Vanguard Corporate Bond Funds. Annual Report January 31, 2018

Transcription

1 Annual Report January 31, 2018 Vanguard Corporate Bond Funds Vanguard Short-Term Investment-Grade Fund Vanguard Intermediate-Term Investment-Grade Fund Vanguard Long-Term Investment-Grade Fund Vanguard High-Yield Corporate 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 Investment-Grade Fund Intermediate-Term Investment-Grade Fund Long-Term Investment-Grade Fund High-Yield Corporate 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, returns of the funds in this report ranged from 1.29% for Investor Shares of Vanguard Short-Term Investment-Grade Fund to 9.39% for Admiral Shares of Vanguard Long-Term Investment-Grade Fund. The funds results compared with those of their benchmarks were mixed, but all four funds outpaced their peer groups. The Federal Reserve increased interest rates three times during the year. This pushed up yields of short-term securities significantly; yields of longer-term bonds moved less. Corporate spreads, already narrow, tightened even further as growth looked set to pick up and corporate profits continued to expand. The Short-Term Fund and Vanguard Intermediate-Term Fund were hurt by an underweight allocation to corporate bonds, particularly those rated BBB. For the Long-Term Fund, security selection in aggregate helped the fund. For Vanguard High-Yield Corporate Fund, issuer selection and sector allocations helped it beat its comparative standards. Total Returns: Fiscal Year Ended January 31, 2018 Vanguard Short-Term Investment-Grade Fund 30-Day SEC Yield Income Returns Capital Returns Total Returns Investor Shares 2.43% 2.02% -0.73% 1.29% Admiral Shares Institutional Shares Bloomberg Barclays U.S. 1 5 Year Credit Bond Index Year Investment-Grade Debt Funds Average Year Investment-Grade Debt Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. Vanguard Intermediate-Term Investment-Grade Fund Investor Shares 2.89% 2.82% -0.35% 2.47% Admiral Shares Bloomberg Barclays U.S Year Credit Bond Index 3.87 Core Bond Funds Average 2.25 Core Bond Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. Vanguard Long-Term Investment-Grade Fund Investor Shares 3.61% 4.31% 4.97% 9.28% Admiral Shares Bloomberg Barclays U.S. Long Credit A or Better Bond Index 9.35 Corporate A-Rated Debt Funds Average 3.72 Corporate A-Rated Debt Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. 1

4 Vanguard High-Yield Corporate Fund 30-Day SEC Yield Income Returns Capital Returns Total Returns Investor Shares 4.80% 5.34% 0.85% 6.19% Admiral Shares High-Yield Corporate Composite Index 5.69 High Yield Funds Average 5.91 High Yield Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. For a benchmark description, see the Glossary. Admiral Shares carry lower expenses and are available to investors who meet certain account-balance requirements. Institutional Shares are available to certain institutional investors who meet specific administrative, service, and account-size criteria. Total Returns: Ten Years Ended January 31, 2018 Average Annual Return Short-Term Investment-Grade Fund Investor Shares 2.66% Bloomberg Barclays U.S. 1 5 Year Credit Bond Index Year Investment-Grade Debt Funds Average Year Investment-Grade Debt Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. Intermediate-Term Investment-Grade Fund Investor Shares 4.76% Bloomberg Barclays U.S Year Credit Bond Index 5.60 Spliced Core Bond Funds Average 3.47 Spliced Core Bond Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. Long-Term Investment-Grade Fund Investor Shares 7.56% Bloomberg Barclays U.S. Long Credit A or Better Bond Index 7.14 Corporate A-Rated Debt Funds Average 4.10 Corporate A-Rated Debt Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. High-Yield Corporate Fund Investor Shares 6.92% High-Yield Corporate Composite Index 7.27 High Yield Funds Average 6.24 High Yield Funds Average: Derived from data provided by Lipper, a Thomson Reuters Company. For a benchmark description, see the Glossary. 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. 2

5 Expense Ratios Your Fund Compared With Its Peer Group Investor Shares Admiral Shares Institutional Shares Peer Group Average Short-Term Investment-Grade Fund 0.20% 0.10% 0.07% 0.71% Intermediate-Term Investment-Grade Fund Long-Term Investment-Grade Fund High-Yield Corporate 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 Investment-Grade Fund, 0.20% for Investor Shares, 0.10% for Admiral Shares, and 0.07% for Institutional Shares; for the Intermediate-Term Investment-Grade Fund, 0.20% for Investor Shares and 0.10% for Admiral Shares; for the Long-Term Investment-Grade Fund, 0.22% for Investor Shares and 0.12% for Admiral Shares; and for the High-Yield Corporate Fund, 0.23% for Investor Shares and 0.13% 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 Investment-Grade Fund, 1 5 Year Investment-Grade Debt Funds; for the Intermediate-Term Investment-Grade Fund, Core Bond Funds; for the Long-Term Investment-Grade Fund, Corporate A-Rated Debt Funds; and for the High-Yield Corporate Fund, High Yield 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 Vanguard Fixed Income Group For the Short-, Intermediate-, and Long-Term Investment-Grade Funds For the year ended January 31, 2018, Vanguard Short-Term Investment-Grade Fund returned 1.29% and Vanguard Intermediate-Term Investment-Grade Fund returned 2.47%. (All returns and yields cited are for the funds Investor Shares.) Both funds underperformed the return of their benchmark indexes but outperformed the average return for their peers. We also manage about 10% of the assets of Vanguard Long-Term Investment-Grade Fund, which returned 9.28%. That result was in line with the return of its benchmark index and significantly higher than the average return of the fund s peers, a group that includes funds that invest across the maturity spectrum. With the significant rise in shorter-term rates, the 30-day SEC yield for the Short-Term Fund rose 58 basis points over the period to 2.43% and that of the Intermediate-Term Fund rose 27 basis points to 2.89%, while the yield of the Long-Term Fund fell 28 basis points to 3.61%. (A basis point is one-hundredth 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 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%. The Fed also 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 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 U.S. Treasury note rose 93 basis points to 2.14%, while 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 U.S. Treasury note was lower than where it had started for a good part of the year, but it finished up 26 basis points at 2.71%. Businesses continuing to post solid revenue and earnings growth, a reduction in corporate tax rates, and investors continuing to reach for yield all supported demand for investment-grade corporate bonds. The average yield of those securities over Treasuries tightened to 86 basis points at the end of the period from 121 basis points at the beginning. By maturity, long-dated bonds significantly outperformed. By credit quality, the picture was more nuanced, but BBB-rated bonds generally fared the best among investment-grade securities. Management of the funds The Short-Term Fund and the Intermediate-Term Fund have a structural underweight to lower-quality corporate bonds. This defensive positioning detracted from relative performance during the period under review as corporate bonds did better than other investment-grade debt and BBB-rated bonds outperformed their higher-rated counterparts. Having a shorter duration than their benchmarks also detracted, especially for the Intermediate-Term Fund. Security selection in corporate bonds, however, added value in a number of segments. Banks were one: They benefited from the improved outlook for profitability that stemmed from the regulatory changes and rise in interest rates. Among industrials, our tactical positions in energy, basic materials, and transportation played out well. By region, security selection in emerging markets, particularly Latin America, helped. 8

11 For diversification purposes, the Short- Term and Intermediate-Term Funds have exposure to segments of the investmentgrade credit market that are not part of their benchmarks, including commercial mortgage-backed securities (pooled mortgages on commercial properties) and asset-backed securities (typically made up of pooled auto loans, creditcard debt, and student loans). The underperformance of these segments over the fiscal year held back the funds relative returns. The funds also held Treasuries for diversification and as a liquidity buffer, and these securities underperformed corporates, as the environment was risk-on most of the period. We added Treasury inflation-protected securities to the Short-Term and Intermediate-Term Funds early in the period when medium-term inflation expectations seemed low, then reduced that out-ofbenchmark allocation as breakeven inflation widened toward our targeted valuation levels. Outlook In spite of long-term structural challenges posed by, among other things, the pace of productivity growth, demographic trends, and the impact of new technologies, the U.S. economy is set to expand at 2.5% in 2018, a little above its long-term potential growth rate. The unemployment rate has fallen to its lowest level since 2000 and is likely to move even lower. While it s taken longer than expected, we have seen some indications of late that the tight labor market is putting some upward pressure on wages. That, along with stable and broader global growth, may well lead to a cyclical upswing in inflation a scenario that 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, 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 likely 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. That said, other potential developments could also fuel volatility, including mid-term elections, stalled or scuttled trade negotiations, and flare-ups in geopolitical tensions. In addition, as 9

12 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, some reducing quantitative easing. Although spreads have become very tight, U.S. corporate bonds could get some support from pension and life insurance companies that may be drawn back into the market for longer-term securities now that their yields have moved higher. The securities should also remain attractive to international investors, given their yield advantage. In addition, the new tax bill could prove supportive to prices if the repatriation of profits results in reduced bond issuance. 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 Gregory S. Nassour, CFA, Principal and Portfolio Manager February 20, 2018 Wellington Management Company llp For the Long-Term Investment- Grade Fund Vanguard Long-Term Investment-Grade Fund returned 9.28% for Investor Shares and 9.39% for Admiral Shares for the 12 months ended January 31, That result was in line with the 9.35% return of its benchmark, the Bloomberg Barclays U.S. Long Credit A or Better Bond Index, and ahead of the 3.72% average return of its peers. The portion of the Long-Term Fund that we manage (the portfolio ) invests primarily in corporate bonds with 10 to 30 years until maturity. The portfolio s returns are influenced by the direction of interest rates and by economic conditions that affect the creditworthiness of the corporate bond issuers. Investment environment Over the fiscal year, global fixed income markets generated solid gains. Escalating geopolitical tensions and disappointments in inflation data helped to contain upward pressure on sovereign yields prompted by central bank policy normalization. In the United States, political controversies led to a short-lived dip in risk assets. Elections in France and the United Kingdom presented potential sources of volatility, but proved benign in the aftermath. Despite concerns about prospects for retailers particularly in the United States generally solid corporate earnings, strong global economic data, and continued demand 10

13 for yield-producing assets supported credit markets. Most developed-market currencies strengthened compared to the U.S. dollar as political uncertainty and continued skepticism about the Federal Reserve s projected rate-hiking path weighed on the currency. Monetary policy continued on a more hawkish path throughout the year. The Fed announced it would begin tapering its asset purchases in October and hiked rates three times in Developed-market government yields were mixed over the period as subdued inflation countered improving global economic data. In the United States, the yield curve flattened; front-end yields, which were heavily influenced by Fed monetary policy expectations, rose more than longer-term yields. Absolute returns in most major fixed income spread sectors were positive during the fiscal year. On an excess return basis, all of the major spread sectors including securitized, high-yield, and emerging markets debt and investmentgrade corporates posted positive returns over the period. The portfolio s successes In aggregate, security selection contributed favorably to relative results, most notably in communications, taxable municipal bonds, and banking. Overweighted allocations to banking and taxable municipal bonds also benefited relative results. The portfolio s shortfalls Underweight positioning in the consumer noncyclical, capital goods, and basic industry sectors weighed most on relative performance. Security selection within technology and basic industry also detracted from relative performance. Outlook Market valuations appear to reflect the improving fundamental and technical backdrop. Spreads across the investmentgrade corporate market are trading very close to post-crisis lows, leading us to a neutral risk posture. The U.S. economy remains on a positive growth trajectory, driven by consumer spending and investment. The Fed is likely to hike rates three or four times in 2018, notwithstanding inflation that remains below the Federal Open Market Committee s target. Any shifts by various central banks toward less accommodative monetary policies will be very important for the supply/demand equation. While gross leverage has increased, net leverage is at a more reasonable level, thanks to elevated cash balances. Free cash flow as a percentage of debt remains healthy compared to historical ratios. Many debt-funded merger and acquisition transactions have pushed the investmentgrade ratings limit. Rating agencies have given companies leeway to add leverage with the promise to later reduce debt, and this has led to higher leverage for the overall index. Cash flow from lower tax 11

14 rates and profit repatriation will help companies to varying degrees. Those with higher percentages of U.S.-based sales should benefit substantially. Repatriation will lead to lower supply from companies that had large overseas cash balances. Market liquidity is as strong as it has been at any time since the global financial crisis, driven by low volatility. Gross issuance set a record in as yields remained low. Net issuance will likely be flat to negative year-over-year for 2018, given a heavy redemption schedule. Scott I. St. John, CFA Senior Managing Director and Fixed Income Portfolio Manager February 20, 2018 Wellington Management Company llp For the High-Yield Corporate Fund For the 12 months ended January 31, 2018, the fund returned 6.19% for Investor Shares and 6.29% for Admiral Shares, outpacing the return of 5.69% for its benchmark index. Investment environment High-yield markets benefited from strong global economic data, positive earnings trends, and continued demand for yield-producing assets. Monetary policy continued on an incrementally less accommodative path as the Federal Reserve hiked interest rates three times during the period and began reducing the size of its balance sheet. Longer-term rates also increased, as the 10-year U.S. Treasury yield rose to 2.71% by the end of January 2018 from 2.45% at the end of January Bouts of elevated political uncertainty and serial disappointments in inflation data supported government bonds over most of the period. However, Treasury yields rose sharply in January. Corporate credit markets faced uncertainty about U.S. health care policy and concerns about prospects for retailers, but generally solid corporate earnings and continued demand for yield-producing assets supported credit markets and credit spreads tightened further. The spread of the high-yield market tightened to 319 basis points over Treasuries, down from 388 basis points at the start of the period. The average price of high-yield bonds was unchanged, at $101. For the 12 months ended January 31, 2018, there was some dispersion in performance by credit quality. The high-yield market continued to favor relatively lower-credit-quality bonds amid the insatiable search for yield. Lower-rated CCC bonds performed best, returning 9.80%, according to Bloomberg Barclays High Yield Index data. Meanwhile, higher-rated BB bonds generated gains of 6.19%; bonds rated B returned 5.77%. As of this writing, we continue to be positive on high yield, given the backdrop of stable corporate fundamentals, a supportive macroeconomic landscape, and strong demand for yield-producing assets. We expect positive U.S. gross 12

15 domestic product (GDP) growth in 2018, driven by consumer spending and corporate investment, and we believe that most high-yield companies will be able to sustain solid credit profiles in that environment. While global political risks remain, valuations appear reasonable relative to our outlook, in particular given our expectation for a benign default rate over the course of Moody s trailing 12-month global issuer-weighted speculative-grade default rate ended December at 2.9%, below the longterm average of 4.2%. Although bouts of volatility may persist, we continue to take a long-term, issuer-specific approach to finding opportunities in this market. We are particularly positive on conditions in the United States and favor issuers expected to benefit from a growing U.S. domestic economy. Of note, a sweeping tax reform law was passed in December that will impact the market and individual companies. The law provides fiscal stimulus at a time of full employment, which could further spur U.S. GDP growth. It will affect companies differently depending on their current tax rate, leverage profile, and other factors, so we expect that there will be winners and losers among individual high-yield issuers, and we will continue to take an issuerspecific approach to investing in the high-yield market. Longer-term, we believe the tax law could have the overall net effect of reducing corporate debt issuance, a supply reduction that could provide support to bond prices going forward. The fund s successes The fund benefited from an underweighted allocation to and positive credit selection within the wirelines and retail sectors, as well as positive credit selection in the pharmaceuticals sector. The fund s shortfalls Positioning and security section within the utilities sector detracted from relative returns. Security selection within the consumer products sector also hurt relative results. The fund s positioning The fund remains consistent in its investment objective and strategy and maintains a meaningful exposure to relatively higher-quality names within the high-yield market. We believe these companies have more stable credit profiles and greater predictability of cash flows than those at the lower end of the quality spectrum. We prefer higher-quality credits in an effort to minimize defaults and to provide stable income. We continue to diversify the fund s holdings by issuer and industry. We also continue to deemphasize non-cash-paying securities, preferred stocks, and equity-linked securities, such as convertibles, because of their potential for volatility. Michael L. Hong, CFA, Managing Director and Fixed Income Portfolio Manager February 20,

16 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 Investment-Grade Fund 1,867,270,276 70,175,292 82,236, ,052, % Short-Term Investment-Grade Fund 3,494,737, ,146, ,156, ,231, % 14

17 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 High-Yield Corporate Fund 2,306,358, ,636, ,670, ,479, % Intermediate-Term Investment-Grade Fund 1,877,203,098 68,089,555 74,389, ,052, % Long-Term Investment-Grade Fund 841,387,789 35,863,825 23,816,163 80,610, % Short-Term Investment-Grade Fund 3,521,910, ,229, ,900, ,231, % 15

18 Short-Term Investment-Grade Fund Fund Profile As of January 31, 2018 Share-Class Characteristics Investor Shares Admiral Shares Institutional Shares Ticker Symbol VFSTX VFSUX VFSIX Expense Ratio % 0.10% 0.07% 30-Day SEC Yield 2.43% 2.53% 2.56% Financial Attributes Bloomberg Fund Barclays 1 5 Year Credit Index Bloomberg Barclays Aggregate Bond Index Number of Bonds 2,048 2,437 9,734 Yield to Maturity (before expenses) 2.8% 2.7% 3.0% Average Coupon 2.3% 3.1% 3.1% Average Duration 2.6 years 2.8 years 6.1 years Average Effective Maturity 3.1 years 2.9 years 8.3 years Short-Term Reserves 4.4% Sector Diversification (% of portfolio) Asset-Backed 12.0% Commercial Mortgage-Backed 9.8 Finance 28.9 Foreign 9.6 Government Mortgage-Backed 0.6 Industrial 28.6 Treasury/Agency 5.7 Utilities 4.4 Other 0.4 The agency and mortgage-backed securities sectors may include issues from government-sponsored enterprises; such issues are generally not backed by the full faith and credit of the U.S. government. Volatility Measures Bloomberg Barclays 1 5 Year Credit Index Bloomberg Barclays US Aggregate Bond Index R-Squared Beta These measures show the degree and timing of the fund s fluctuations compared with the indexes over 36 months. Distribution by Effective Maturity (% of portfolio) Under 1 Year 15.0% 1-3 Years Years Years Years Years Years 0.2 Distribution by Credit Quality (% of portfolio) U.S. Government 5.7% Aaa 21.2 Aa 14.1 A 32.0 Baa 23.5 Ba 2.4 B 0.3 Caa 0.1 Not Rated 0.7 Credit-quality ratings are obtained from Moody's and S&P, and the higher rating for each issue is shown. "Not Rated" is used to classify securities for which a rating is not available. Not rated securities include a fund's investment in Vanguard Market Liquidity Fund or Vanguard Municipal Cash Management Fund, each of which invests in high-quality money market instruments and may serve as a cash management vehicle for the Vanguard funds, trusts, and accounts. For more information about these ratings, see the Glossary entry for Credit Quality. 1 The expense ratios shown are from the prospectus dated 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, 0.10% for Admiral Shares, and 0.07% for Institutional Shares. 16

19 Short-Term Investment-Grade Fund -1 Investment Focus Average Maturity Short Med. Long Credit Quality Treasury/ Agency Investment-Grade Corporate Below Investment-Grade 17

20 Short-Term Investment-Grade 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 $17,000 13, ,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 Investment-Grade Fund Investor Shares 1.29% 1.61% 2.66% $13,007 Bloomberg Barclays U.S. 1 5 Year Credit Bond Index , Year Investment-Grade Debt Funds Average ,042 Bloomberg Barclays U.S. Aggregate Bond Index , Year Investment-Grade Debt 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 Investment-Grade Fund Admiral Shares 1.39% 1.71% 2.77% $65,704 Bloomberg Barclays U.S. 1 5 Year Credit Bond Index ,847 Bloomberg Barclays U.S. Aggregate Bond Index ,990 See Financial Highlights for dividend and capital gains information. 18

21 Short-Term Investment-Grade Fund One Year Average Annual Total Returns Periods Ended January 31, 2018 Five Years Ten Years Final Value of a $5,000,000 Investment Short-Term Investment-Grade Fund Institutional Shares 1.42% 1.74% 2.80% $6,592,347 Bloomberg Barclays U.S. 1 5 Year Credit Bond Index ,884,738 Bloomberg Barclays U.S. Aggregate Bond Index ,199,034 Fiscal-Year Total Returns (%): January 31, 2008, Through January 31, 2018 Bloomberg Barclays 1 5 Year Credit Investor Shares Index Fiscal Year Income Returns Capital Returns Total Returns Total Returns % -8.83% -4.35% -1.17% 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 10/29/ % 1.70% 2.71% 0.14% 2.85% Admiral Shares 2/12/ Institutional Shares 9/30/

22 Short-Term Investment-Grade Fund Financial Statements Statement of Net Assets Investments Summary As of January 31, 2018 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). Face Market Percentage Maturity Amount Value of Net Coupon Date ($000) ($000) Assets U.S. Government and Agency Obligations U.S. Government Securities 1 United States Treasury Inflation Indexed Bonds 0.125% 4/15/19 870, , % 1 United States Treasury Note/Bond 2.125% 8/31/20 940, , % 1 United States Treasury Note/Bond 1.500% 7/15/20 673, , % 1,2 United States Treasury Note/Bond 1.375% 10/31/20 470, , % 1,2 United States Treasury Note/Bond 1.375% 8/31/20 200, , % United States Treasury Note/Bond 1.375% 1/31/21 150, , % 1,3 United States Treasury Note/Bond 1.500% 1.875% 11/30/20 8/15/26 142, , % 3,453, % *Nonconventional Mortgage-Backed Securities 365, % Total U.S. Government and Agency Obligations (Cost $3,869,414) 3,819, % Asset-Backed/Commercial Mortgage-Backed Securities 4 AmeriCredit Automobile Receivables Trust % 7/8/19 17,620 17, % 4 AmeriCredit Automobile Receivables Trust % 10/8/19 4,355 4, % 4 AmeriCredit Automobile Receivables Trust % 2.860% 11/8/19 12/9/19 8,698 8, % 4 AmeriCredit Automobile Receivables Trust % 3/9/20 3,269 3, % 4 AmeriCredit Automobile Receivables Trust % 6/8/20 8,627 8, % 20

23 Short-Term Investment-Grade Fund Face Market Percentage Maturity Amount Value of Net Coupon Date ($000) ($000) Assets 4 AmeriCredit Automobile Receivables Trust % 3.340% 3/9/20 8/8/21 37,203 37, % 4 AmeriCredit Automobile Receivables Trust % 3.590% 10/8/20 2/8/22 27,653 27, % 4 AmeriCredit Automobile Receivables Trust % 3.650% 11/9/20 5/9/22 34,890 34, % 4 AmeriCredit Automobile Receivables Trust % 9/8/22 10,170 10, % 4 AmeriCredit Automobile Receivables Trust % 7/8/22 25,630 25, % 4 AmeriCredit Automobile Receivables Trust % 12/18/20 78,970 78, % 4 Banc of America Commercial Mortgage Trust 2015-UBS % 4.366% 9/15/48 16,700 17, % 4 Banc of America Commercial Mortgage Trust 2017-BNK % 2/15/50 4,760 4, % 4 Banc of America Funding 2006-H Trust 3.629% 9/20/46 12,212 11, % 4 Bank of America Mortgage 2002-J Trust 4.259% 9/25/ % 4,5 Chrysler Capital Auto Receivables Trust 2014-AA 2.280% 11/15/19 10,230 10, % 4,5 Chrysler Capital Auto Receivables Trust 2014-BA 3.440% 8/16/ % 4,5 Chrysler Capital Auto Receivables Trust 2015-BA 2.260% 4.170% 10/15/20 1/16/23 49,125 49, % 4,5 Chrysler Capital Auto Receivables Trust 2016-AA 2.880% 4.220% 2/15/22 2/15/23 31,070 31, % 4,5 Chrysler Capital Auto Receivables Trust 2016-BA 1.640% 1.870% 7/15/21 2/15/22 16,690 16, % 4 Citibank Credit Card Issuance Trust 2018-A % 1/20/23 181, , % 4 Citigroup Mortgage Loan Trust 2007-AR % 7/25/ % 4 COMM 2012-CCRE2 Mortgage Trust 3.147% 3.791% 8/15/45 7,025 7, % 4,5 COMM 2012-CCRE3 Mortgage Trust 2.822% 3.416% 10/15/45 35,732 35, % 4 COMM 2012-CCRE4 Mortgage Trust 2.853% 3.251% 10/15/45 12,961 12, % 4 COMM 2012-CCRE5 Mortgage Trust 2.771% 12/10/45 2,640 2, % 4 COMM 2013-CCRE10 Mortgage Trust 2.972% 3.795% 8/10/46 29,359 29, % 4 COMM 2013-CCRE11 Mortgage Trust 3.983% 4.258% 8/10/50 57,295 60, % 21

24 Short-Term Investment-Grade Fund Face Market Percentage Maturity Amount Value of Net Coupon Date ($000) ($000) Assets 4 COMM 2013-CCRE12 Mortgage Trust 3.623% 4.046% 10/10/46 64,091 66, % 4 COMM 2013-CCRE13 Mortgage Trust 4.194% 4.747% 11/10/46 39,717 41, % 4,5 COMM 2013-CCRE6 Mortgage Trust 3.147% 3.397% 3/10/46 19,740 19, % 4 COMM 2013-CCRE8 Mortgage Trust 3.334% 3.612% 6/10/46 43,309 44, % 4,5 COMM 2013-CCRE9 Mortgage Trust 4.230% 4.254% 7/10/45 51,349 53, % 4,5 COMM 2013-LC13 Mortgage Trust 3.009% 4.557% 8/10/46 59,675 61, % 4 COMM 2013-LC6 Mortgage Trust 2.941% 1/10/46 4,100 4, % 4,5 COMM 2013-SFS Mortgage Trust 2.987% 4/12/35 5,490 5, % 4,5 COMM P Mortgage Trust 3.611% 8/10/49 33,245 34, % 4 COMM 2014-CCRE14 Mortgage Trust 3.955% 4.236% 2/10/47 19,605 20, % 4 COMM 2014-CCRE15 Mortgage Trust 2.928% 4.426% 2/10/47 49,223 50, % 4 COMM 2014-CCRE17 Mortgage Trust 3.700% 4.735% 5/10/47 86,756 89, % 4 COMM 2014-CCRE18 Mortgage Trust 3.550% 3.828% 7/15/47 38,124 39, % 4 COMM 2014-CCRE20 Mortgage Trust 3.326% 3.590% 11/10/47 38,105 38, % 4 COMM 2014-CCRE21 Mortgage Trust 3.528% 12/10/47 36,723 37, % 4 COMM 2014-LC17 Mortgage Trust 3.917% 10/10/47 11,570 12, % 4 COMM 2015-CCRE22 Mortgage Trust 3.309% 3/10/48 36,015 36, % 4 COMM 2015-CCRE24 Mortgage Trust 3.696% 8/10/48 19,415 19, % 4 COMM 2015-CCRE25 Mortgage Trust 3.759% 8/10/48 38,840 40, % 4 COMM 2015-CCRE26 Mortgage Trust 3.630% 10/10/48 22,007 22, % 4 COMM 2015-CCRE27 Mortgage Trust 3.612% 4.472% 10/10/48 20,092 20, % 4 COMM 2015-LC19 Mortgage Trust 3.183% 2/10/48 18,400 18, % 4,5 Drive Auto Receivables Trust 2015-AA 3.060% 4.120% 5/17/21 7/15/22 9,565 9, % 4,5 Drive Auto Receivables Trust 2015-BA 2.760% 3.840% 7/15/21 16,400 16, % 4,5 Drive Auto Receivables Trust 2015-CA 3.010% 4.200% 5/17/21 9/15/21 24,094 24, % 4,5 Drive Auto Receivables Trust 2015-DA 3.380% 4.590% 11/15/21 1/17/23 41,327 42, % 4,5 Drive Auto Receivables Trust 2016-AA 3.910% 5/17/21 7,608 7, % 22

25 Short-Term Investment-Grade Fund Face Market Percentage Maturity Amount Value of Net Coupon Date ($000) ($000) Assets 4,5 Drive Auto Receivables Trust 2016-BA 2.560% 4.530% 6/15/20 8/15/23 41,063 41, % 4,5 Drive Auto Receivables Trust 2016-C 1.670% 4.180% 11/15/19 3/15/24 46,425 46, % 4 Drive Auto Receivables Trust % 3.840% 3/16/20 3/15/23 14,560 14, % 4 Drive Auto Receivables Trust % 2.800% 8/15/19 7/15/22 76,970 76, % 4 Ford Credit Auto Lease Trust 2015-B 1.920% 3/15/19 16,270 16, % 4 Ford Credit Auto Lease Trust 2017-B 2.030% 2.170% 12/15/20 2/15/21 45,030 44, % 4,5 Ford Credit Auto Owner Trust 2014-REV % 2.410% 11/15/25 30,329 30, % 4,5 Ford Credit Auto Owner Trust 2014-REV % 2.510% 4/15/26 36,995 36, % 4 Ford Credit Auto Owner Trust 2015-C 2.010% 2.260% 3/15/21 3/15/22 17,415 17, % 4,5 Ford Credit Auto Owner Trust 2015-REV % 1/15/27 61,000 60, % 4 Ford Credit Auto Owner Trust 2016-B 1.850% 9/15/21 7,040 6, % 4,5 Ford Credit Auto Owner Trust 2016-REV % 8/15/27 20,800 20, % 4,5 Ford Credit Auto Owner Trust 2016-REV % 12/15/27 74,340 72, % 4,5 Ford Credit Auto Owner Trust % 8/15/28 21,295 21, % 4,5 Ford Credit Auto Owner Trust % 2.750% 3/15/29 59,182 57, % 4,5 Ford Credit Auto Owner Trust 2018-REV % 3.340% 7/15/31 133, , % 4 Ford Credit Floorplan Master Owner Trust A Series % 2.790% 6/15/20 15,460 15, % 4 Ford Credit Floorplan Master Owner Trust A Series % 2/15/21 4,473 4, % 4 Ford Credit Floorplan Master Owner Trust A Series % 8/15/22 23,545 23, % 4,6 Ford Credit Floorplan Master Owner Trust A Series % 7/15/20 48,100 48, % 4 Ford Credit Floorplan Master Owner Trust A Series % 9/15/22 60,820 60, % 4,5 GMF Floorplan Owner Revolving Trust % 1.970% 5/15/20 68,210 68, % 4,5,6 GMF Floorplan Owner Revolving Trust % 2.850% 5/17/21 61,589 61, % 4,5,6 GMF Floorplan Owner Revolving Trust % 1/18/ % 23

26 Short-Term Investment-Grade Fund Face Market Percentage Maturity Amount Value of Net Coupon Date ($000) ($000) Assets 4,5 GMF Floorplan Owner Revolving Trust % 2.630% 7/15/22 81,380 80, % 4,5,6 Golden Credit Card Trust A 1.999% 2/15/20 31,694 31, % 4,5 Golden Credit Card Trust A 2.020% 4/15/22 53,490 52, % 4,5 Golden Credit Card Trust A 1.600% 9/15/21 76,602 75, % 4,5 Golden Credit Card Trust A 2.620% 1/15/23 153, , % 4,5 GS Mortgage Securities Corporation II 2012-BWTR 2.954% 11/5/34 36,047 35, % 4 GS Mortgage Securities Corporation II 2015-GC % 5/10/50 24,410 24, % 4,5 GS Mortgage Securities Corporation Trust 2012-ALOHA 3.551% 4/10/34 32,716 33, % 4,5 GS Mortgage Securities Trust 2010-C % 12/10/43 3,530 3, % 4,5 GS Mortgage Securities Trust 2011-GC % 3/10/44 2,280 2, % 4,5 GS Mortgage Securities Trust 2012-GC % 1/10/45 1,000 1, % 4 GS Mortgage Securities Trust 2012-GCJ % 5/10/45 7,150 7, % 4,5 GS Mortgage Securities Trust 2013-GC % 4.090% 7/10/46 28,584 29, % 4 GS Mortgage Securities Trust 2013-GCJ % 3.777% 6/10/46 21,310 21, % 4 GS Mortgage Securities Trust 2013-GCJ % 4.243% 8/10/46 96, , % 4 GS Mortgage Securities Trust 2014-GC % 4.258% 4/10/47 42,753 44, % 4 GS Mortgage Securities Trust 2014-GC % 4.529% 9/10/47 86,227 88, % 4 GS Mortgage Securities Trust 2014-GC % 11/10/47 47,290 48, % 4 GS Mortgage Securities Trust 2015-GC % 3.396% 2/10/48 79,805 79, % 4 GS Mortgage Securities Trust 2015-GC % 7/10/48 14,551 15, % 4 GS Mortgage Securities Trust 2015-GC % 4.654% 10/10/48 34,512 34, % 4,5 JP Morgan Chase Commercial Mortgage Securities Trust 2009-IWST 5.633% 12/5/27 6,185 6, % 4,5 JP Morgan Chase Commercial Mortgage Securities Trust 2010-C % 6/15/43 1,321 1, % 4,5 JP Morgan Chase Commercial Mortgage Securities Trust 2010-C % 5.662% 11/15/43 16,958 17, % 24

27 Short-Term Investment-Grade Fund Face Market Percentage Maturity Amount Value of Net Coupon Date ($000) ($000) Assets 4,5 JP Morgan Chase Commercial Mortgage Securities Trust 2011-C % 4.717% 2/15/46 31,105 32, % 4,5 JP Morgan Chase Commercial Mortgage Securities Trust 2011-C % 8/15/46 4,100 4, % 4,5 JP Morgan Chase Commercial Mortgage Securities Trust 2011-RR % 3/16/46 2,778 2, % 4 JP Morgan Chase Commercial Mortgage Securities Trust 2012-C % 5/15/45 16,114 16, % 4,5 JP Morgan Chase Commercial Mortgage Securities Trust 2012-C % 3.424% 10/15/45 16,592 16, % 4 JP Morgan Chase Commercial Mortgage Securities Trust 2012-CIBX 4.271% 6/15/45 27,000 28, % 4,5 JP Morgan Chase Commercial Mortgage Securities Trust 2012-HSBC 3.093% 7/5/32 5,785 5, % 4 JP Morgan Chase Commercial Mortgage Securities Trust 2012-LC % 12/15/47 40,130 39, % 4 JP Morgan Chase Commercial Mortgage Securities Trust 2013-C % 4.052% 1/15/46 24,500 25, % 4 JP Morgan Chase Commercial Mortgage Securities Trust 2013-C % 4.975% 12/15/46 72,360 75, % 4 JP Morgan Chase Commercial Mortgage Securities Trust 2013-LC % 4/15/46 28,354 28, % 4 JP Morgan Chase Commercial Mortgage Securities Trust 2016-JP % 12/15/49 14,370 14, % 4 JP Morgan Chase Commercial Mortgage Securities Trust 2017-JP % 7/15/50 12,517 12, % 4 JPMCC Commercial Mortgage Securities Trust 2017-JP % 3/15/50 33,410 34, % 4 JPMCC Commercial Mortgage Securities Trust 2017-JP % 9/15/50 20,090 20, % 4 Merrill Lynch Mortgage Investors Trust MLMI Series 2003-A % 2/25/33 1,157 1, % 25