Past performace 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 www.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.

 

 

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 cover of this report. Of course, the risks of investing in your fund are spelled out in the prospectus.

 

Your Fund’s Total Returns

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1 A lower-cost class of shares available to many longtime shareholders and to those with significant investments in the fund.

2 Derived from data provided by Lipper Inc.

 

 

1

 

Chairman’s Letter

 

Dear Shareholder,

 

Propelled by soaring oil prices, Vanguard Energy Fund Investor Shares returned 25.0% in fiscal year 2008. The lower-cost Admiral Shares returned 25.1%. The fund’s return slightly lagged the average return of peer funds, but surpassed the benchmark Standard & Poor’s Energy Sector Index return by 3 percentage points. (Although this index is a fair gauge of energy stock performance, it’s important to note that it includes only United States-based companies and is far less diversified than your fund and the energy industry in general.)

During the past year, supply-and-demand dynamics drove oil prices ever higher, to a record of $100 per barrel in January. The seemingly insatiable appetite for energy—especially in rapidly developing economies such as China, India, and even oil exporters such as Saudi Arabia—was a major factor. Supply-side drivers included political instability and greater solidarity among producing nations, limited new discoveries, and concern about future resources. Your fund benefited from the energy sector’s position as the market’s best performer over the 12 months and from excellent stock selection by the fund’s advisors, Wellington Management Company and Vanguard Quantitative Equity Group.

If you invest in the Energy Fund through a taxable account, you may wish to review the fund’s after-tax performance on page 25.

 

 

 

 

 

 

 

 

 

 

 

 

 

2

Stocks gained in the first half but faltered in the second

The broad U.S. stock market returned –2.7% for the 12 months ended January 31, reflecting a volatile year punctuated by sharp declines for equities. Gains in the first half of the fiscal period were largely relinquished in midsummer and fall as repercussions from the subprime mortgage debacle began to be felt in the broader U.S. economy. The stock market’s retreat accelerated in January amid tightening global credit markets, a weakening U.S. dollar, and widening fears of a U.S. recession.

 

Large-capitalization stocks fared best in these unsettled conditions, outperforming small-caps for the year; meanwhile, growth stocks outpaced their value-oriented counterparts.

International stocks outperformed U.S. stocks for the sixth straight year, largely owing to exchange-rate gains produced by the weak U.S. dollar. Emerging markets and developed economies in Europe and Asia posted strong performances earlier in the fiscal year, but slumped after November as a result of increased concern about a U.S.-led downturn.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3

Bond returns grew stronger as Fed lowered rates

During the first half of the fiscal year, a stronger U.S. economy made investors more willing to take on risk to earn higher yields; spreads thus narrowed between the yields of U.S. Treasury securities and those of lower-quality issues. But as the subprime lending problems unraveled further in summer, investors flocked to higher-quality government and corporate bonds. This drove Treasury prices higher and yields lower, widening the spread between Treasury yields and those of riskier bonds.

The Federal Reserve Board responded to the credit market turmoil and deteriorating economic outlook with aggressive reductions in its target for the federal funds rate. The Fed cut the rate five times during the fiscal year (twice in January), ending the period at 3.0%, the lowest rate since May 2005.

Lower interest rates depressed bond yields, but pushed prices higher. The broad taxable bond market returned 8.8% for the fiscal year. Tax-exempt municipal bonds returned 4.9%.

Robust returns across the oil patch

Soaring oil prices were a dominant theme in economies, stock markets, and households around the globe during the year. West Texas Intermediate crude oil—an industry benchmark—skyrocketed from about $58 per barrel to a record $100 in early January 2008, then retreated

 

 

 

 

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 www.vanguard.com/performance.) Note, too, that both investment returns and principal value can fluctuate widely, so an investor’s shares, when sold, could be worth more or less than their original cost.

 

 

 

 

 

1 Fund expense ratios reflect the 12 months ended January 31, 2008. Peer-group expense ratio is derived from data provided by Lipper Inc. and captures information through year-end 2007.

2 Derived from data provided by Lipper Inc.

 

4

modestly. Natural gas prices also rose, but far less dramatically. Despite dismal performance in January, energy stocks delivered robust returns for the fiscal year.

Like most segments of the portfolio, integrated oil and gas producers—which participate globally in the entire supply chain from high-risk exploration through refining and marketing—were major beneficiaries of rising prices. The stocks of these companies accounted for about half of the fund’s total return, commensurate with their 53% average weighting in the portfolio. Leading contributors included three top-ten holdings: ExxonMobil, Chevron, and ConocoPhillips. In addition to these U.S.-based giants, the fund held some excellent performers in international markets. (Like the energy industry itself, your fund is globally diversified.) Petroleo Brasileiro (or Petrobras), which returned more than 131%, and BG Group (British Gas), which returned nearly 69%, contributed significantly: They jointly discovered an ultra-deep-water oil field off the Brazilian coast, potentially one of the world’s largest finds in recent years.

Higher prices spurred exploration activity, enhancing earnings of oil-field equipment and service providers, which generated almost 5 percentage points of return for the fund. Top-ten holdings Schlumberger and Weatherford International were notable contributors, as were Halliburton and Fugro (a Netherlands-based geoscience company). Transocean and Global Santa Fe, drilling contractors and merger partners, added 1.5 percentage points to total return. The global resource quest also helped exploration and production companies to contribute 4 percentage points to total return, led by Canadian Natural Resources, EnCana, EOG Resources, and Noble Energy.

At the other end of the pipeline, refiners and marketers—a small slice of the fund and its benchmark—had a mixed year. Although consumers felt the pinch of higher retail prices, profit margins were squeezed by rising costs for raw materials.

Beyond the oil patch, the fund’s above-benchmark weighting in coal producers and its inclusion of BHP Billiton—a diversified metals and mining company that benefited from booming global demand for commodities and base metals—boosted returns and contributed notably to outperforming the index.

Fund’s long-term record reveals deep strengths

After a modest showing a year ago, the Energy Fund resumed its long-term path of impressive returns and significant outperformance. For the decade ended January 31, 2008, the average annual return of 18.1% for the fund’s Investor Shares bested both the peer average and the sector index return by more than 3 percentage points, as shown in the table on page 4.

This superior performance is a tribute to the fund’s investment advisors. In seeking to identify companies with the potential for significant capital appreciation, Wellington Management Company focuses on the bottom-up selection of stocks it considers undervalued, while Vanguard Quantitative Equity Group uses a risk-controlled, computer-based approach to evaluate

 

 

 

5

and rank stocks. Within the confines of a single sector fund, these distinct yet complementary approaches can help to provide the benefit of diversification. For more about the advisors’ strategies and the fund’s positioning during the year, see the Advisors’ Report, which begins on page 7.

In addition, your fund’s low expenses help investors keep more of the fund’s return, an advantage that compounds over time.

Stay diversified even when energy is hot

It can be tempting to chase the stocks or industries that are leading the market at the moment. All too often, however, this approach leads investors to disappointment. Rather than chase performance, Vanguard encourages shareholders to invest with a long-term view, to diversify within and across asset classes, and to pay attention to costs.

Just as oil and gas exploration companies encounter dry holes, the Energy Fund is likely to experience occasional years of underperformance. The fund’s focus on a single market segment, combined with the energy industry’s ever-changing economic and geopolitical dynamics, can lead to heightened volatility in the short term. That’s why we encourage investors to consider the fund not on a stand-alone basis but as part of a balanced, diversified portfolio consistent with their comfort level and long-term goals. The Energy Fund can provide low-cost exposure to a meaningful market sector and can help you achieve your personal investment objectives.

As I close this report to you, it’s my pleasure to introduce the fund’s new president, F. William McNabb III. Bill is a man of great character and integrity who is intimately familiar with all aspects of Vanguard—from how we serve our clients to how we invest for our clients.

Bill and I have worked together very closely for more than two decades. I’m thrilled that the fund’s board elected him president, effective March 1, and designated him as my successor as chief executive officer, a role he will assume within a year, after an orderly transition. Bill and the rest of our team will serve you and our other clients extremely well in the years ahead.

Thank you for entrusting your assets to Vanguard.

 

Sincerely,

 

 

John J. Brennan

Chairman and Chief Executive Officer

February 22, 2008

 

 

 

 

 

6

Advisors’ Report

 

For the fiscal year ended January 31, 2008, the Investor Shares of Vanguard Energy Fund returned 25.0%, and the Admiral Shares returned 25.1%. This impressive performance reflected the combined efforts of your fund’s two advisors. The use of multiple advisors enhances the fund’s diversification by providing exposure to distinct, yet complementary, investment approaches.

The advisors, the percentage of fund assets each manages, and brief descriptions of their investment strategies are presented in the table below. The advisors have also prepared a discussion of the investment environment that existed during the fiscal year and of how their portfolio positioning reflects this assessment. These reports were prepared on February 13, 2008.

 

Wellington Management Company, LLP

Portfolio Managers:

Karl E. Bandtel, Senior Vice President

James A. Bevilacqua, Senior Vice President

The environment for energy investing has remained positive over the last 12 months. The price of oil continued to set record highs as it rose throughout the period. Prices were supported by low spare capacity, supply disappointments outside the Organization of Petroleum Exporting Countries (OPEC), and persistently strong demand. Natural gas prices fluctuated throughout the fiscal year before finishing the period somewhat higher than they had been at the start.

 

 

 

 

 

 

 

1 These short-term reserves are invested by Vanguard in equity index products to stimulate investments in stocks. Each advisor may also maintain a modest cash position.

 

7

Despite high prices and solid demand globally, Saudi Arabia and other OPEC members have been holding oil off the market voluntarily. North American natural gas markets do not have a producer organization to manage supplies. However, as imports of liquefied natural gas grow in importance, that may change. We continue to believe supply expansions are likely to become more challenging going forward.

Top absolute contributors to performance for our portion of the fund included BHP Billiton, Petroleo Brasileiro (Petrobras), and CONSOL Energy. Detractors for the period included Hyundai Heavy Industries and Lukoil. We created new positions in OMV, Repsol, and Seadrill, and added to our existing position in Gazprom. We trimmed holdings in ENI and Norsk Hydro. We also reduced our position in Valero Energy because of concerns about refining margins.

Vanguard Quantitative Equity Group

Portfolio Manager:

James D. Troyer, CFA, Principal

Our quantitative investment process evaluates a security’s attractiveness on three dimensions: valuation, sentiment, and balance-sheet prospects. We believe that having multiple indicators in our model creates a better overall evaluation process than relying on each signal alone.

 

A key characteristic of our strategy is that we do not maintain a “view” on the overall market for energy shares. This is reflected in our portfolio, where we are always fully invested. We apply a stringent risk-control process to neutralize our exposure to market-capitalization, volatility, and industry risks relative to our energy benchmark. The resulting portfolio takes many small positions in individual stocks in an attempt to capture the market’s tendency to overreact or underreact to new information.

 

During the last 12 months, overseas energy stocks performed particularly well. Our positions in the Australian company Santos and the Brazilian firm Petrobras were particularly successful. In the United States, Hess and Massey Energy were good performers. Detracting from our performance were our holdings of Cameco and Rowan Companies.

 

Focusing on the performance of individual firms, however, can distract us from the objective of a quantitative model, which is to make many small, systematic bets, rigorously tested and applied, in order to catch relatively small mispricings across large numbers of stocks. The success or failure of a few holdings is not as important as the average return we earn over our entire portfolio.

 

 

 

 

 

 

 

 

 

8

Fund Profile

As of January 31, 2008

 

 

 

 

 

 

 

 

 

 

 

 

9

 

 

Investment Focus

 

 

 

1 S&P Energy Sector Index.

2 Dow Jones Wilshire 5000 Index.

3 Short-term reserves exclude futures and currency contracts held by the fund.

4 Sector percentages combine U.S. and international holdings.

5 For an explanation of R-squared, beta, and other terms used here, see the Glossary on page 28.

6 “Ten Largest Holdings” excludes any temporary cash investments and equity index products.

 

 

 

 

 

 

 

 

 

 

 

10

 

 

 

 

 

 

 

11

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 www.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, 1998–January 31, 2008

Initial Investment of $25,000

 

 

 

 

 

 

 

 

 

 

1 Total returns do not reflect the 1% fee assessed on redemptions of shares held less than one year, nor do they include the account service fee that may be applicable to certain accounts with balances below $10,000.

2 Derived from data provided by Lipper Inc.

3 Performance for the fund’s Admiral Shares and comparative standards is calculated since the Admiral Shares’ inception: November 12, 2001.

 

 

12

 

Fiscal-Year Total Returns (%): January 31, 1998—January 31, 2008

 

 

Average Annual Total Returns: Periods Ended December 31, 2007

This table presents average annual total 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.

 

 

 

 

 

 

 

 

 

 

 

 

 

1 Total returns do not reflect the 1% fee assessed on redemptions of shares held less than one year, nor do they include the account service fee that may be applicable to certain accounts with balances below $10,000.

2 Return since inception.

Note: See Financial Highlights tables on pages 18 and 19 for dividend and capital gains information.

 

 

 

13

Financial Statements

 

Statement of Net Assets

As of January 31, 2008

 

The fund provides a complete list of its holdings 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 www.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).

 

 

 

 

 

14

 

 

 

 

 

 

 

 

 

15

 

 

16

 

 

 

17

 

 

 

 

 

 

 

 

 

 

18

 

 

^ Part of security position is on loan to broker-dealers. See Note F in Notes to Financial Statements.

1 The fund invests a portion of its cash reserves in equity markets through the use of index futures contracts. After giving effect to futures investments, the fund’s effective common stock and temporary cash investment positions represent 96.2% and 4.0%, respectively, of net assets. See Note D in Notes to Financial Statements.

2 Security exempt from registration under Rule 144A of the Securities Act of 1933. Such securities may be sold in transactions exempt from registration, normally to qualified institutional buyers. At January 31, 2008, the value of this security represented 0.07% of net assets.

3 Affiliated money market fund available only to Vanguard funds and certain trusts and accounts managed by Vanguard. Rate shown is the 7-day yield.

4 The issuer operates under a congressional charter; its securities are neither issued nor guaranteed by the U.S. government. If needed, access to additional funding from the U.S. Treasury (beyond the issuer’s line of credit) would require congressional action.

5 Securities with a value of $25,443,000 have been segregated as initial margin for open futures contracts.

6 See Note D in Notes to Financial Statements for the tax-basis components of net assets.

ADR—American Depositary Receipt.

 

 

19

Statement of Operations

 

 

 

 

 

 

 

 

1 Dividends are net of foreign withholding taxes of $13,645,000.

2 Interest income from an affiliated company of the fund was $13,886,000.

 

 

20

Statement of Changes in Net Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

1 Includes fiscal 2008 and 2007 short-term gain distributions totaling $64,462,000 and $6,548,000, 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 ($7,458,000) and ($6,604,000).

 

 

21

Financial Highlights

 

 

 

 

 

 

 

 

 

 

 

 

 

1 Includes increases from redemption fees of $.02, $.03, $.03, $.02, and $.00.

2 Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year, or the account service fee that may be applicable to certain accounts with balances below $10,000.

3 Excludes the value of portfolio securities received or delivered as a result of in-kind purchases or redemptions of the fund’s capital shares.

 

 

22

 

 

 

 

 

 

 

 

 

 

 

 

 

1 Includes increases from redemption fees of $.03, $.05, $.03, $.03, and $.01.

2 Total returns do not reflect the 1% fee assessed on redemptions of shares held for less than one year.

3 Excludes the value of portfolio securities received or delivered as a result of in-kind purchases or redemptions of the fund’s capital shares.

See accompanying Notes, which are an integral part of the Financial Statements.

 

 

23

Notes to Financial Statements

 

Vanguard Energy Fund is registered under the Investment Company Act of 1940 as an open-end investment company, or mutual fund. The fund files reports with the SEC under the company name Vanguard Specialized Funds. The fund may invest in securities of foreign issuers, which may subject it to investment risks not normally associated with investing in securities of United States corporations. The fund offers two classes of shares, Investor Shares and Admiral Shares. Investor Shares are available to any investor who meets the fund’s minimum purchase requirements. Admiral Shares are designed for investors who meet certain administrative, service, tenure, and account-size criteria.

 

A. The following significant accounting policies conform to generally accepted accounting principles for U.S. mutual funds. The fund consistently follows such policies in preparing its financial statements.

 

1. Security Valuation: Securities are valued as of the close of trading on the New York Stock Exchange (generally 4 p.m., Eastern time) on the valuation date. Equity securities are valued at the latest quoted sales prices or official closing prices taken from the primary market in which each security trades; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Securities for which market quotations are not readily available, or whose values have been affected by events occurring before the fund’s pricing time but after the close of the securities’ primary markets, are valued at their fair values calculated according to procedures adopted by the board of trustees. These procedures include obtaining quotations from an independent pricing service, monitoring news to identify significant market- or security-specific events, and evaluating changes in the values of foreign market proxies (for example, ADRs, futures contracts, or exchange-traded funds), between the time the foreign markets close and the fund’s pricing time. When fair-value pricing is employed, the prices of securities used by a fund to calculate its net asset value may differ from quoted or published prices for the same securities. Investments in Vanguard Market Liquidity Fund are valued at that fund’s net asset value. Temporary cash investments acquired over 60 days to maturity are valued using the latest bid prices or using valuations based on a matrix system (which considers such factors as security prices, yields, maturities, and ratings), both as furnished by independent pricing services. Other temporary cash investments are valued at amortized cost, which approximates market value.

 

2. Foreign Currency: Securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars using exchange rates obtained from an independent third party as of the fund’s pricing time on the valuation date. Realized gains (losses) and unrealized appreciation (depreciation) on investment securities include the effects of changes in exchange rates since the securities were purchased, combined with the effects of changes in security prices. Fluctuations in the value of other assets and liabilities resulting from changes in exchange rates are recorded as unrealized foreign currency gains (losses) until the assets or liabilities are settled in cash, at which time they are recorded as realized foreign currency gains (losses).

 

3. Futures Contracts: The fund uses index futures contracts to a limited extent, with the objective of maintaining full exposure to the stock market while maintaining liquidity. The fund may purchase or sell futures contracts to achieve a desired level of investment, whether to accommodate portfolio turnover or cash flows from capital share transactions. The primary risks associated with the use of futures contracts are imperfect correlation between changes in market values of stocks held by the fund and the prices of futures contracts, and the possibility of an illiquid market.

 

Futures contracts are valued based upon their quoted daily settlement prices. The aggregate principal amounts of the contracts are not recorded in the Statement of Net Assets. Fluctuations in the value of the contracts are recorded in the Statement of Net Assets as an asset (liability) and in the Statement of Operations as unrealized appreciation (depreciation) until the contracts are closed, when they are recorded as realized futures gains (losses).

 

24

4. Repurchase Agreements: The fund may invest in repurchase agreements. Securities pledged as collateral for repurchase agreements are held by a custodian bank until the agreements mature. Each agreement requires that the market value of the collateral be sufficient to cover payments of interest and principal; however, in the event of default or bankruptcy by the other party to the agreement, retention of the collateral may be subject to legal proceedings.

 

5. Federal Income Taxes: The fund intends to continue to qualify as a regulated investment company and distribute all of its taxable income. Accordingly, no provision for federal income taxes is required in the financial statements.

 

6. Distributions: Distributions to shareholders are recorded on the ex-dividend date.

 

7. Security Lending: The fund may lend its securities to qualified institutional borrowers to earn additional income. Security loans are required to be secured at all times by collateral at least equal to the market value of securities loaned. The fund invests cash collateral received in Vanguard Market Liquidity Fund, and records a liability for the return of the collateral, during the period the securities are on loan. Security lending income represents the income earned on investing cash collateral, less expenses associated with the loan.

 

8. Other: Dividend income is recorded on the ex-dividend date. Interest income includes income distributions received from Vanguard Market Liquidity Fund and is accrued daily. Security transactions are accounted for on the date securities are bought or sold. Costs used to determine realized gains (losses) on the sale of investment securities are those of the specific securities sold. Fees assessed on redemptions of capital shares are credited to paid-in capital.

 

Each class of shares has equal rights as to assets and earnings, except that each class separately bears certain class-specific expenses related to maintenance of shareholder accounts (included in Management and Administrative expenses) and shareholder reporting. Marketing and distribution expenses are allocated to each class of shares based on a method approved by the board of trustees. Income, other non-class-specific expenses, and gains and losses on investments are allocated to each class of shares based on its relative net assets.

 

B. Wellington Management Company, LLP, provides investment advisory services to a portion of the fund for a fee calculated at an annual percentage rate of average net assets managed by the advisor. Beginning in February 2008, the investment advisory fee will be subject to quarterly adjustments based on performance since May 1, 2007, relative to a combined index composed of the S&P Citigroup BMI World Energy Index and the S&P 500 Energy Equal Weight Index.

 

The Vanguard Group provides investment advisory services to a portion of the fund on an at-cost basis; the fund paid Vanguard advisory fees of $292,000 for the year ended January 31, 2008.

 

For the year ended January 31, 2008, the aggregate investment advisory fee represented an effective annual rate of 0.07% of the fund’s average net assets.

 

C. The Vanguard Group furnishes at cost corporate management, administrative, marketing, and distribution services. The costs of such services are allocated to the fund under methods approved by the board of trustees. The fund has committed to provide up to 0.40% of its net assets in capital contributions to Vanguard. At January 31, 2008, the fund had contributed capital of $1,230,000, to Vanguard (included in Other Assets), representing 0.01% of the fund’s net assets and 1.23% of Vanguard’s capitalization. The fund’s trustees and officers are also directors and officers of Vanguard.

25

D. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. Differences may be permanent or temporary. Permanent differences are reclassified among capital accounts in the financial statements to reflect their tax character. Temporary differences arise when certain items of income, expense, gain, or loss are recognized in different periods for financial statement and tax purposes; these differences will reverse at some time in the future. Differences in classification may also result from the treatment of short-term gains as ordinary income for tax purposes.

 

The fund used a tax accounting practice to treat a portion of the price of capital shares redeemed during the year as distributions from net investment income and realized capital gains. Accordingly, the fund has reclassified $10,419,000 from undistributed net investment income, and $43,759,000 from accumulated net realized gains, to paid-in capital.

 

During the year ended January 31, 2008, the fund realized net foreign currency gains of $1,415,000, which increased distributable net income for tax purposes; accordingly, such gains have been reclassified from undistributed net investment income to accumulated net realized gains.

 

For tax purposes, at January 31, 2008, the fund had $4,375,000 of ordinary income and $323,379,000 of long-term capital gains available for distribution.

 

At January 31, 2008, the cost of investment securities for tax purposes was $7,131,992,000. Net unrealized appreciation of investment securities for tax purposes was $6,023,858,000, consisting of unrealized gains of $6,121,863,000 on securities that had risen in value since their purchase and $98,005,000 in unrealized losses on securities that had fallen in value since their purchase.

 

At January 31, 2008, the aggregate settlement value of open futures contracts expiring in March 2008 and the related unrealized appreciation (depreciation) were:

 

 

Unrealized appreciation (depreciation) on open futures contracts is required to be treated as realized gain (loss) for tax purposes.

 

E. During the year ended January 31, 2008, the fund purchased $3,203,618,000 of investment securities and sold $2,511,828,000 of investment securities other than temporary cash investments.

 

F. The market value of securities on loan to broker-dealers at January 31, 2008, was $24,210,000, for which the fund received cash collateral of $24,723,000.

 

 

 

 

26

G. Capital share transactions for each class of shares were:

 

 

 

 

H. In June 2006, the Financial Accounting Standards Board issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes.” FIN 48 establishes the minimum threshold for recognizing, and a system for measuring, the benefits of tax-return positions in financial statements, effective for the fund’s current fiscal year. Management has analyzed the fund’s tax positions taken on federal income tax returns for all open tax years (tax years ended January 31, 2005–2008) for purposes of implementing FIN 48, and has concluded that no provision for income tax is required in the fund’s financial statements.

 

 

 

 

 

 

 

 

 

 

 

 

1 Net of redemption fees of $3,474,000 and $3,975,000 (fund totals).

 

 

27

Report of Independent Registered Public Accounting Firm

 

To the Trustees of Vanguard Specialized Funds and the Shareholders of Vanguard Energy Fund:

 

In our opinion, the accompanying statement of net assets and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Vanguard Energy Fund (constituting a separate portfolio of Vanguard Specialized Funds, hereafter referred to as the “Fund”) at January 31, 2008, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended and the financial highlights for each of the five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as “financial statements”) are the responsibility of the Fund’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at January 31, 2008 by correspondence with the custodians and brokers and by agreement to the underlying ownership records for Vanguard Market Liquidity Fund, provide a reasonable basis for our opinion.

 

PricewaterhouseCoopers LLP

Philadelphia, Pennsylvania

 

March 12, 2008

 

 

 

 

 

Special 2007 tax information (unaudited) for Vanguard Energy Fund

 

This information for the fiscal year ended January 31, 2008, is included pursuant to provisions of the Internal Revenue Code.

 

The fund distributed $692,666,000 as capital gain dividends (from net long-term capital gains) to shareholders during the fiscal year.

 

The fund distributed $159,284,000 of qualified dividend income to shareholders during the fiscal year.

 

For corporate shareholders, 27.5% of investment income (dividend income plus short-term gains, if any) qualifies for the dividends-received deduction.

 

 

28

Your Fund’s After-Tax Returns

 

This table presents returns for your fund both before and after taxes. The after-tax returns are shown in two ways: (1) assuming that an investor owned the fund during the entire period and paid taxes on the fund’s distributions, and (2) assuming that an investor paid taxes on the fund’s distributions and sold all shares at the end of each period.

 

Calculations are based on the highest individual federal income tax and capital gains tax rates in effect at the times of the distributions and the hypothetical sales. State and local taxes were not considered. After-tax returns reflect any qualified dividend income, using actual prior-year figures and estimates for 2008. (In the example, returns after the sale of fund shares may be higher than those assuming no sale. This occurs when the sale would have produced a capital loss. The calculation assumes that the investor received a tax deduction for the loss.)

 

The table shows returns for Investor Shares only; returns for other share classes will differ. Please note that your actual after-tax returns will depend on your tax situation and may differ from those shown. Also note that if you own the fund in a tax-deferred account, such as an individual retirement account or a 401(k) plan, this information does not apply to you. Such accounts are not subject to current taxes.

 

Finally, keep in mind that a fund’s performance—whether before or after taxes—does not guarantee future results.

 

 

 

 

 

 

 

 

 

 

 

1 Total returns do not reflect the 1% fee assessed on redemptions of shares held less than one year, nor do they include the account service fee that may be applicable to certain accounts with balances below $10,000.

 

 

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About Your Fund’s Expenses

 

As a shareholder of the fund, you incur ongoing costs, which include costs for portfolio management, administrative services, and shareholder reports (like this one), among others. Operating expenses, which are deducted from a fund’s gross income, directly reduce the investment return of the fund.

 

A fund’s expenses are expressed as a percentage of its average net assets. This figure is known as the expense ratio. The following examples are intended to help you understand the ongoing costs (in dollars) of investing in your fund and to compare these costs with those of other mutual funds. The examples are based on an investment of $1,000 made at the beginning of the period shown and held for the entire period.

 

The table below illustrates your fund’s costs in two ways:

 

• Based on actual fund return. This section helps you to estimate the actual expenses that you paid over the period. The “Ending Account Value” shown is derived from the fund’s actual return, and the third column shows the dollar amount that would have been paid by an investor who started with $1,000 in the fund. You may use the information here, together with the amount you invested, to estimate the expenses that you paid over the period.

 

To do so, simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number given for your fund under the heading “Expenses Paid During Period.”

 

• Based on hypothetical 5% yearly return. This section is intended to help you compare your fund’s costs with those of other mutual funds. It assumes that the fund had a yearly return of 5% before expenses, but that the expense ratio is unchanged. In this case—because the return used is not the fund’s actual return—the results do not apply to your investment. The example is useful in making comparisons because the Securities and Exchange Commission requires all mutual funds to calculate expenses based on a 5% return. You can assess your fund’s costs by comparing this hypothetical example with the hypothetical examples that appear in shareholder reports of other funds.

 

 

 

 

1 These calculations are based on expenses incurred in the most recent six-month period. The fund’s annualized six-month expense ratios for that period are 0.25% for Investor Shares and 0.16% for Admiral Shares. The dollar amounts shown as “Expenses Paid” are equal to the annualized expense ratio multiplied by the average account value over the period, multiplied by the number of days in the most recent six-month period, then divided by the number of days in the most recent 12-month period.

 

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Note that the expenses shown in the table on page 26 are meant to highlight and help you compare ongoing costs only and do not reflect transaction costs incurred by the fund for buying and selling securities. Further, the expenses do not include the 1% fee on redemptions of shares held for less than one year, nor do they include the account service fee described in the prospectus. If such fees were applied to your account, your costs would be higher. Your fund does not carry a “sales load.”

 

The calculations assume no shares were bought or sold during the period. Your actual costs may have been higher or lower, depending on the amount of your investment and the timing of any purchases or redemptions.

 

You can find more information about the fund’s expenses, including annual expense ratios, in the Financial Statements section of this report. For additional information on operating expenses and other shareholder costs, please refer to your fund’s current prospectus.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Glossary

 

Beta. A measure of the magnitude of a fund’s past share-price fluctuations in relation to the ups and downs of a given market index. The index is assigned a beta of 1.00. Compared with a given index, a fund with a beta of 1.20 typically would have seen its share price rise or fall by 12% when the index rose or fell by 10%. For this report, beta is based on returns over the past 36 months for both the fund and the index. Note that a fund’s beta should be reviewed in conjunction with its R-squared (see definition below). The lower the R-squared, the less correlation there is between the fund and the index, and the less reliable beta is as an indicator of volatility.

 

Earnings Growth Rate. The average annual rate of growth in earnings over the past five years for the stocks now in a fund.

 

Equity Exposure. A measure that reflects a fund’s investments in stocks and stock futures. Any holdings in short-term reserves are excluded.

 

Expense Ratio. The percentage of a fund’s average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors.

 

Foreign Holdings. The percentage of a fund represented by stocks or depositary receipts of companies based outside the United States.

 

Inception Date. The date on which the assets of a fund (or one of its share classes) are first invested in accordance with the fund’s investment objective. For funds with a subscription period, the inception date is the day after that period ends. Investment performance is measured from the inception date.

 

Median Market Cap. An indicator of the size of companies in which a fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund’s stocks, weighted by the proportion of the fund’s assets invested in each stock. Stocks representing half of the fund’s assets have market capitalizations above the median, and the rest are below it.

 

Price/Book Ratio. The share price of a stock divided by its net worth, or book value, per share. For a fund, the weighted average price/book ratio of the stocks it holds.

 

Price/Earnings Ratio. The ratio of a stock’s current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company’s future growth.

 

R-Squared. A measure of how much of a fund’s past returns can be explained by the returns from the market in general, as measured by a given index. If a fund’s total returns were precisely synchronized with an index’s returns, its R-squared would be 1.00. If the fund’s returns bore no relationship to the index’s returns, its R-squared would be 0. For this report, R-squared is based on returns over the past 36 months for both the fund and the index.

 

Return on Equity. The annual average rate of return generated by a company during the past five years for each dollar of shareholder’s equity (net income divided by shareholder’s equity). For a fund, the weighted average return on equity for the companies whose stocks it holds.

 

Short-Term Reserves. The percentage of a fund invested in highly liquid, short-term securities that can be readily converted to cash.

 

Turnover Rate. An indication of the fund’s trading activity. Funds with high turnover rates incur higher transaction costs and may be more likely to distribute capital gains (which may be taxable to investors). The turnover rate excludes in-kind transactions, which have minimal impact on costs.

 

Yield. A snapshot of a fund’s income from interest and dividends. The yield, expressed as a percentage of the fund’s net asset value, is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. The index yield is based on the current annualized rate of income provided by securities in the index.

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The People Who Govern Your Fund

 

The trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are a part owner of the fund. Your fund’s trustees also serve on the board of directors of The Vanguard Group, Inc., which is owned by the Vanguard funds and provides services to them on an at-cost basis.

 

A majority of Vanguard’s board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals.

 

Our independent board members bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the activities of the funds. Among board members’ responsibilities are selecting investment advisors for the funds; monitoring fund operations, performance, and costs; reviewing contracts; nominating and selecting new trustees/directors; and electing Vanguard officers.

 

Each trustee serves a fund until its termination; or until the trustee’s retirement, resignation, or death; or otherwise as specified in the fund’s organizational documents. Any trustee may be removed at a shareholders’ meeting by a vote representing two-thirds of the net asset value of all shares of the fund together with shares of other Vanguard funds organized within the same trust. The table on these two pages shows information for each trustee and executive officer of the fund. The mailing address of the trustees and officers is P.O. Box 876, Valley Forge, PA 19482.

 

 

 

 

 

 

1 Officers of the funds are “interested persons” as defined in the Investment Company Act of 1940.

2 December 2002 for Vanguard Equity Income Fund, Vanguard Growth Equity Fund, the Vanguard Municipal Bond Funds, and the Vanguard State Tax-Exempt Funds.

More information about the trustees is in the Statement of Additional Information, available from The Vanguard Group.

 

Connect with Vanguard® > www.vanguard.com