Some Plain Talk® About Proxy Proposal 3

As you might imagine, given our very large client base, Vanguard is often asked by shareholders to sell stocks for a variety of reasons—from environmental and social issues to humanitarian and political concerns. Our position, in general, is that we cannot manage our funds in a manner that would address all of these issues while fulfilling our fiduciary obligation to produce the highest possible investment returns for all shareholders.

In addition, we believe that mutual funds are investment vehicles designed to help investors reach their financial goals, and are not optimal or effective agents for addressing social change. However, we acknowledge that there may be instances when it is appropriate to assess such issues. As noted in the proxy statement, Vanguard has implemented a procedure for identifying and regularly reporting to the trustees on portfolio companies whose direct involvement in crimes against humanity or patterns of egregious abuses of human rights could warrant engagement or divestment. This procedure applies to all 157 Vanguard funds.

Proposal 3 of the Vanguard proxy statement similarly calls for the board to institute procedures to prevent holding investments in companies that, in the judgment of the board, substantially contribute to genocide or other crimes against humanity. Given the redundancy of this procedure, Vanguard is recommending that you vote against the proposal.

The following Q&A provides more information on the issue.

What is Vanguard’s screening procedure? 

Vanguard’s corporate governance group uses a variety of inputs, including reports from independent firms that are recognized authorities on investment and social research, to evaluate the governance practices and business operations of portfolio companies. For both actively managed and passively managed funds, the group seeks to identify companies whose involvement in crimes against humanity or human rights violations would warrant the trustees' consideration. When such companies are identified, they are reported to the funds’ trustees for consideration. The trustees then apply their judgment to determine whether further action is warranted.

What actions could be pursued?

Engagement is discussing governance issues with portfolio companies. In this way, a stockholder gains the opportunity to become an agent of change. Vanguard often engages companies, discussing various issues directly with executives and directors of the firms in which our funds invest.  Divestment means selling the stock to another investor.

Does Vanguard own large stakes in PetroChina and China National Petroleum Corporation (CNPC), which are companies cited in the shareholder proposal?

No. The holdings of PetroChina and CNPC in Vanguard’s funds are modest. For example, our largest holding of PetroChina represented only 0.95% of the $12 billion Vanguard Emerging Markets Stock Index Fund as of March 31, 2009. This holding reflected the stock’s weighting in the MSCI Emerging Markets Index, the fund’s target benchmark.

Of our 157 funds, only five—four international index funds and one actively managed fund—had direct holdings in one or both of these companies as of March 31, 2009. For four of the five, the stocks represented two-tenths of 1% or less of their assets, as shown in the accompanying tables.

Vanguard Funds with Holdings in PetroChina as of 3/31/2009 Number of Shares Owned Market Value of Shares Total Net Assets of Fund % of Fundís Total Holdings
Vanguard Total International Stock Index Fund 39 million $31 million $15.6 billion 0.20%
Vanguard Emerging Markets Stock Index Fund 141 million $113 million $12 billion 0.95%
Vanguard Total World Stock Index Fund 374,000 $298,000 $303 million 0.10%
Vanguard FTSE All-World ex-US Index Fund 7 million $6 million $3.4 billion 0.17%
Vanguard Energy Fund 1 million $1 million $7.4 billion 0.01%

Vanguard Funds with Holdings in CNPC as of 3/31/2009 Number of Shares Owned Market Value of Shares Total Net Assets of Fund % of Fundís Total Holdings
Vanguard Total International Stock Index Fund 4.6 million $2 million $15.6 billion 0.01%
Vanguard Emerging Markets Stock Index Fund 15 million $6 million $12 billion 0.05%
Vanguard FTSE All-World ex-US Index Fund 860,000 $364,000 $3.4 billion 0.01%
Vanguard Total World Stock Index Fund 20,000 $8,500 $303 million 0.003%

Why do these funds hold PetroChina and CNPC?

Four of the five are index funds, whose sole objective is to seek to track the performance of their target benchmarks. The funds, therefore, typically hold the stocks that are in the indexes they seek to track. The indexes are developed and maintained by independent, third-party companies, and Vanguard has no say about what stocks are included in them.  With respect to our actively managed funds, their investment advisors are charged with choosing securities that they believe will produce the highest returns possible within their given mandate.

Why did Vanguard include the shareholder proposal on the proxy?
Federal securities laws require investment companies to include such proposals on a fund’s proxy statement, so long as the shareholder meets certain eligibility and procedural requirements. A handful of Vanguard fund shareholders have complied with these requirements, so the proposal was included even though it duplicates an existing Vanguard practice. To be clear, the proposal was instigated by a special interest advocacy group that has targeted other investment management firms in the past.

Is the shareholder proposal similar to Vanguard’s existing procedure?

We view them as substantially identical, as the procedure outlined in the shareholder proposal and Vanguard’s existing practice rely on the judgment of a fund’s board of trustees. Since adopting the procedure called for in the proposal would simply duplicate an established practice, Vanguard recommends that shareholders vote against the proposal.

Has Vanguard engaged with PetroChina and CNPC?

Vanguard engages with hundreds of companies each year on corporate governance issues, but as a matter of policy, we do not publicly discuss our interactions with specific firms.  We believe that doing so would reduce our effectiveness with corporate directors and management.

Have the trustees instructed Vanguard to divest from PetroChina and CNPC?

No. While the process is continuous, the trustees have determined that no companies have warranted divestment to date.

I would rather not own a fund that holds PetroChina or CNPC. What are my options?

At Vanguard, our shareholders have the opportunity to direct their personal investments to a broad range of low-cost funds that have no exposure to oil companies operating in Sudan. Indeed, the vast majority of 150-plus Vanguard funds have absolutely no holdings in these stocks. These offerings include our prominent market index funds, such as Vanguard Total Stock Market Index Fund, Vanguard 500 Index Fund, Vanguard Balanced Index Fund, and Vanguard Total Bond Market Index Fund. Vanguard has also offered the FTSE Social Index Fund since 2000. This low-cost, broadly diversified fund seeks to track the performance of an index comprising companies that are evaluated on social, human rights, and environmental issues.

The funds or securities referred to herein are not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to any such funds or securities. For any such funds or securities, the prospectus or the Statement of Additional Information contains a more detailed description of the limited relationship MSCI has with The Vanguard Group and any related funds.

FTSE® is a trademark jointly owned by the London Stock Exchange plc and The Financial Times Limited and is used by FTSE International Limited under license. FTSE International Limited does not sponsor, endorse, or promote the fund; is not in any way connected to it; and does not accept any liability in relation to its issue, operation, and trading.

All investments, including a portfolio's current and future holdings, are subject to risk.Investments in bond funds are subject to interest rate, credit, and inflation risk. Foreign investing involves additional risks including currency fluctuations and political uncertainty. Stocks of companies in emerging markets are generally more risky than stocks of companies in developed countries. Funds that concentrate on a relatively narrow market sector face the risk of higher share-price volatility.

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