,750 United States Treasury Note/Bond 1.750% 11/30/19 200, ,624 United States Treasury Note/Bond 1.375% 12/15/19 215, ,044 United States Treasury Note/Bond 1.125% 12/31/19 12,000 11,773 United States Treasury Note/Bond 1.625% 12/31/19 50,000 49,516 United States Treasury Note/Bond 1.375% 1/15/20 17,807 17,549 United States Treasury Note/Bond 1.250% 1/31/20 150, ,375 United States Treasury Note/Bond 1.375% 2/15/20 150, ,633 United States Treasury Note/Bond 1.125% 3/31/20 13,000 12,710 United States Treasury Note/Bond 1.375% 3/31/20 43,100 42,366 United States Treasury Note/Bond 1.375% 4/30/20 4,350 4,271 United States Treasury Note/Bond 1.375% 5/31/20 249, ,843 United States Treasury Note/Bond 1.500% 5/31/20 126, ,973 United States Treasury Note/Bond 1.625% 6/30/20 153, ,539 United States Treasury Note/Bond 1.875% 6/30/20 49,100 48,693 United States Treasury Note/Bond 1.500% 7/15/20 127, ,974 United States Treasury Note/Bond 1.625% 7/31/20 195, ,075 United States Treasury Note/Bond 2.000% 7/31/20 90,000 89,465 United States Treasury Note/Bond 1.500% 8/15/20 45,000 44,177 18

21 Short-Term Treasury Fund Face Market Maturity Amount Value Coupon Date ($000) ($000) United States Treasury Note/Bond 2.625% 8/15/20 114, ,033 United States Treasury Note/Bond 1.375% 8/31/20 85,000 83,140 United States Treasury Note/Bond 2.125% 8/31/20 90,000 89,719 United States Treasury Note/Bond 1.375% 9/30/20 140, ,807 United States Treasury Note/Bond 2.000% 9/30/20 50,000 49,656 United States Treasury Note/Bond 1.625% 10/15/20 88,200 86,725 United States Treasury Note/Bond 1.375% 10/31/20 30,000 29,278 United States Treasury Note/Bond 1.750% 10/31/20 50,000 49,297 United States Treasury Note/Bond 2.625% 11/15/20 104, ,683 United States Treasury Note/Bond 1.875% 12/15/20 11,150 11,023 United States Treasury Note/Bond 1.750% 12/31/20 23,415 23,053 1 United States Treasury Note/Bond 2.125% 1/31/21 64,000 63,660 United States Treasury Note/Bond 3.625% 2/15/21 32,000 33,220 United States Treasury Note/Bond 1.125% 2/28/21 112, ,011 United States Treasury Note/Bond 2.000% 2/28/21 25,000 24,762 United States Treasury Note/Bond 1.250% 3/31/21 28,500 27,556 United States Treasury Note/Bond 2.250% 3/31/21 44,000 43,876 United States Treasury Note/Bond 1.375% 4/30/21 35,000 33,939 United States Treasury Note/Bond 3.125% 5/15/21 46,000 47,107 United States Treasury Note/Bond 1.375% 5/31/21 55,000 53,264 United States Treasury Note/Bond 1.125% 6/30/21 93,000 89,222 United States Treasury Note/Bond 2.125% 6/30/21 93,000 92,245 United States Treasury Note/Bond 1.125% 7/31/21 150, ,695 United States Treasury Note/Bond 2.125% 8/15/21 170, ,485 United States Treasury Note/Bond 1.125% 8/31/21 125, ,570 United States Treasury Note/Bond 1.750% 3/31/22 14,000 13,615 United States Treasury Note/Bond 1.875% 4/30/22 5,000 4,880 United States Treasury Note/Bond 2.000% 11/30/22 53,530 52,275 7,014,052 Agency Bonds and Notes (7.2%) 2 AID-Iraq 2.149% 1/18/22 11,991 11,813 2 AID-Tunisia 1.416% 8/5/21 16,500 15,913 3 Fannie Mae Interest Strip 0.000% 1/15/19 2,197 2,152 3 Fannie Mae Principal Strip 0.000% 2/1/19 9,900 9,690 3 Federal National Mortgage Assn % 10/9/19 162, ,978 4 Financing Corp % 5/11/18 72,000 71,666 4 Financing Corp % 11/2/18 2,150 2,118 4 Financing Corp % 3/7/19 5,475 5,348 4 Financing Corp % 4/5/19 9,060 9,843 Private Export Funding Corp % 3/15/19 13,330 13,660 Private Export Funding Corp % 8/15/19 30,534 30,143 Private Export Funding Corp % 3/15/20 5,800 5,785 Private Export Funding Corp % 9/15/20 7,550 7,517 Residual Funding Corp. Principal Strip 0.000% 1/15/21 47,000 43,734 Resolution Funding Corp. Principal Strip 0.000% 10/15/19 101,170 97,377 Resolution Funding Corp. Principal Strip 0.000% 7/15/20 27,490 25,938 Resolution Funding Corp. Principal Strip 0.000% 10/15/20 58,220 54, ,239 Conventional Mortgage-Backed Securities (0.0%) 3,5 Freddie Mac Gold Pool 6.000% 5/1/18 4/1/ Nonconventional Mortgage-Backed Securities (0.6%) 3,5,6 Fannie Mae REMICS % 2/25/46 11,828 11,849 3,5,6 Fannie Mae REMICS % 2/25/46 7,966 8,009 19

22 Short-Term Treasury Fund Face Market Maturity Amount Value Coupon Date ($000) ($000) 3,5,6 Fannie Mae REMICS % 12/25/46 8,597 8,604 3,5,6 Freddie Mac REMICS 1.959% 5/15/46 8,335 8,381 3,5,6 Freddie Mac REMICS 2.009% 10/15/46 7,595 7,643 44,486 Total U.S. Government and Agency Obligations (Cost $7,682,883) 7,621,868 Shares Temporary Cash Investment (0.9%) Money Market Fund (0.9%) 7 Vanguard Market Liquidity Fund (Cost $73,545) 1.545% 735,454 73,546 Total Investments (98.9%) (Cost $7,756,428) 7,695,414 Notional Expiration Exercise Amount Date Contracts Price ($000) Liability for Options Written (0.0%) Call Options on 10-Year U.S. Treasury Note Futures Contracts 02/23/18 53 USD ,519 (4) Put Options on 10-Year U.S. Treasury Note Futures Contracts 02/23/ USD ,803 (570) Put Options on 10-Year U.S. Treasury Note Futures Contracts 02/23/18 53 USD ,413 (16) Total Liability for Options Written (Premiums Received $150) (590) Amount ($000) Other Assets and Other Liabilities (1.1%) Other Assets Investment in Vanguard 427 Receivables for Investment Securities Sold 168,674 Receivables for Accrued Income 24,716 Receivables for Capital Shares Issued 11,062 Variation Margin Receivable Futures Contracts 198 Other Assets 747 Total Other Assets 205,824 Other Liabilities Payables for Investment Securities Purchased (105,625) Payables for Capital Shares Redeemed (8,260) Payables for Distributions (1,819) Payables to Vanguard (3,311) Variation Margin Payable Futures Contracts (1,083) Total Other Liabilities (120,098) Net Assets (100%) 7,780,550 20

23 Short-Term Treasury Fund At January 31, 2018, net assets consisted of: Amount ($000) Paid-in Capital 7,931,132 Undistributed Net Investment Income 17 Accumulated Net Realized Losses (84,919) Unrealized Appreciation (Depreciation) Investment Securities (61,014) Futures Contracts (4,226) Options on Futures Contracts 8 (440) Net Assets 7,780,550 Investor Shares Net Assets Applicable to 70,255,894 outstanding $.001 par value shares of beneficial interest (unlimited authorization) 736,896 Net Asset Value Per Share Investor Shares $10.49 Admiral Shares Net Assets Applicable to 671,544,613 outstanding $.001 par value shares of beneficial interest (unlimited authorization) 7,043,654 Net Asset Value Per Share Admiral Shares $10.49 See Note A in Notes to Financial Statements. 1 Securities with a value of $4,381,000 have been segregated as initial margin for open futures contracts. 2 U.S. government-guaranteed. 3 The issuer was placed under federal conservatorship in September 2008; since that time, its daily operations have been managed by the Federal Housing Finance Agency and it receives capital from the U.S. Treasury, as needed to maintain a positive net worth, in exchange for senior preferred stock. 4 The issuer operates under a congressional charter; its securities are generally neither guaranteed by the U.S. Treasury nor backed by the full faith and credit of the U.S. government. 5 The average or expected maturity is shorter than the final maturity shown because of the possibility of interim principal payments and prepayments or the possibility of the issue being called. 6 Adjustable-rate security based upon 1-month USD LIBOR plus spread. 7 Affiliated money market fund available only to Vanguard funds and certain trusts and accounts managed by Vanguard. Rate shown is the 7-day yield. 8 Unrealized appreciation (depreciation) on options on futures contracts is required to be treated as realized gain (loss) for tax purposes. REMICS Real Estate Mortgage Investment Conduits. 21

24 Short-Term Treasury Fund Derivative Financial Instruments Outstanding as of Period End Futures Contracts ($000) Value and Number of Unrealized Long (Short) Notional Appreciation Expiration Contracts Amount (Depreciation) Long Futures Contracts 2-Year U.S. Treasury Note March , ,216 (3,494) 5-Year U.S. Treasury Note March , ,649 (639) Ultra 10-Year U.S. Treasury Note March ,555 (361) 10-Year U.S. Treasury Note March , (4,432) Short Futures Contracts Ultra Long U.S. Treasury Bond March 2018 (308) (49,877) 206 (4,226) Unrealized appreciation (depreciation) on open futures contracts is required to be treated as realized gain (loss) for tax purposes. See accompanying Notes, which are an integral part of the Financial Statements. 22

25 Short-Term Treasury Fund Statement of Operations Year Ended January 31, 2018 ($000) Investment Income Income Interest 1 109,139 Total Income 109,139 Expenses The Vanguard Group Note B Investment Advisory Services 1,039 Management and Administrative Investor Shares 1,309 Management and Administrative Admiral Shares 5,135 Marketing and Distribution Investor Shares 160 Marketing and Distribution Admiral Shares 586 Custodian Fees 82 Auditing Fees 39 Shareholders Reports and Proxy Investor Shares 73 Shareholders Reports and Proxy Admiral Shares 203 Trustees Fees and Expenses 6 Total Expenses 8,632 Net Investment Income 100,507 Realized Net Gain (Loss) Investment Securities Sold 1 (57,275) Futures Contracts (17,241) Purchased Options (679) Written Options 2,372 Realized Net Gain (Loss) (72,823) Change in Unrealized Appreciation (Depreciation) Investment Securities 1 (38,480) Futures Contracts (5,127) Purchased Options 36 Written Options (527) Change in Unrealized Appreciation (Depreciation) (44,098) Net Increase (Decrease) in Net Assets Resulting from Operations (16,414) 1 Interest income, realized net gain (loss), and change in unrealized appreciation (depreciation) from an affiliated company of the fund were $2,185,000, ($60,000), and $0, respectively. See accompanying Notes, which are an integral part of the Financial Statements. 23

26 Short-Term Treasury Fund Statement of Changes in Net Assets Year Ended January 31, ($000) ($000) Increase (Decrease) in Net Assets Operations Net Investment Income 100,507 72,757 Realized Net Gain (Loss) (72,823) 17,160 Change in Unrealized Appreciation (Depreciation) (44,098) (54,440) Net Increase (Decrease) in Net Assets Resulting from Operations (16,414) 35,477 Distributions Net Investment Income Investor Shares (9,933) (8,403) Admiral Shares (90,580) (64,428) Realized Capital Gain 1 Investor Shares (2,705) Admiral Shares (20,173) Total Distributions (100,513) (95,709) Capital Share Transactions Investor Shares (151,453) (98,559) Admiral Shares 344, ,883 Net Increase (Decrease) from Capital Share Transactions 192, ,324 Total Increase (Decrease) 76, ,092 Net Assets Beginning of Period 7,704,481 7,276,389 End of Period 2 7,780,550 7,704,481 1 Includes fiscal 2018 and 2017 short-term gain distributions totaling $0 and $21,440,000, respectively. Short-term gain distributions are treated as ordinary income dividends for tax purposes. 2 Net Assets End of Period includes undistributed (overdistributed) net investment income of $17,000 and ($15,000). See accompanying Notes, which are an integral part of the Financial Statements. 24

27 Short-Term Treasury Fund Financial Highlights Investor Shares For a Share Outstanding Year Ended January 31, Throughout Each Period Net Asset Value, Beginning of Period $10.65 $10.73 $10.75 $10.71 $10.73 Investment Operations Net Investment Income Net Realized and Unrealized Gain (Loss) on Investments (.160) (.048) (.004).053 (.009) Total from Investment Operations (.033) Distributions Dividends from Net Investment Income (.127) (.094) (.074) (.055) (.039) Distributions from Realized Capital Gains (.032) (.016) (.013) (.011) Total Distributions (.127) (.126) (.090) (.068) (.050) Net Asset Value, End of Period $10.49 $10.65 $10.73 $10.75 $10.71 Total Return % 0.43% 0.66% 1.01% 0.28% Ratios/Supplemental Data Net Assets, End of Period (Millions) $737 $900 $1,005 $1,044 $1,151 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 1.20% 0.87% 0.69% 0.52% 0.37% Portfolio Turnover Rate 3 280% 249% 211% 87% 80% 1 Calculated based on average shares outstanding. 2 Total returns do not include account service fees that may have applied in the periods shown. Fund prospectuses provide information about any applicable account service fees. 3 Includes 7%, 3%, 35%, 22%, and 0% attributable to mortgage-dollar-roll activity. See accompanying Notes, which are an integral part of the Financial Statements. 25