N-30D 1 s6376.txt AXP SELECTIVE FUND, INC. AXP(R) Selective Fund 2001 ANNUAL REPORT (PROSPECTUS ENCLOSED) American Express(R) Funds (icon of) clock AXP Selective Fund seeks to provide shareholders with current income and preservation of capital. (This annual report includes a prospectus that describes in detail the Fund's objective, investment strategy, risks, sales charges, fees and other matters of interest. Please read the prospectus carefully before you invest or send money.) A Quest for Quality Not all bonds are created equal. A bond's quality depends on the ability of its issuers to make the interest and principal payments owed to the bondholders. The quality is determined by independent rating agencies, which assign a credit rating (in the form of a letter grade) to each bond. Since its establishment in 1945, AXP Selective Fund has concentrated its investments in the four highest investment grades. Along the way, investors have enjoyed a steady stream of interest income with minimum risk to their principal. Table of Contents 2001 ANNUAL REPORT The purpose of this annual report is to tell investors how the Fund performed. From the Chairman 3 From the Portfolio Manager 3 Fund Facts 5 The 10 Largest Holdings 6 Making the Most of the Fund 7 The Fund's Long-term Performance 8 Board Members and Officers 9 Independent Auditors' Report (Fund) 11 Financial Statements (Fund) 12 Notes to Financial Statements (Fund) 15 Independent Auditors' Report (Portfolio) 22 Financial Statements (Portfolio) 23 Notes to Financial Statements (Portfolio) 25 Investments in Securities 29 Federal Income Tax Information 34 -------------------------------------------------------------------------------- 2 AXP SELECTIVE FUND (picture of) Arne H. Carlson Arne H. Carlson Chairman of the board From the Chairman First, I want to thank you for being a shareholder in American Express funds. While we strongly believe in the virtues of investment, we also are very sensitive to the fluctuations of the financial markets. That is why we want to re-emphasize the importance of making certain that you frequently review your investments and regularly meet with your financial advisor. By doing so, you can take advantage of shifts in the markets to position your portfolio relative to expected market volatility and, possibly, achieve better overall performance. Second, I strongly advise that you keep a focus on the long-term. Reviewing past performance is helpful, but it should not be viewed as a leading indicator of the future. One constant is the necessity to have a financial plan based on appropriate asset allocation. Make sure that the plan provides what you need and expect. Our job, as a Board, is to monitor and confirm that the Fund complies with its investment objective and that its management style stays on target. We want the Fund to be able to deliver to you, the shareholder, the type of performance you expect and the best results that can be obtained. Toward that end, American Express has made significant changes, and will continue to make changes as it strives to provide a consistent standard of excellence. On behalf of the Board, Arne H. Carlson (picture of) Brad Stone Brad Stone Portfolio manager From the Portfolio Manager A drop in interest rates and a well-positioned portfolio resulted in a very productive 12 months for AXP Selective Fund. During the past fiscal year -- June 2000 through May 2001 -- the total return, which includes net asset value change and distributions, for the Fund's Class A shares was 11.52% (excluding the sales charge). Setting the stage for what would be a positive period for most types of bonds was a slowdown in economic growth. After roaring ahead in the first several months of 2000 and consequently giving rise to concerns about a potential run-up in inflation, the economy started to show signs of slowing down last summer. Soothed by that development, bond investors began moving more money into the bond market around the outset of the past period. As a result, longer-term interest rates fell steadily through the end of 2000, driving up bond prices in the process. (Falling interest rates boost bond prices, while rising rates depress them.) The Fund's net asset value enjoyed a healthy increase as well. -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 3 THE FED GETS INVOLVED By the time new year came around, the Federal Reserve, concerned that the economy might slip into recession, began reducing short-term interest rates. Usually, that would prompt a further decline in longer-term rates. But in this case, forward-thinking investors, who decided that the Fed's actions would stimulate economic growth and, perhaps, inflation, eased off on their buying. That kept longer-term interest rates in a stable-to-slightly-higher range through the end of the period, which in turn put a lid on bond prices. Prior to that, when buying was considerably heavier, high-quality mortgage-backed bonds sponsored by federal agencies and U.S. Treasury issues attracted the most attention from investors. Consequently, they experienced particularly good price appreciation. That worked to the Fund's advantage, given that "mortgages" and "Treasurys" made up the bulk of the portfolio. The other major area of investment was high-quality corporate bonds, which, while they provided positive performance, couldn't keep up with the gains generated by the other two sectors. I also maintained a small investment in high-quality foreign government bonds denominated in dollars. Like U.S. Treasurys, they were strong performers. Finally, to manage the overall risk level in the portfolio and enhance the Fund's total return, I used investments in futures, options, dollar rolls and forward contracts. Looking at portfolio changes, because Treasury prices had risen substantially prior to the start of the period, I decided to reduce holdings in that sector and add to those in the mortgage and corporate areas. That strategy yielded mixed results for the Fund early in the period, as mortgages performed especially well while "corporates" lagged behind. Corporates subsequently improved during the first quarter of 2001. At period-end, corporates comprised about 36% of the portfolio, followed by mortgages at 42% and U.S. Treasury and foreign government bonds at 16%. Given that I expect the economy to pick up before year-end, I think the bond market is likely to experience little, if any, price appreciation in the months ahead. Therefore, I plan to stick with a slightly defensive portfolio structure that emphasizes generating a healthy level of interest income from corporate and mortgage-backed bonds. Brad Stone -------------------------------------------------------------------------------- 4 AXP SELECTIVE FUND Fund Facts Class A -- 12-month performance (All figures per share) Net asset value (NAV) May 31, 2001 $8.74 May 31, 2000 $8.32 Increase $0.42 Distributions -- June 1, 2000 - May 31, 2001 From income $0.52 From long-term capital gains $ -- Total distributions $0.52 Total return** +11.52% Class B -- 12-month performance (All figures per share) Net asset value (NAV) May 31, 2001 $8.74 May 31, 2000 $8.32 Increase $0.42 Distributions -- June 1, 2000 - May 31, 2001 From income $0.45 From long-term capital gains $ -- Total distributions $0.45 Total return** +10.69% Class C -- June 26, 2000* - May 31, 2001 (All figures per share) Net asset value (NAV) May 31, 2001 $8.74 June 26, 2000* $8.40 Increase $0.34 Distributions -- June 26, 2000* - May 31, 2001 From income $0.42 From long-term capital gains $ -- Total distributions $0.42 Total return** +9.27%*** Class Y -- 12-month performance (All figures per share) Net asset value (NAV) May 31, 2001 $8.74 May 31, 2000 $8.32 Increase $0.42 Distributions -- June 1, 2000 - May 31, 2001 From income $0.53 From long-term capital gains $ -- Total distributions $0.53 Total return** +11.70% * Inception date. ** The total return is a hypothetical investment in the Fund with all distributions reinvested. Returns do not include sales load. The prospectus discusses the effect of sales charges, if any, on the various classes. *** The total return for Class C is not annualized. -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 6 The 10 Largest Holdings Percent Value (of net assets) (as of May 31, 2001) Ford Motor 7.45% 2031 1.29% $19,261,200 Goldman Sachs Group 6.88% 2011 1.24 18,489,712 Qwest Capital Funding 7.25% 2011 1.14 17,053,380 DaimlerChrysler 8.50% 2031 1.06 15,743,400 General Electric Capital 6.70% 2002 1.01 15,025,736 MBNA 5.75% 2008 1.00 14,978,655 France Telecom 7.75% 2011 .97 14,420,000 CIT Group 5.63% 2004 .96 14,319,475 Railcar Leasing 7.13% 2013 .84 12,511,949 Dominion Virginia Power 5.75% 2006 .79 11,808,240 Excludes U.S. Treasury and government agencies holdings For further detail about these holdings, please refer to the section entitled "Investments in Securities." (icon of) pie chart The 10 holdings listed here make up 10.30% of net assets -------------------------------------------------------------------------------- 6 AXP SELECTIVE FUND Making the Most of the Fund BUILD YOUR ASSETS SYSTEMATICALLY One of the best ways to invest in the Fund is by dollar-cost averaging -- a time-tested strategy that can make market fluctuations work for you. To dollar-cost average, simply invest a fixed amount of money regularly. You'll automatically buy more shares when the Fund's share price is low, fewer shares when it is high. The chart below shows how dollar-cost averaging works. In these three hypothetical scenarios, you will see six months of share price fluctuations. This strategy does not ensure a profit or avoid a loss if the market declines. But, if you can continue to invest regularly through changing market conditions even when the price of your shares falls or the market declines, it can be an effective way to accumulate shares to meet your long-term goals. How dollar-cost averaging works Jan Feb Mar Apr May Jun $15 $16 $18 $20 $10 $10 $12 $14 $ 5 Accumulated shares* Average market Your average price per share cost per share 42.25 $15 $14.20 ------------------------------------------------------------------------------- Jan Feb Mar Apr May Jun $15 $10 $10 $10 $ 5 $8 $5 $5 $8 Accumulated shares* Average market Your average price per share cost per share 85.0 $7.66 $7.05 ------------------------------------------------------------------------------- Jan Feb Mar Apr May Jun $15 $10 $10 $ 5 $8 $6 $4 $4 $7 Accumulated shares* Average market Your average price per share cost per share 103.5 $6.50 $5.80 ------------------------------------------------------------------------------- $100 invested per month. Total invested: $600. * Shares purchased is determined by dividing the amount invested per month by the current share price. THREE WAYS TO BENEFIT FROM A MUTUAL FUND: o your shares increase in value when the Fund's investments do well o you receive capital gains when the gains on investments sold by the Fund exceed losses o you receive income when the Fund's stock dividends, interest and short-term gains exceed its expenses. All three make up your total return. You potentially can increase your investment if, like most investors, you reinvest your dividends and capital gain distributions to buy additional shares of the Fund or another fund. -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 7 The Fund's Long-term Performance (line graph depicting performance of the Fund and key indexes) How your $10,000 has grown in AXP Selective Fund $30,000 Lipper Corporate Debt -- A rated Index $20,000 $20,257 AXP Selective Fund Lehman Brothers Class A Aggregate Bond Index $9,525 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 Average Annual Total Returns (as of May 31, 2001) 1 year 5 years 10 years Since inception Class A +6.23% +5.74% +7.31% N/A Class B +6.69% +5.82% N/A +6.52%* Class C N/A N/A N/A +8.93%** Class Y +11.70% +6.91% N/A +7.47%* * Inception date was March 20, 1995. ** Inception date was June 26, 2000. Assumes: Holding period from 6/1/91 to 5/31/01. Returns do not reflect taxes payable on distributions. Reinvestment of all income and capital gain distributions for the Fund has a value of $11,159. Also see "Past Performance" in the Fund's current prospectus. On the graph above you can see how the Fund's total return compared to two widely cited performance indexes, the Lehman Brothers Aggregate Bond Index and the Lipper Corporate Debt - A rated Index. In comparing AXP Selective Fund (Class A) to these indexes, you should take into account the fact that the Fund's performance reflects the maximum sales charge of 4.75%, while such charges are not reflected in the performance of the index. Your investment and return values fluctuate so that your shares, when redeemed, may be worth more or less than the original cost. Average annual total return figures reflect the impact of the maximum applicable sales charge. This was a period of widely fluctuating security prices. Past performance is no guarantee of future results. Lehman Brothers Aggregate Bond Index, an unmanaged index, is made up of a representative list of government, corporate, asset-backed and mortgage-backed securities. The index is frequently used as a general measure of bond market performance. The index reflects reinvestment of all distributions and changes in market prices, but excludes brokerage commissions or other fees. However, the securities used to create the index may not be representative of the bonds held in the Fund. Lipper Corporate Debt - A rated Index, an unmanaged index published by Lipper Inc., includes the 30 largest funds that are generally similar to the Fund, although some funds in the index may have somewhat different investment policies or objectives. -------------------------------------------------------------------------------- 8 AXP SELECTIVE FUND Board Members and Officers Shareholders elect a board that oversees the Fund's operations. The board appoints officers who are responsible for day-to-day business decisions based on policies set by the board. The following is a list of the Fund's board members. Each member oversees 15 Master Trust portfolios and 65 American Express mutual funds. Board members serve until the next regular shareholders' meeting or until he or she reaches the mandatory retirement age established by the board.
Independent Board Members Name, address, age Position held with Principal occupations during Other directorships Registrant and length past five years of service ------------------------------- ------------------------- ---------------------------------- ----------------------------- H. Brewster Atwater, Jr. Board member since 1996 Retired chair and chief Merck & Co., Inc. 4900 IDS Tower Minneapolis, executive officer, General (pharmaceuticals) MN 55402 Mills, Inc. (consumer foods) Born in 1931 ------------------------------- ------------------------- ---------------------------------- ----------------------------- Arne H. Carlson Chair of the Board Chair, Board Services 901 S. Marquette Ave. since 1999 Corporation (provides Minneapolis, MN 55402 administrative services to Born in 1934 boards) Former Governor of Minnesota ------------------------------- ------------------------- ---------------------------------- ----------------------------- Lynne V. Cheney American Board member since 1994 Distinguished Fellow, AEI The Reader's Digest Enterprise Institute for Association Inc. Public Policy Research (AEI) 1150 17th St., N.W. Washington, D.C. 20036 Born in 1941 ------------------------------- ------------------------- ---------------------------------- ----------------------------- Livio D. DeSimone Board member since 2001 Retired chair of the board and Cargill, Incorporated 30 Seventh Street St. Paul, chief executive officer, (commodity merchants and MN 55101-4901 Minnesota Mining and processors), Target Manufacturing (3M) Corporation (department stores), General Mills, Inc. (consumer foods) and Vulcan Materials Company (construction Born in 1936 materials/chemicals) ------------------------------- ------------------------- ---------------------------------- ----------------------------- Ira D. Hall Board member since 2001 Treasurer, Texaco Inc. since Texaco, Inc. 1998. Prior to that, director, 2000 Westchester Avenue International Operations IBM White Plains, NY 10650 Corp. Born in 1944 ------------------------------- ------------------------- ---------------------------------- ----------------------------- Heinz F. Hutter Board member since 1994 Retired president and chief P.O. Box 2187 operating officer, Cargill, Minneapolis, MN 55402 Incorporated (commodity Born in 1929 merchants and processors) ------------------------------- ------------------------- ---------------------------------- ----------------------------- Anne P. Jones Board member since 1985 Attorney and telecommunications Motorola, Inc. (electronics) 5716 Bent Branch Rd. consultant Bethesda, MD 20816 Born in 1935 ------------------------------- ------------------------- ---------------------------------- ----------------------------- William R. Pearce Board member since 1980 RII Weyerhaeuser World 2050 One Financial Plaza Timberfund, L.P. (develops Minneapolis, MN 55402 timber resources) - management Born in 1927 committee; Former chair, American Express Funds ------------------------------- ------------------------- ---------------------------------- -----------------------------
-------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 9
Independent Board Members Name, address, age Position held Principal occupations during past Other directorships with five years Registrant and length of service ---------------------------- ---------------- ---------------------------------------- ---------------------------------------- Alan K. Simpson Board member Former three-term United States Biogen, Inc. (bio-pharmaceuticals) 1201 Sunshine Ave. Cody, since 1997 Senator for Wyoming WY 82414 Born in 1931 ---------------------------- ---------------- ---------------------------------------- ---------------------------------------- ---------------------------- ---------------- ---------------------------------------- ---------------------------------------- C. Angus Wurtele Suite Board member Retired chair of the board and chief The Valspar Corporation (paints), 1700, Foshay Tower since 1994 executive officer, The Valspar Bemis Corporation (packaging) Minneapolis, MN 55402 Born Corporation in 1934 ---------------------------- ---------------- ---------------------------------------- ----------------------------------------
Board Members Affiliated with American Express Financial Corporation (AEFC) Name, address, age Position held Principal occupations during past Other directorships with five years Registrant and length of service ---------------------------- ---------------- ---------------------------------------- ---------------------------------------- David R. Hubers Board member Retired chief executive officer and Chronimed Inc. (specialty 50643 AXP Financial Center since 1993 director and current chair of the pharmaceutical distribution) RTW Inc. Minneapolis, MN 55474 board of AEFC (manages workers compensation Born in 1943 programs) Lawson Software, Inc. (technology based business applications) ---------------------------- ---------------- ---------------------------------------- ---------------------------------------- John R. Thomas Board member Senior vice president - information 50652 AXP Financial Center since 1987, and technology of AEFC Minneapolis, MN 55474 president Born in 1937 since 1997 ---------------------------- ---------------- ---------------------------------------- ----------------------------------------
The board has appointed officers who are responsible for day-to-day business decisions based on policies it has established. The officers serve at the pleasure of the board. In addition to Mr. Thomas, who is president, the Fund's other officers are:
Other Officers Name, address, age Position held Principal occupations during past Other directorships with five years Registrant and length of service ---------------------------- ---------------- ---------------------------------------- ---------------------------------------- John M. Knight Treasurer Vice president - investment 50005 AXP Financial Center since 1999 accounting of AEFC Minneapolis, MN 55474 Born in 1952 ---------------------------- ---------------- ---------------------------------------- ---------------------------------------- Leslie L. Ogg Vice President of Board Services 901 S. Marquette Ave. president, Corporation Minneapolis, MN 55402 general Born in 1938 counsel and secretary since 1978 ---------------------------- ---------------- ---------------------------------------- ---------------------------------------- Frederick C. Quirsfeld Vice president Senior vice president - fixed income 53609 AXP Financial Center since 1998 and director of AEFC Minneapolis, MN 55474 Born in 1947 ---------------------------- ---------------- ---------------------------------------- ----------------------------------------
The SAI has additional information about the Fund's directors and is available, without charge, upon request by calling (800) 862-7919. -------------------------------------------------------------------------------- 10 AXP SELECTIVE FUND Independent Auditors' Report THE BOARD AND SHAREHOLDERS AXP SELECTIVE FUND, INC. We have audited the accompanying statement of assets and liabilities of AXP Selective Fund, Inc. as of May 31, 2001, the related statement of operations for the year then ended, the statements of changes in net assets for each of the years in the two-year period ended May 31, 2001, and the financial highlights for the each of the years in the five-year period ended May 31, 2001. These financial statements and the financial highlights are the responsibility of fund management. Our responsibility is to express an opinion on these financial statements and the financial highlights based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and the financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of AXP Selective Fund, Inc. as of May 31, 2001, and the results of its operations, changes in its net assets and the financial highlights for each of the periods stated in the first paragraph above, in conformity with accounting principles generally accepted in the United States of America. KPMG LLP Minneapolis, Minnesota July 6, 2001 -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 11 Financial Statements Statement of assets and liabilities AXP Selective Fund, Inc. May 31, 2001 Assets Investment in Quality Income Portfolio (Note 1) $1,491,632,137 Capital shares receivable 61,551 ------ Total assets 1,491,693,688 ------------- Liabilities Dividends payable to shareholders 1,538,893 Accrued distribution fee 14,114 Accrued service fee 594 Accrued transfer agency fee 5,322 Accrued administrative services fee 1,962 Other accrued expenses 121,599 ------- Total liabilities 1,682,484 --------- Net assets applicable to outstanding capital stock $1,490,011,204 ============== Represented by Capital stock -- $.01 par value (Note 1) $ 1,705,441 Additional paid-in capital 1,499,295,434 Undistributed net investment income 167,789 Accumulated net realized gain (loss) (Note 5) (24,650,972) Unrealized appreciation (depreciation) on investments and on translation of assets and liabilities in foreign currencies 13,493,512 ---------- Total -- representing net assets applicable to outstanding capital stock $1,490,011,204 ============== Net assets applicable to outstanding shares: Class A $1,004,209,944 Class B $ 263,947,253 Class C $ 3,894,842 Class Y $ 217,959,165 Net asset value per share of outstanding capital stock: Class A shares 114,941,705 $ 8.74 Class B shares 30,211,983 $ 8.74 Class C shares 445,815 $ 8.74 Class Y shares 24,944,632 $ 8.74 ---------- -------------- See accompanying notes to financial statements. -------------------------------------------------------------------------------- 12 AXP SELECTIVE FUND Statement of operations AXP Selective Fund, Inc. Year ended May 31, 2001 Investment income Income: Dividends $ 807,337 Interest 94,583,477 ---------- Total income 95,390,814 ---------- Expenses (Note 2): Expenses allocated from Quality Income Portfolio 7,173,035 Distribution fee Class A 2,405,438 Class B 2,146,775 Class C 13,771 Transfer agency fee 1,640,170 Incremental transfer agency fee Class A 101,514 Class B 38,916 Class C 214 Service fee -- Class Y 186,519 Administrative services fees and expenses 670,649 Compensation of board members 9,019 Printing and postage 169,797 Registration fees 95,530 Audit fees 10,750 Other 9,707 ----- Total expenses 14,671,804 Earnings credits on cash balances (Note 2) (101,057) -------- Total net expenses 14,570,747 ---------- Investment income (loss) -- net 80,820,067 ---------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions (3,128,732) Foreign currency transactions (424,797) Futures contracts (2,325,748) Options contracts written 157,326 ------- Net realized gain (loss) on investments (5,721,951) Net change in unrealized appreciation (depreciation) on investments and on translation of assets and liabilities in foreign currencies 69,508,963 ---------- Net gain (loss) on investments and foreign currencies 63,787,012 ---------- Net increase (decrease) in net assets resulting from operations $144,607,079 ============ See accompanying notes to financial statements. -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 13 Statements of changes in net assets AXP Selective Fund, Inc. Year ended May 31, 2001 2000 Operations and distributions Investment income (loss) -- net $ 80,820,067 $ 87,700,873 Net realized gain (loss) on investments (5,721,951) (12,934,749) Net change in unrealized appreciation (depreciation) on investments and on translation of assets and liabilities in foreign currencies 69,508,963 (65,462,165) ---------- ----------- Net increase (decrease) in net assets resulting from operations 144,607,079 9,303,959 ----------- --------- Distributions to shareholders from: Net investment income Class A (57,805,147) (66,760,760) Class B (11,220,115) (11,028,617) Class C (68,694) -- Class Y (11,461,005) (10,960,196) Net realized gain Class A -- (20,690,756) Class B -- (3,916,530) Class Y -- (2,953,080) ---- ---------- Total distributions (80,554,961) (116,309,939) ----------- ------------ Capital share transactions (Note 3) Proceeds from sales Class A shares (Notes 2 and 6) 174,749,533 103,800,236 Class B shares 123,918,483 70,590,408 Class C shares 4,162,840 -- Class Y shares 106,067,010 74,872,917 Reinvestment of distributions at net asset value Class A shares 43,475,836 65,226,463 Class B shares 9,823,481 13,239,420 Class C shares 61,067 -- Class Y shares 11,422,265 13,735,844 Payments for redemptions Class A shares 208,981,146) (311,498,945) Class B shares (Note 2) (65,880,375) (92,600,002) Class C shares (Note 2) (342,918) -- Class Y shares (74,810,965) (104,662,927) ----------- ------------ Increase (decrease) in net assets from capital share transactions 123,665,111 (167,296,586) ----------- ------------ Total increase (decrease) in net assets 187,717,229 (274,302,566) Net assets at beginning of year 1,302,293,975 1,576,596,541 ------------- ------------- Net assets at end of year $1,490,011,204 $1,302,293,975 ============== ============== Undistributed net investment income $ 167,789 $ 204,476 -------------- -------------- See accompanying notes to financial statements. -------------------------------------------------------------------------------- 14 AXP SELECTIVE FUND Notes to Financial Statements AXP Selective Fund, Inc. 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Fund is registered under the Investment Company Act of 1940 (as amended) as a diversified, open-end management investment company. The Fund has 10 billion authorized shares of capital stock. Class C shares of the Fund were offered to the public on June 26, 2000. Prior to this date, American Express Financial Corporation (AEFC) purchased 238 shares of capital stock at $8.41 per share, which represented the initial capital in Class C. The Fund offers Class A, Class B, Class C and Class Y shares. o Class A shares are sold with a front-end sales charge. o Class B shares may be subject to a contingent deferred sales charge (CDSC) and automatically convert to Class A shares during the ninth calendar year of ownership. o Class C shares may be subject to a CDSC. o Class Y shares have no sales charge and are offered only to qualifying institutional investors. All classes of shares have identical voting, dividend and liquidation rights. The distribution fee, incremental transfer agency fee and service fee (class specific expenses) differ among classes. Income, expenses (other than class specific expenses) and realized and unrealized gains or losses on investments are allocated to each class of shares based upon its relative net assets. Investment in Quality Income Portfolio The Fund invests all of its assets in Quality Income Portfolio (the Portfolio), a series of Income Trust (the Trust), an open-end investment company that has the same objectives as the Fund. The Portfolio invests primarily in investment-grade bonds. The Fund records daily its share of the Portfolio's income, expenses and realized and unrealized gains and losses. The financial statements of the Portfolio are included elsewhere in this report and should be read in conjunction with the Fund's financial statements. The Fund records its investment in the Portfolio at the value that is equal to the Fund's proportionate ownership interest in the Portfolio's net assets. The percentage of the Portfolio owned by the Fund as of May 31, 2001 was 99.99%. Valuation of securities held by the Portfolio is discussed in Note 1 of the Portfolio's "Notes to financial statements" (included elsewhere in this report). Use of estimates Preparing financial statements that conform to accounting principles generally accepted in the United States of America requires management to make estimates (e.g., on assets, liabilities and contingent assets and liabilities) that could differ from actual results. Federal taxes The Fund's policy is to comply with all sections of the Internal Revenue Code that apply to regulated investment companies and to distribute substantially all of its taxable income to the shareholders. No provision for income or excise taxes is thus required. -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 15 Net investment income (loss) and net realized gains (losses) may differ for financial statement and tax purposes primarily because of deferred losses on certain futures contracts, the recognition of certain foreign currency gains (losses) as ordinary income (loss) for tax purposes, and losses deferred due to "wash sale" transactions. The character of distributions made during the year from net investment income or net realized gains may differ from their ultimate characterization for federal income tax purposes. Also, due to the timing of dividend distributions, the fiscal year in which amounts are distributed may differ from the year that the income or realized gains (losses) were recorded by the Fund. On the statement of assets and liabilities, as a result of permanent book-to-tax differences, undistributed net investment income has been decreased by $301,959 and accumulated net realized loss has been decreased by $301,959. Dividends to shareholders Dividends from net investment income, declared daily and payable monthly, are reinvested in additional shares of the Fund at net asset value or payable in cash. Capital gains, when available, are distributed along with the last income dividend of the calendar year. 2. EXPENSES AND SALES CHARGES In addition to the expenses allocated from the Portfolio, the Fund accrues its own expenses as follows: The Fund has an agreement with AEFC to provide administrative services. Under an Administrative Services Agreement, the Fund pays AEFC a fee for administration and accounting services at a percentage of the Fund's average daily net assets in reducing percentages from 0.05% to 0.025% annually. A minor portion of additional administrative service expenses paid by the Fund are consultants' fees and fund office expenses. Under this agreement, the Fund also pays taxes, audit and certain legal fees, registration fees for shares, compensation of board members, corporate filing fees and any other expenses properly payable by the Fund and approved by the board. Under a separate Transfer Agency Agreement, American Express Client Service Corporation (AECSC) maintains shareholder accounts and records. The Fund pays AECSC an annual fee per shareholder account for this service as follows: o Class A $19.50 o Class B $20.50 o Class C $20.00 o Class Y $17.50 The Fund has agreements with American Express Financial Advisors Inc. (the Distributor) for distribution and shareholder services. Under a Plan and Agreement of Distribution, the Fund pays a distribution fee at an annual rate up to 0.25% of the Fund's average daily net assets attributable to Class A shares and up to 1.00% for Class B and Class C shares. Under a Shareholder Service Agreement, the Fund pays the Distributor a fee for service provided to shareholders by financial advisors and other servicing agents. The fee is calculated at a rate of 0.10% of the Fund's average daily net assets attributable to Class Y shares. -------------------------------------------------------------------------------- 16 AXP SELECTIVE FUND Sales charges received by the Distributor for distributing Fund shares were $1,592,412 for Class A and $156,531 for Class B for the year ended May 31, 2001 and $375 for Class C for the period ended May 31, 2001. During the year ended May 31, 2001, the Fund's transfer agency fees were reduced by $101,057 as a result of earnings credits from overnight cash balances. 3. CAPITAL SHARE TRANSACTIONS Transactions in shares of capital stock for the years indicated are as follows: Year ended May 31, 2001 Class A Class B Class C* Class Y Sold 20,114,774 14,273,778 478,028 12,164,023 Issued for reinvested distributions 5,035,406 1,136,801 7,001 1,322,093 Redeemed (24,264,710) (7,638,038) (39,214) (8,631,923) ----------- ---------- ------- ---------- Net increase (decrease) 885,470 7,772,541 445,815 4,854,193 ------- --------- ------- --------- * Inception date was June 26, 2000. Year ended May 31, 2000 Class A Class B Class C Class Y Sold 12,019,328 8,162,545 N/A 8,744,743 Issued for reinvested distributions 7,608,344 1,545,461 N/A 1,601,656 Redeemed (36,214,650) (10,747,197) N/A (12,107,793) ----------- ----------- ------ ----------- Net increase (decrease) (16,586,978) (1,039,191) N/A (1,761,394) ----------- ---------- ------ ---------- 4. BANK BORROWINGS The Fund has a revolving credit agreement with U.S. Bank, N.A., whereby the Fund is permitted to have bank borrowings for temporary or emergency purposes to fund shareholder redemptions. The Fund must have asset coverage for borrowings not to exceed the aggregate of 333% of advances equal to or less than five business days plus 367% of advances over five business days. The agreement, which enables the Fund to participate with other American Express mutual funds, permits borrowings up to $200 million, collectively. Interest is charged to each Fund based on its borrowings at a rate equal to the Federal Funds Rate plus 0.30% or the Eurodollar Rate (Reserve Adjusted) plus 0.20%. Borrowings are payable up to 90 days after such loan is executed. The Fund also pays a commitment fee equal to its pro rata share of the amount of the credit facility at a rate of 0.05% per annum. The Fund had no borrowings outstanding during the year ended May 31, 2001. 5. CAPITAL LOSS CARRY-OVER For federal income tax purposes, the Fund has a capital loss carry-over of $22,500,692 as of May 31, 2001, that if not offset by subsequent capital gains, will expire in 2007 through 2010. It is unlikely the board will authorize a distribution of any net realized capital gains until the available capital loss carry-over has been offset or expires. -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 17 6. FUND MERGER As of the close of business on July 14, 2000, AXP Selective Fund acquired the assets and assumed the identified liabilities of Strategist Quality Income Fund. The aggregate net assets of AXP Selective Fund immediately before the acquisition were $1,308,361,652. The merger was accomplished by a tax-free exchange of 87,827 shares of Strategist Quality Income Fund valued at $759,710. In exchange for the Strategist Quality Income Fund shares and net assets, AXP Selective Fund issued the following number of shares: Shares Net assets Class A 89,906 $759,710 Strategist Quality Income Fund's net assets at that date consisted of capital stock of $775,363 and unrealized depreciation of $15,653. 7. NEW ACCOUNTING PRONOUNCEMENT In November 2000, the AICPA issued a revised Audit and Accounting Guide, Audits of Investment Companies, which is effective for fiscal years beginning after Dec. 15, 2000. Adopting the revised Guide is not expected to have a significant impact on the Fund's financial position, results of operations or changes in its net assets. -------------------------------------------------------------------------------- 18 AXP SELECTIVE FUND 8. FINANCIAL HIGHLIGHTS The tables below show certain important financial information for evaluating the Fund's results.
Class A Per share income and capital changes(a) Fiscal period ended May 31, 2001 2000 1999 1998 1997 Net asset value, beginning of period .. $8.32 $8.96 $9.23 $9.00 $9.00 ----- ----- ----- ----- ----- Income from investment operations: Net investment income (loss) .......... .52 .52 .54 .57 .59 Net gains (losses) (both realized and unrealized) ....................... .42 (.46) (.20) .31 .12 --- ---- ---- --- --- Total from investment operations ...... .94 .06 .34 .88 .71 --- --- --- --- --- Less distributions: Dividends from net investment income .. (.52) (.53) (.54) (.58) (.58) Distributions from realized gains ..... -- (.17) (.07) (.07) (.13) -- ---- ---- ---- ---- Total distributions ................... (.52) (.70) (.61) (.65) (.71) ---- ---- ---- ---- ---- Net asset value, end of period ........ $8.74 $8.32 $8.96 $9.23 $9.00 ----- ----- ----- ----- ----- Ratios/supplemental data Net assets, end of period (in millions) $1,004 $ 949 $1,170 $1,231 $1,286 ------ ----- ------ ------ ------ Ratio of expenses to average daily net assets(c) ....................... .97% .97% .89% .86% .88% --- --- --- --- --- Ratio of net investment income (loss) to average daily net assets ........ 6.01% 6.17% 5.85% 6.20% 6.36% ---- ---- ---- ---- ---- Portfolio turnover rate (excluding short-term securities) .............. 150% 62% 30% 20% 31% --- -- -- -- -- Total return(e) ....................... 11.52% .83% 3.68% 10.15% 8.08% ----- --- ---- ----- ---- Class B Per share income and capital changes(a) Fiscal period ended May 31, 2001 2000 1999 1998 1997 Net asset value, beginning of period .. $8.32 $8.96 $9.23 $9.00 $9.00 ----- ----- ----- ----- ----- Income from investment operations: Net investment income (loss) .......... .45 .46 .47 .50 .52 Net gains (losses) (both realized and unrealized) ..................... .42 (.47) (.20) .31 .12 --- ---- ---- --- --- Total from investment operations ...... .87 (.01) .27 .81 .64 --- ---- --- --- --- Less distributions: Dividends from net investment income .. (.45) (.46) (.47) (.51) (.51) Distributions from realized gains ..... -- (.17) (.07) (.07) (.13) --- ---- ---- ---- ---- Total distributions ................... (.45) (.63) (.54) (.58) (.64) ---- ---- ---- ---- ---- Net asset value, end of period ........ $8.74 $8.32 $8.96 $9.23 $9.00 ----- ----- ----- ----- ----- Ratios/supplemental data Net assets, end of period (in millions) $ 264 $ 187 $ 210 $ 153 $ 126 ----- ----- ----- ----- ----- Ratio of expenses to average daily net assets(c) ....................... 1.73% 1.73% 1.65% 1.62% 1.64% ---- ---- ---- ---- ---- Ratio of net investment income (loss) to average daily net assets ........ 5.25% 5.41% 5.10% 5.44% 6.40% ---- ---- ---- ---- ---- Portfolio turnover rate (excluding short-term securities) .............. 150% 62% 30% 20% 31% --- -- -- -- -- Total return(e) ....................... 10.69% .06% 2.89% 9.32% 7.26% ----- --- ---- ---- ----
See accompanying notes to financial highlights. -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 19 Class C Per share income and capital changes(a) Fiscal period ended May 31, 2001(b) Net asset value, beginning of period $8.40 ----- Income from investment operations: Net investment income (loss) .42 Net gains (losses) (both realized and unrealized) .34 --- Total from investment operations .76 --- Less distributions: Dividends from net investment income (.42) Distributions from realized gains -- ---- Total distributions (.42) ---- Net asset value, end of period $8.74 ----- Ratios/supplemental data Net assets, end of period (in millions) $4 -- Ratio of expenses to average daily net assets(c) 1.73%(d) ---- Ratio of net investment income (loss) to average daily net assets 5.16%(d) ---- Portfolio turnover rate (excluding short-term securities) 150% --- Total return(e) 9.27% ----
Class Y Per share income and capital changes(a) Fiscal period ended May 31, 2001 2000 1999 1998 1997 Net asset value, beginning of period .. $8.32 $8.96 $9.23 $9.00 $9.00 ----- ----- ----- ----- ----- Income from investment operations: Net investment income (loss) .......... .53 .54 .55 .58 .60 Net gains (losses) (both realized and unrealized) ..................... .42 (.47) (.20) .31 .12 --- ---- ---- --- --- Total from investment operations ...... .95 .07 .35 .89 .72 --- --- --- --- --- Less distributions: Dividends from net investment income .. (.53) (.54) (.55) (.59) (.59) Distributions from realized gains ..... -- (.17) (.07) (.07) (.13) ---- ---- ---- ---- ---- Total distributions ................... (.53) (.71) (.62) (.66) (.72) ---- ---- ---- ---- ---- Net asset value, end of period ........ $8.74 $8.32 $8.96 $9.23 $9.00 ----- ----- ----- ----- ----- Ratios/supplemental data Net assets, end of period (in millions) $ 218 $ 167 $ 196 $ 221 $ 202 ----- ----- ----- ----- ----- Ratio of expenses to average daily net assets(c) ....................... .82% .81% .81% .79% .72% --- --- --- --- --- Ratio of net investment income (loss) to average daily net assets ........ 6.16% 6.33% 5.93% 6.27% 7.02% ---- ---- ---- ---- ---- Portfolio turnover rate (excluding short-term securities) .............. 150% 62% 30% 20% 31% --- -- -- -- -- Total return(e) ....................... 11.70% .97% 3.77% 10.21% 8.27% ----- --- ---- ----- ----
See accompanying notes to financial highlights. -------------------------------------------------------------------------------- 20 AXP SELECTIVE FUND Notes to financial highlights (a) For a share outstanding throughout the period. Rounded to the nearest cent. (b) Inception date was June 26, 2000. (c) Expense ratio is based on total expenses of the Fund before reduction of earnings credits on cash balances. (d) Adjusted to an annual basis. (e) Total return does not reflect payment of a sales charge. -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 21 Independent Auditors' Report THE BOARD OF TRUSTEES AND UNITHOLDERS INCOME TRUST We have audited the accompanying statement of assets and liabilities, including the schedule of investments in securities, of Quality Income Portfolio (a series of Income Trust) as of May 31, 2001, the related statement of operations for the year then ended and the statements of changes in net assets for each of the years in the two-year period ended May 31, 2001. These financial statements are the responsibility of portfolio management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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. Our procedures included confirmation of securities owned as of May 31, 2001, by correspondence with the custodian and brokers. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Quality Income Portfolio as of May 31, 2001, and the results of its operations and the changes in its net assets for each of the periods stated in the first paragraph above, in conformity with accounting principles generally accepted in the United States of America. KPMG LLP Minneapolis, Minnesota July 6, 2001 -------------------------------------------------------------------------------- 22 AXP SELECTIVE FUND Financial Statements Statement of assets and liabilities Quality Income Portfolio May 31, 2001 Assets Investments in securities, at value (Note 1) (identified cost $1,599,684,312) $1,612,459,735 Cash in bank on demand deposit 301,297 Dividends and accrued interest receivable 17,120,199 Receivable for investment securities sold 16,692,779 ---------- Total assets 1,646,574,010 ------------- Liabilities Payable for investment securities purchased 8,638,503 Payable for securities purchased on a when-issued basis (Note 1) 99,274,500 Payable upon return of securities loaned (Note 4) 46,125,000 Accrued investment management services fee 20,785 Other accrued expenses 72,713 Options contracts written, at value (premium received $771,322) (Note 5) 701,323 ------- Total liabilities 154,832,824 ----------- Net assets $1,491,741,186 ============== See accompanying notes to financial statements. -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 23 Statement of operations Quality Income Portfolio Year ended May 31, 2001 Investment income Income: Dividends $ 807,500 Interest 94,587,976 ---------- Total income 95,395,476 ---------- Expenses (Note 2): Investment management services fee 7,024,987 Compensation of board members 9,936 Custodian fees 84,913 Audit fees 32,500 Other 25,447 ------ Total expenses 7,177,783 Earnings credits on cash balances (Note 2) (3,788) ------ Total net expenses 7,173,995 --------- Investment income (loss) -- net 88,221,481 ---------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions (Note 3) (3,128,289) Foreign currency transactions (424,844) Futures contracts (2,326,554) Options contracts written (Note 5) 157,340 ------- Net realized gain (loss) on investments (5,722,347) ---------- Net change in unrealized appreciation (depreciation) on investments and on translation of assets and liabilities in foreign currencies 69,524,334 ---------- Net gain (loss) on investments and foreign currencies 63,801,987 ---------- Net increase (decrease) in net assets resulting from operations $152,023,468 ============ Statements of changes in net assets Quality Income Portfolio Year ended May 31, 2001 2000 Operations Investment income (loss) -- net $ 88,221,481 $ 95,271,140 Net realized gain (loss) on investments (5,722,347) (12,944,533) Net change in unrealized appreciation (depreciation) on investments and on translation of assets and liabilities in foreign currencies 69,524,334 (65,492,632) ---------- ----------- Net increase (decrease) in net assets resulting from operations 152,023,468 16,833,975 Net contributions (withdrawals) from partners 34,957,283 (289,912,100) ---------- ------------ Total increase (decrease) in net assets 186,980,751 (273,078,125) Net assets at beginning of year 1,304,760,435 1,577,838,560 ------------- ------------- Net assets at end of year $1,491,741,186 $1,304,760,435 ============== ============== See accompanying notes to financial statements. -------------------------------------------------------------------------------- 24 AXP SELECTIVE FUND Notes to Financial Statements Quality Income Portfolio 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Quality Income Portfolio (the Portfolio) is a series of Income Trust (the Trust) and is registered under the Investment Company Act of 1940 (as amended) as a diversified, open-end management investment company. The Portfolio invests primarily in investment-grade bonds. The Declaration of Trust permits the Trustees to issue non-transferable interests in the Portfolio. The Portfolio's significant accounting policies are summarized below: Use of estimates Preparing financial statements that conform to accounting principles generally accepted in the United States of America requires management to make estimates (e.g., on assets, liabilities and contingent assets and liabilities) that could differ from actual results. Valuation of securities All securities are valued at the close of each business day. Securities traded on national securities exchanges or included in national market systems are valued at the last quoted sales price. Debt securities are generally traded in the over-the-counter market and are valued at a price that reflects fair value as quoted by dealers in these securities or by an independent pricing service. Securities for which market quotations are not readily available are valued at fair value according to methods selected in good faith by the board. Short-term securities maturing in more than 60 days from the valuation date are valued at the market price or approximate market value based on current interest rates; those maturing in 60 days or less are valued at amortized cost. Option transactions To produce incremental earnings, protect gains and facilitate buying and selling of securities for investments, the Portfolio may buy and write options traded on any U.S. or foreign exchange or in the over-the-counter market where completing the obligation depends upon the credit standing of the other party. The Portfolio also may buy and sell put and call options and write covered call options on portfolio securities as well as write cash-secured put options. The risk in writing a call option is that the Portfolio gives up the opportunity for profit if the market price of the security increases. The risk in writing a put option is that the Portfolio may incur a loss if the market price of the security decreases and the option is exercised. The risk in buying an option is that the Portfolio pays a premium whether or not the option is exercised. The Portfolio also has the additional risk of being unable to enter into a closing transaction if a liquid secondary market does not exist. Option contracts are valued daily at the closing prices on their primary exchanges and unrealized appreciation or depreciation is recorded. The Portfolio will realize a gain or loss when the option transaction expires or closes. When options on debt securities or futures are exercised, the Portfolio will realize a gain or loss. When other options are exercised, the proceeds on sales for a written call option, the purchase cost for a written put option or the cost of a security for a purchased put or call option is adjusted by the amount of premium received or paid. -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 25 Futures transactions To gain exposure to or protect itself from market changes, the Portfolio may buy and sell financial futures contracts traded on any U.S. or foreign exchange. The Portfolio also may buy and write put and call options on these futures contracts. Risks of entering into futures contracts and related options include the possibility of an illiquid market and that a change in the value of the contract or option may not correlate with changes in the value of the underlying securities. Upon entering into a futures contract, the Portfolio is required to deposit either cash or securities in an amount (initial margin) equal to a certain percentage of the contract value. Subsequent payments (variation margin) are made or received by the Portfolio each day. The variation margin payments are equal to the daily changes in the contract value and are recorded as unrealized gains and losses. The Portfolio recognizes a realized gain or loss when the contract is closed or expires. Foreign currency translations and foreign currency contracts Securities and other assets and liabilities denominated in foreign currencies are translated daily into U.S. dollars. Foreign currency amounts related to the purchase or sale of securities and income and expenses are translated at the exchange rate on the transaction date. The effect of changes in foreign exchange rates on realized and unrealized security gains or losses is reflected as a component of such gains or losses. In the statement of operations, net realized gains or losses from foreign currency transactions, if any, may arise from sales of foreign currency, closed forward contracts, exchange gains or losses realized between the trade date and settlement date on securities transactions, and other translation gains or losses on dividends, interest income and foreign withholding taxes. The Portfolio may enter into forward foreign currency exchange contracts for operational purposes and to protect against adverse exchange rate fluctuation. The net U.S. dollar value of foreign currency underlying all contractual commitments held by the Portfolio and the resulting unrealized appreciation or depreciation are determined using foreign currency exchange rates from an independent pricing service. The Portfolio is subject to the credit risk that the other party will not complete its contract obligations. Securities purchased on a when-issued basis Delivery and payment for securities that have been purchased by the Portfolio on a forward-commitment or when-issued basis can take place one month or more after the transaction date. During this period, such securities are subject to market fluctuations, and they may affect the Portfolio's gross net assets the same as owned securities. The Portfolio designates cash or liquid securities at least equal to the amount of its commitment. As of May 31, 2001, the Portfolio had entered into outstanding when-issued or forward-commitments of $99,274,500. The Portfolio also enters into transactions to sell purchase commitments to third parties at current market values and concurrently acquires other purchase commitments for similar securities at later dates. As an inducement for the Portfolio to "roll over" its purchase commitments, the Portfolio receives negotiated amounts in the form of reductions of the purchase price of the commitment. -------------------------------------------------------------------------------- 26 AXP SELECTIVE FUND Federal taxes For federal income tax purposes the Portfolio qualifies as a partnership and each investor in the Portfolio is treated as the owner of its proportionate share of the net assets, income, expenses and realized and unrealized gains and losses of the Portfolio. As a "pass-through" entity, the Portfolio therefore does not pay any income dividends or capital gain distributions. Other Security transactions are accounted for on the date securities are purchased or sold. Dividend income is recognized on the ex-dividend date or upon receipt of ex-dividend notification in the case of certain foreign securities. Interest income, including level-yield amortization of premium and discount, is accrued daily. 2. FEES AND EXPENSES The Trust, on behalf of the Portfolio, has an Investment Management Services Agreement with AEFC to manage its portfolio. Under this agreement, AEFC determines which securities will be purchased, held or sold. The management fee is a percentage of the Portfolio's average daily net assets in reducing percentages from 0.52% to 0.395% annually. Under the agreement, the Trust also pays taxes, brokerage commissions and nonadvisory expenses, which include custodian fees, audit and certain legal fees, fidelity bond premiums, registration fees for units, office expenses, consultants' fees, compensation of trustees, corporate filing fees, expenses incurred in connection with lending securities of the Portfolio and any other expenses properly payable by the Trust or Portfolio and approved by the board. During the year ended May 31, 2001, the Portfolio's custodian fees were reduced by $3,788 as a result of earnings credits from overnight cash balances. The Portfolio also pays custodian fees to American Express Trust Company, an affiliate of AEFC. According to a Placement Agency Agreement, American Express Financial Advisors Inc. acts as placement agent of the Trust's units. 3. SECURITIES TRANSACTIONS Cost of purchases and proceeds from sales of securities (other than short-term obligations) aggregated $2,075,596,850 and $1,981,190,208, respectively, for the year ended May 31, 2001. For the same period, the portfolio turnover rate was 150%. Realized gains and losses are determined on an identified cost basis. 4. LENDING OF PORTFOLIO SECURITIES As of May 31, 2001, securities valued at $45,021,150 were on loan to brokers. For collateral, the Portfolio received $46,125,000 in cash. Income from securities lending amounted to $64,174 for the year ended May 31, 2001. The risks to the Portfolio of securities lending are that the borrower may not provide additional collateral when required or return the securities when due. -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 27 5. OPTIONS CONTRACTS WRITTEN Contracts and premium amounts associated with options contracts written on interest rate futures are as follows: Year ended May 31, 2001 Puts Calls Contracts Premium Contracts Premium Balance May 31, 2000 -- $ -- -- $ -- Opened 1,095 544,996 1,095 505,156 Closed (420) (129,570) (420) (149,260) ---- -------- ---- -------- Balance May 31, 2001 675 $ 415,426 675 $ 355,896 --- --------- --- --------- See "Summary of significant accounting policies." 6. INTEREST RATE FUTURES CONTRACTS As of May 31, 2001, investments in securities included securities valued at $13,987,440 that were pledged as collateral to cover initial margin deposits on 428 open purchase contracts. The notional market value of the open purchase contracts as of May 31, 2001, was $42,915,000 with a net unrealized gain of $371,351. See "Summary of significant accounting policies." 7. NEW ACCOUNTING PRONOUNCEMENT In November 2000, the AICPA issued a revised Audit and Accounting Guide, Audits of Investment Companies, which is effective for fiscal years beginning after Dec. 15, 2000. Adopting the revised Guide is not expected to have a significant impact on the Portfolio's financial position, results of operations or changes in its net assets. -------------------------------------------------------------------------------- 28 AXP SELECTIVE FUND Investments in Securities Quality Income Portfolio May 31, 2001 (Percentages represent value of investments compared to net assets) Bonds (94.8%) Issuer Coupon Principal Value(a) rate amount Government obligations & agencies (16.2%) Overseas Private Investment U.S. Govt Guaranty Series 1996A 01-15-09 6.99% $8,333,302 $8,616,300 U.S. Treasury 03-31-03 4.25 45,000,000(g) 45,021,150 05-15-04 7.25 25,000,000 26,781,250 08-15-04 7.25 6,800,000 7,316,392 08-15-05 6.50 15,300,000 16,220,448 02-15-07 6.25 12,800,000 13,507,968 11-15-08 4.75 5,000,000 4,823,450 08-15-10 5.75 5,700,000 5,823,804 08-15-29 6.13 25,835,000 26,658,361 05-15-30 6.25 23,200,000 24,494,096 11-15-16 7.50 53,515,000(h) 62,378,155 Total 241,641,374 Mortgage-backed securities (42.2%) Federal Home Loan Mtge Corp 11-15-03 6.38 30,000,000 31,082,700 11-01-14 7.50 8,337,436 8,599,260 04-01-15 7.50 18,238,810 18,811,571 01-01-16 7.00 23,802,015 24,300,429 07-01-16 8.00 272 285 01-01-17 8.00 2,912 3,053 03-01-17 8.50 61,560 65,273 06-01-17 8.50 43,403 46,116 04-01-20 9.00 699,220 752,753 04-01-21 9.00 603,834 649,876 03-01-22 8.50 1,415,062 1,503,065 08-01-22 8.50 1,372,750 1,457,325 06-01-24 7.50 6,369,661 6,563,744 02-01-25 8.00 2,417,126 2,525,389 Collateralized Mtge Obligation 09-01-19 8.50 80,566 85,501 Federal Housing Admin 01-01-24 7.43 4,731,505 4,525,981 Federal Natl Mtge Assn 11-01-02 10.00 38 39 08-15-04 6.50 60,000,000 62,500,679 02-15-05 7.13 8,000,000 8,485,680 06-15-09 6.38 35,000,000 35,887,949 01-01-14 6.00 13,891,686 13,846,806 04-01-14 5.50 2,431,976 2,367,455 04-01-14 6.00 13,916,310 13,871,351 04-01-14 6.50 14,499,769 14,638,722 05-01-14 6.00 9,193,133 9,144,596 08-01-14 6.50 13,575,212 13,685,126 06-01-15 6.00 14,229,082 14,153,956 07-01-23 7.50 25,568,352 6,529,625 10-01-23 6.50 6,405,484 6,373,457 12-01-26 8.00 4,054,042 4,217,460 04-01-27 7.50 5,606,900 5,762,828 06-01-27 7.50 6,342,441 6,518,824 08-01-27 8.00 4,615,790 4,803,718 01-01-28 6.50 2,346,428 2,323,691 05-01-28 6.50 14,122,821 13,977,215 12-01-28 6.50 16,033,779 15,868,471 02-01-29 6.50 16,163,875 15,997,226 03-01-29 6.00 3,428,308 3,314,762 03-01-29 6.50 12,921,220 12,782,390 05-01-29 6.00 29,896,637 28,927,621 06-01-29 7.00 17,833,189 18,005,672 07-01-29 6.00 13,552,941 13,086,991 09-01-29 7.00 18,111,148 18,286,318 12-01-29 7.50 17,535,575 17,944,139 01-01-30 8.00 4,417,953 4,580,126 03-01-30 8.00 13,330,413 13,819,744 05-01-30 6.00 15,000,000(b) 14,446,875 06-01-30 7.00 15,300,000(b) 15,424,313 06-01-30 7.00 7,380,648 7,448,780 06-01-30 7.50 50,000,000(b) 51,109,374 06-01-30 8.00 17,500,000(b) 18,117,969 07-01-30 8.00 8,290,778 8,589,564 Collateralized Mtge Obligation 10-25-19 8.50 1,448,659 1,537,679 Principal Only 09-01-18 9.50 311,019(f) 263,422 Govt Natl Mtge Assn 05-15-26 7.50 7,907,853 8,152,522 Prudential Bache Collateralized Mtge Obligation 04-01-19 7.97 1,915,115 1,962,169 Total 629,727,625 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 29 Bonds (continued) Issuer Coupon Principal Value(a) rate amount Aerospace & defense (0.4%) Northrop-Grumman 02-15-31 7.75% $5,700,000(d) $5,636,103 Airlines (0.5%) American Airline 11-23-12 6.82 7,000,000(d) 7,020,993 Automotive & related (2.8%) DaimlerChrysler Company Guaranty 01-18-31 8.50 15,000,000 15,743,400 Ford Motor 07-16-31 7.45 20,000,000 19,261,200 Ford Motor Credit 02-01-11 7.38 6,000,000 6,108,468 Total 41,113,068 Banks and savings & loans (4.2%) Bank of America Sub Nts 11-01-01 9.25 8,950,000 9,131,417 Capital One Bank Sr Nts 06-15-05 8.25 9,000,000 9,329,670 J.P. Morgan Chase Sub Nts 02-01-11 6.75 10,000,000 10,045,200 NCNB Sub Nts 10-15-01 9.13 10,000,000 10,175,800 Wachovia Sr Nts 07-15-05 7.45 9,100,000 9,595,495 Wells Fargo 02-01-11 6.45 10,000,000 9,862,300 Wells Fargo Financial 05-03-04 5.45 5,000,000 5,005,100 Total 63,144,982 Chemicals (0.2%) Praxair 03-01-08 6.50 3,000,000 2,985,810 Communications equipment & services (1.9%) Qwest Capital Funding 02-15-11 7.25 17,000,000(d) 17,053,380 02-15-31 7.75 11,660,000(d) 11,528,825 Total 28,582,205 Energy (1.5%) Anadarko Finance Company Guaranty 05-01-31 7.50 6,000,000(d) 6,079,140 Mirant Amerias Generation Sr Nts 05-01-11 8.30 6,150,000(d) 6,222,878 Phillips Petroleum (U.S. Dollar) 03-15-28 7.13 12,000,000(c) 10,639,680 Total 22,941,698 Energy equipment & services (0.4%) Transocean Sedco Forex 04-15-11 6.63 6,000,000(d) 5,897,400 Financial services (10.3%) CIT Group 05-17-04 5.63 14,500,000 14,319,475 Citigroup Sr Nts 12-01-05 6.75 5,000,000 5,168,350 Sub Nts 10-01-10 7.25 10,000,000 10,386,700 Countrywide Home Company Guaranty Series H 04-15-09 6.25 10,000,000 9,635,400 Goldman Sachs Group 01-15-11 6.88 18,550,000 18,489,712 Heller Financial 03-15-06 6.38 10,000,000 10,079,800 Household Finance 07-15-10 8.00 10,000,000 10,743,200 Marlin Water Trust Sr Nts 12-15-01 7.09 8,300,000(d) 8,368,641 MBNA 10-15-08 5.75 15,000,000 14,978,655 Merrill Lynch Medium-term Nts Series B 01-26-06 6.15 8,500,000 8,546,665 Morgan Stanley, Dean Witter, Discover & Co 06-15-05 7.75 10,000,000 10,655,170 04-15-11 6.75 9,000,000 8,940,510 Railcar Leasing (U.S. Dollar) 01-15-13 7.13 12,150,000(c,d) 12,511,949 Verizon Global Funding 12-01-30 7.75 10,500,000(d) 10,878,200 Total 153,702,427 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 30 AXP SELECTIVE FUND Bonds (continued) Issuer Coupon Principal Value(a) rate amount Food (0.7%) Delhaize America 04-15-06 7.38% $6,000,000(d) $6,056,220 Kellogg 04-01-06 6.00 5,000,000(d) 4,932,700 Total 10,988,920 Health care (0.5%) American Home Products 03-15-04 5.88 7,000,000(d) 6,989,710 Insurance (0.7%) Allstate Sr Nts 12-01-09 7.20 10,000,000 10,330,100 Leisure time & entertainment (0.5%) AOL Time Warner 04-15-31 7.63 7,000,000 7,030,590 Media (1.0%) Comcast Cable Communications 11-15-08 6.20 6,000,000 5,792,400 01-30-11 6.75 4,000,000 3,928,960 Time Warner Entertainment 03-15-23 8.38 5,000,000 5,427,150 Total 15,148,510 Metals (0.7%) Alcan (U.S. Dollar) 01-15-22 8.88 9,600,000(c) 10,018,752 Multi-industry conglomerates (1.0%) General Electric Capital Series A 10-01-02 6.70 14,600,000 15,025,736 Retail (1.3%) Dayton Hudson 06-15-23 7.88 8,850,000 9,101,429 Kroger Company Guaranty 02-01-10 8.05 10,000,000 10,643,500 Total 19,744,929 Transportation (2.7%) Burlington Northern Santa Fe 12-15-25 7.00 10,000,000 9,453,310 CSX 03-15-11 6.75 4,200,000 4,116,588 05-01-27 7.95 6,250,000 6,379,000 Enterprise Rent-A-Car USA Finance 02-15-08 6.80 10,000,000(d) 9,493,400 Union Pacific 01-15-11 6.65 11,700,000 11,509,992 Total 40,952,290 Utilities -- electric (1.4%) Dominion Virginia Power Sr Nts Series A 03-31-06 5.75 12,000,000 11,808,240 NRG Energy Sr Nts 09-15-10 8.25 8,000,000 8,339,040 Total 20,147,280 Utilities -- gas (0.8%) El Paso Energy Sr Nts Series B 07-15-01 6.63 8,675,000 8,691,126 Southern Natural Gas 02-15-31 7.35 4,000,000 3,775,640 Total 12,466,766 Utilities -- telephone (2.9%) AT&T Wireless Sr Nts 03-01-06 7.35 5,000,000(d) 5,110,950 BellSouth Capital Funding 02-15-10 7.75 7,000,000 7,534,905 Citizens Communications 05-15-11 9.25 9,000,000 9,281,250 France Telecom (U.S. Dollar) 03-01-11 7.75 14,000,000(c,d) 14,420,000 WorldCom 05-15-11 7.50 7,000,000 6,926,290 Total 43,273,395 Total bonds (Cost: $1,401,853,441) $1,414,510,663 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 32 ANNUAL REPORT -- 2001 Preferred stock (0.6%) Issuer Shares Value(a) SI Financing Trust 9.50% Cm 340,000 $8,656,400 Total preferred stock (Cost: $8,500,000) $8,656,400 Short-term securities (12.7%)(i) Issuer Annualized Amount Value(a) yield on date payable at of purchase maturity U.S. government agencies (10.6%) Federal Home Loan Bank Disc Nts 06-13-01 4.23% $10,000,000 $9,984,760 06-18-01 4.20 15,000,000 14,968,575 06-20-01 4.59 14,200,000 14,164,578 06-22-01 4.58 14,900,000 14,857,775 07-13-01 4.17 15,000,000 14,924,688 Federal Natl Mtge Assn Disc Nts 07-19-01 4.17 30,000,000 29,830,668 07-26-01 4.17 10,000,000 9,936,283 08-10-01 3.87 50,000,000 49,605,555 Total 158,272,882 Commercial paper (2.1%) Barclays U.S. Funding 06-25-01 4.01% $3,800,000 $3,789,444 Ciesco LP 06-01-01 4.71 6,100,000 6,099,134 Electronic Data Systems 06-13-01 4.08 3,100,000(e) 3,095,443 06-14-01 4.34 2,900,000(e) 2,895,117 Natl Rural Utilities 06-18-01 3.98 4,200,000 4,191,663 Salomon Smith Barney 06-18-01 4.05 5,000,000 4,989,900 Societe Generale North America 08-10-01 4.00 5,000,000 4,960,556 UBS Finance (Delaware) 06-11-01 4.67 1,000,000 998,533 Total 31,019,790 Total short-term securities (Cost: $189,330,871) $189,292,672 Total investments in securities (Cost: $1,599,684,312)(j) $1,612,459,735 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 32 AXP SELECTIVE FUND Notes to investments in securities (a) Securities are valued by procedures described in Note 1 to the financial statements. (b) At May 31, 2001, the cost of securities purchased, including interest purchased, on a when-issued basis was $99,274,500. (c) Foreign security values are stated in U.S. dollars. For debt securities, principal amounts are denominated in the currency indicated. As of May 31, 2001, the value of foreign securities represented 3.19% of net assets. (d) Represents a security sold under Rule 144A, which is exempt from registration under the Securities Act of 1933, as amended. This security has been determined to be liquid under guidelines established by the board. (e) Commercial paper sold within terms of a private placement memorandum, exempt from registration under Section 4(2) of the Securities Act of 1933, as amended, and may be sold only to dealers in that program or other "accredited investors." This security has been determined to be liquid under guidelines established by the board. (f) Principal-only represents securities that entitle holders to receive only principal payments on the underlying mortgages. The yield to maturity of a principal-only is sensitive to the rate of principal payments on the underlying mortgage assets. A slow (rapid) rate of principal repayments may have an adverse (positive) effect on yield to maturity. Interest rate disclosed represents original yield based upon the estimated timing of future cash flows. (g) Security is partially or fully on loan. See Note 4 to the financial statements. (h) Partially pledged as initial deposit on the following open interest rate futures contracts (see Note 6 to the financial statements): Type of security Notional amount Purchase contracts U.S. Treasury Bonds Sept. 2001 $33,500,000 U.S. Treasury Notes Sept. 2001, 10-year 9,300,000 (i) At May 31, 2001, cash or short-term securities were held to cover open call options written as follows (see Note 5 to the financial statements): Issuer Notional Exercise Expiration Value(a) amount price date U.S. Treasury Bond $45,000,000 $104 Aug. 2001 $203,904 U.S. Treasury Note 22,500,000 105 Aug. 2001 139,725 ---------- --- ---- ------- Total value $343,629 -------- At May 31, 2001, cash or short-term securities were designated to cover open put options written as follows (see Note 5 to the financial statements): Issuer Notional Exercise Expiration Value(a) amount price date U.S. Treasury Bond $45,000,000 $ 96 Aug. 2001 $253,125 U.S. Treasury Note 22,500,000 100 Aug. 2001 104,569 ---------- --- ---- ------- Total value $357,694 -------- (j) At May 31, 2001, the cost of securities for federal income tax purposes was $1,600,069,940 and the aggregate gross unrealized appreciation based on that cost was: Unrealized appreciation $21,226,218 Unrealized depreciation (8,836,423) ---------- Net unrealized appreciation $12,389,795 ----------- -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 33 Federal Income Tax Information (Unaudited) The Fund is required by the Internal Revenue Code of 1986 to tell its shareholders about the tax treatment of the dividends it pays during its fiscal year. The dividends listed below are reported to you on Form 1099-DIV, Dividends and Distributions. Shareholders should consult a tax advisor on how to report distributions for state and local tax purposes. AXP Selective Fund, Inc. Fiscal year ended May 31, 2001 Class A Income distributions taxable as dividend income, 1.00% qualifying for deduction by corporations. Payable date Per share June 21, 2000 $0.04004 July 24, 2000 0.04850 Aug. 24, 2000 0.04579 Sept. 21, 2000 0.04061 Oct. 24, 2000 0.04804 Nov. 21, 2000 0.04067 Dec. 20, 2000 0.05856 Jan. 26, 2001 0.04824 Feb. 26, 2001 0.03758 March 26, 2001 0.03261 April 26, 2001 0.04127 May 24, 2001 0.03700 Total distributions $0.51891 Class B Income distributions taxable as dividend income, 1.00% qualifying for deduction by corporations. Payable date Per share June 21, 2000 $0.03518 July 24, 2000 0.04272 Aug. 24, 2000 0.04033 Sept. 21, 2000 0.03567 Oct. 24, 2000 0.04205 Nov. 21, 2000 0.03573 Dec. 20, 2000 0.05337 Jan. 26, 2001 0.04153 Feb. 26, 2001 0.03197 March 26, 2001 0.02752 April 26, 2001 0.03564 May 24, 2001 0.03193 Total distributions $0.45364 -------------------------------------------------------------------------------- 34 AXP SELECTIVE FUND Class C Income distributions taxable as dividend income, 1.00% qualifying for deduction by corporations. Payable date Per share July 24, 2000 $0.03979 Aug. 24, 2000 0.03997 Sept. 21, 2000 0.03582 Oct. 24, 2000 0.04233 Nov. 21, 2000 0.03583 Dec. 20, 2000 0.05351 Jan. 26, 2001 0.04181 Feb. 26, 2001 0.03222 March 26, 2001 0.02762 April 26, 2001 0.03568 May 24, 2001 0.03201 Total distributions $0.41659 Class Y Income distributions taxable as dividend income, 1.00% qualifying for deduction by corporations. Payable date Per share June 21, 2000 $0.04108 July 24, 2000 0.04974 Aug. 24, 2000 0.04695 Sept. 21, 2000 0.04167 Oct. 24, 2000 0.04933 Nov. 21, 2000 0.04173 Dec. 20, 2000 0.05967 Jan. 26, 2001 0.04966 Feb. 26, 2001 0.03878 March 26, 2001 0.03372 April 26, 2001 0.04248 May 24, 2001 0.03808 Total distributions $0.53289 -------------------------------------------------------------------------------- ANNUAL REPORT -- 2001 35 AXP Selective Fund 70100 AXP Financial Center Minneapolis, MN 55474 americanexpress.com Ticker Symbol Class A: INSEX Class B: ISEBX Class C: N/A Class Y: IDEYX PRSRT STD AUTO U.S. POSTAGE PAID AMERICAN EXPRESS This report must be accompanied or preceded by the Fund's current prospectus. Distributed by American Express Financial Advisors Inc. Member NASD. American Express Company is separate from American Express Financial Advisors Inc. and is not a broker-dealer. S-6376 V (7/01)