N-30D 1 s6385t.txt AXP SELECTIVE FUND AXP(R) Selective Fund 2002 SEMIANNUAL REPORT AXP Selective Fund seeks to provide shareholders with current income and preservation of capital. American Express(R) Funds AMERICAN EXPRESS(R) Table of Contents From the Chairman 2 Economic and Market Update 4 Fund Snapshot 6 Questions & Answers with Portfolio Management 7 Investments in Securities 10 Financial Statements (Portfolio) 16 Notes to Financial Statements (Portfolio) 19 Financial Statements (Fund) 23 Notes to Financial Statements (Fund) 26 Results of Meeting of Shareholders 32 (photo of) Arne H. Carlson From the Chairman Arne H. Carlson Chairman of the board Dear Shareholders, As we begin a new year, the proposed Bush economic stimulus package and potential conflicts around the globe are capturing headlines. While we don't know exactly what the future will bring for investors, we do know the past three years have been extremely difficult. Negative investment returns persisted in 2002 and the investing public also had their confidence in the integrity of corporations shaken. While the scandals appear to be largely behind us, the recent past offers lessons on investing and on governance, which I would like to discuss with you. First, and importantly, we have learned that diversification is not just a concept but a key tactic investors can use to help preserve assets. Many investors have come to a new understanding of their own degree of risk tolerance after three years of down markets. We would encourage you to work closely with your financial advisor to build a diversified portfolio designed to match your current thoughts about risk and reward. -------------------------------------------------------------------------------- 2 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT From the Chairman A second lesson of 2002 is that we must have enhanced oversight of corporations to ensure their financial statements are accurate, their officers act in the interest of shareholders and their directors are truly independent. The Sarbanes-Oxley Act passed by Congress in August, is already having an impact in these areas. We believe governance of the American Express(R) Funds is consistent with the standards imposed by Sarbanes-Oxley. The American Express Funds Board is an independent body comprised of 10 members who are nominated by the independent directors. American Express Financial Corporation is represented by three board members, however, they do not play a role on the nominating committee. I am proud of our board members who come from across the United States and bring strong, diverse skills to the assignment of looking out for the interest of the Funds' shareholders. In 2002, we saw solid evidence of progress in several areas including, importantly, investment performance. In addition, the Funds auditors, KPMG LLP, are independent of American Express Financial Corporation. KPMG serves the interest of shareholders by supporting the work of the Board and certifying unbiased financial reports. Further, the Board has confidence in Ted Truscott, American Express Financial Corporation's Chief Investment Officer, and shares his enthusiasm in the management changes he has effected to improve the investment performance of all American Express funds. The focus of the Board and American Express Financial Corporation is simple; we strive for consistent, competitive investment performance. All of the proposals in the proxy statement you received in September were approved at the shareholder meeting on Nov. 13, 2002, and most will be implemented in the coming weeks. On behalf of the Board, Arne H. Carlson -------------------------------------------------------------------------------- 3 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Economic and Market Update FROM CIO WILLIAM F. "TED" TRUSCOTT (photo of) William F. "Ted" Truscott William F. "Ted" Truscott Chief Investment Officer American Express Financial Corporation Dear Shareholders, In spite of a mostly positive fourth quarter*, 2002 proved to be an extraordinarily challenging year for investors, with the benchmark stock indices -- the Dow, the Nasdaq and the S&P 500 -- all registering percentage losses well into the double digits. While there were technical factors that put a damper on market performance last year, most notably, P/E ratios that are surprisingly high after three years of a bear market, it was corporate governance issues that fostered a general atmosphere of mistrust. The collapse of several large, high profile companies due to outright fraud and malfeasance has been -- and ought to be -- outrageous to the investing public. The magnitude of this wrongdoing is still shocking months after the fact. When many economic factors should have been giving investors reason for optimism, the steady drip of news about these companies sapped overall confidence. I believe there is ample evidence that conditions are not as bad as the markets seem to think. While corporate earnings have been weak, the economy grew at the respectable rate of about 3% last year, compared to 0.1% in 2001. A portion of the softness in earnings can be attributed to excess capacity added in the late `90s. KEY POINTS -- Stocks are continuing to get less expensive. -- Credit "crunch" for business sector persists. -- Those saving for long-term goals should maintain a significant allocation to equities. -------------------------------------------------------------------------------- 4 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Economic and Market Update Interest rates are another bright spot. They are the lowest they have been in 40 years, which has added to consumer and business purchasing power. There's no better illustration of this than the housing market, which has remained vigorous. Finally, the business productivity gains we've seen since the mid-`90s are remarkable, making products and services less expensive. The macroeconomic picture, while not ideal, is certainly positive. For these reasons, I'm cautiously optimistic about market prospects for 2003. Of course, there are still risks. Much of what happens this year will depend on external factors, such as whether or not more scandals arise and the implications of potential conflict in Iraq. In the short term, military action in Iraq would almost certainly produce an oil price spike; if that increase became severe enough for a significant period of time, it would create inflationary pressures that could endanger economic growth. In addition to stocks, some bond categories offer opportunity. Though we believe U.S. Treasuries are currently overvalued, select corporate, high-yield and municipal issues may provide competitive returns this year. Speak to your financial advisor to learn more about different asset classes. After three years of negative stock market returns, many individual investors are rebalancing portfolios with regard to risk and return. If you are repositioning, we would encourage moderate changes from stocks to bonds. The risk inherent in emotion-based repositioning is that you will go too far too fast. I encourage gradual movement across categories. Should interest rates move at all in 2003, it's likely that they'll go up, which will have a negative impact on most bonds. Continue to invest according to your individual timeframe and financial goals. As always, thank you for investing with American Express Financial Advisors. William F. Truscott * Please see portfolio manager Q&A for fiscal period economic coverage. -------------------------------------------------------------------------------- 5 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Fund Snapshot AS OF NOV. 30, 2002 PORTFOLIO MANAGER Portfolio manager Colin Lundgren Tenure/since 4/02 Years in industry 9 FUND OBJECTIVE For investors seeking current income and preservation of capital. Inception dates A: 4/6/45 B: 3/20/95 C: 6/26/00 Y: 3/20/95 Ticker symbols A: INSEX B: ISEBX C: ASLCX Y: IDEYX Total net assets $1.513 billion Number of holdings approximately 190 STYLE MATRIX Shading within the style matrix indicates areas in which the Fund generally invests. DURATION SHORT INT. LONG X HIGH MEDIUM QUALITY LOW TOP FIVE SECTORS Percentage of portfolio assets Mortgage-backed securities 48.4% Government obligations 20.0 Financial services 7.6 Utilities -- electric 1.2 Banks and savings & loans 1.1 CREDIT QUALITY SUMMARY Percentage of portfolio assets AAA bonds 70.3% AA bonds 4.2 A bonds 7.3 BAA bonds 5.7 Non-investment grade bonds 0.6 Fund holdings are subject to change. -------------------------------------------------------------------------------- 6 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Questions & Answers WITH PORTFOLIO MANAGEMENT Q: How did the AXP Selective Fund perform for the six-month period ended Nov. 30, 2002? A: For the period, the Fund's Class A shares returned 0.23% excluding sales charge. In comparison, the Lehman Brothers Aggregate Bond Index returned 4.98% and the Lipper Corporate Debt - A rated Funds Index generated a return of 3.79% for the same period. Q: What factors significantly impacted performance? A: Three main factors had a negative impact on performance. The biggest detractors from results were our losses on futures and the Fund's fairly light exposure to short-term Treasury securities. It was our belief that the Federal Reserve's next move, still some time off, would be to raise interest rates. Therefore, we reduced the Fund's position in short-term Treasuries and in high-quality securities that are sensitive to Fed movements. As it turned out, the two-year Treasury remained unchanged during the fourth quarter, while most Treasury yields moved up 0.25% to 0.50%, hurting the Fund's return. The Fund's performance was also affected by geo-political issues. Most bond investors believe that the United States is likely to become engaged in military action in the Middle East. Therefore, they sought the highest quality securities -- short-term Treasuries. The increased (bar graph) PERFORMANCE COMPARISON For the six-month period ended Nov. 30, 2002 6% (bar 1) (bar 2) (bar 3) 4% +0.23% +4.98% +3.79% 2% 0% (bar 1) AXP Selective Fund Class A (excluding sales charge) (bar 2) Lehman Brothers Aggregate Bond Index(1) (unmanaged) (bar 3) Lipper Corporate Debt - A rated Funds Index(2) (1) The 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. (2) The Lipper Corporate Debt - A rated Funds 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. Past performance is no guarantee of future results. The 4.75% sales charge applicable to Class A shares of the Fund is not reflected in the bar chart; if reflected, returns would be lower than those shown. The performance of Class B, Class C and Class Y may vary from that shown above because of differences in sales charges and fees. The indices do not reflect the effects of sales charges, expenses (excluding Lipper) and taxes. -------------------------------------------------------------------------------- 7 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT
Questions & Answers (begin callout quote) >...we expect the Fed will begin raising rates at a modest pace over the next several months as the economy continues to improve. (end callout quote) demand for such securities boosted prices. Because the Fund had a relatively small position in short-term Treasuries, it did not fully benefit from the higher prices that these securities offered. Earlier in the year, the lack of investor enthusiasm for corporate bonds caused prices to decline to very attractive levels and yields to rise. Corporate bonds had been out of favor for more than a year, therefore, we positioned the Fund to take advantage of a rebound in the corporate area. We concentrated the corporate bond portion of the Fund in about 40 names. As more cases of corporate malfeasance came to light, however, the lack of diversification in the corporate sector held back performance. The bonds in the portfolio that were affected by AVERAGE ANNUAL TOTAL RETURNS as of Nov. 30, 2002 Class A Class B Class C Class Y (Inception dates) (4/6/45) (3/20/95) (6/26/00) (3/20/95) NAV(1) POP(2) NAV(1) After CDSC(3) NAV(1) After CDSC(4) NAV(5) POP(5) 6 months* +0.23% -4.54% -0.15% -5.05% -0.16% -1.14% +0.31% +0.31% 1 year -0.10% -4.85% -0.86% -4.67% -0.86% -0.86% +0.06% +0.06% 5 years +4.90% +3.88% +4.11% +3.95% N/A N/A +5.04% +5.04% 10 years +6.51% +6.00% N/A N/A N/A N/A N/A N/A Since inception N/A N/A +5.74% +5.74% +5.36% +5.36% +6.69% +6.69%
* Not annualized. (1) Excluding sales charge. (2) Returns at public offering price (POP) reflect a sales charge of 4.75%. (3) Returns at maximum contingent deferred sales charge (CDSC). CDSC applies as follows: first year 5%; second and third year 4%; fourth year 3%; fifth year 2%; sixth year 1%; no sales charge thereafter. (4) 1% CDSC applies to redemptions made within the first year of purchase. (5) Sales charge is not applicable to these shares. Shares available to institutional investors only. Past performance is no guarantee of future results. Investment return and principal value will fluctuate, so that your shares, when redeemed, may be worth more or less than the original cost. The performance shown for each class of shares will vary due to differences in sales charges and fees. Short term performance may be higher or lower than the figures shown. Visit americanexpress.com for current information. -------------------------------------------------------------------------------- 8 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Questions & Answers corporate governance problems declined significantly in value, and their volatility had a negative effect on the rest of the corporate bond position. By the end of the period, we began to expand our corporate bond position. Q: What changes did you make to the portfolio during the six-month period? (The leadership of the portfolio team transitioned from Brad Stone to Colin Lundgren during the semi-annual period.) A: When it became clear that accounting issues and a sluggish economic recovery would continue to have a negative effect on corporate securities, we reduced exposure to the corporate sector. We continued to add to the Fund's position in mortgage-backed securities, and we maintained a relatively light position in longer-duration agency bonds. We also built a slightly overweighted position in long-term Treasury securities. We positioned the Fund to take advantage of a flatter yield curve, one for which short-term interest rates would remain fairly stable, while yields on intermediate- and long-term securities would decline. Because we maintained a more neutral position in terms of the Fund's interest-rate sensitivity, we were successful in offsetting some of the problems that affected the corporate bond sector. Overall, we are increasing diversification in the corporate bond portfolio to minimize possible issuer risk. Q: What is your outlook for the months ahead? A: The most recent data indicate that the economy is recovering at an annual rate of about 3-4%. While the Federal Reserve (the Fed) lowered short-term interest rates by 0.5% early in November, we expect the Fed will begin raising rates at a modest pace over the next several months as the economy continues to improve. In this environment, we will slowly boost the Fund's corporate allocation to high-quality corporate bonds. In the corporate area, we will focus on owning a broadly diversified portfolio so that any possible problem issues will have less of an effect on the portfolio as a whole. We will maintain our neutral position from the standpoint of interest-rate sensitivity, as the market is balancing the expectation of a stronger economy with other concerns such as global tensions and uncertainty about corporate earnings. We expect that the difference in yields between intermediate- and longer-term issues compared to those on shorter-term securities will narrow in the months ahead. We will maintain a fairly liquid portfolio so that we can make adjustments should rapid changes in interest rates create an unusually volatile environment. -------------------------------------------------------------------------------- 9 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Investments in Securities Quality Income Portfolio Nov. 30, 2002 (Unaudited) (Percentages represent value of investments compared to net assets) Bonds (95.3%) Issuer Coupon Principal Value(a) rate amount Government obligations (21.6%) Overseas Private Investment U.S. Govt Guaranty Series 1996A 01-15-09 6.99% $6,666,667 $7,346,000 Province of British Columbia (U.S. Dollar) 10-29-08 5.38 4,760,000(c) 5,108,665 Province of Ontario (U.S. Dollar) 09-17-07 3.50 6,350,000(c) 6,305,518 Province of Quebec (U.S. Dollar) 07-17-09 5.00 6,350,000(c) 6,607,118 U.S. Treasury 05-15-04 7.25 5,000,000 5,393,165 06-30-04 2.88 7,425,000(g) 7,542,389 08-15-05 6.50 15,300,000 16,939,364 02-15-11 5.00 10,100,000 10,748,612 02-15-12 4.88 26,020,000 27,381,991 08-15-12 4.38 18,270,000 18,505,500 11-15-12 4.00 29,010,000 28,504,588 02-15-15 11.25 7,100,000 11,481,474 11-15-16 7.50 20,700,000 26,162,854 02-15-26 6.00 15,925,000 17,567,266 08-15-29 6.13 13,300,000 15,024,318 05-15-30 6.25 11,450,000 13,182,259 02-15-31 5.38 42,315,000 44,401,003 Principal Only 08-15-21 6.11 50,000,000(f) 17,681,500 TIPS 01-15-07 3.38 18,000,000(h) 21,817,382 07-15-12 3.00 17,000,000(h) 17,758,549 United Mexican States (U.S. Dollar) 01-14-12 7.50 3,000,000(c) 3,150,000 Total 328,609,515 Mortgage-backed securities (52.3%) Collateralized Mtge Obligation Trust 09-15-31 4.85 5,400,000 5,278,716 Federal Home Loan Bank 01-14-05 4.13 28,820,000 29,870,430 Federal Home Loan Mtge Corp 09-15-07 3.50 15,000,000 14,959,050 07-15-12 5.13 16,890,000 17,375,081 11-01-14 7.50 4,349,199 4,619,540 04-01-15 7.50 7,137,830 7,581,509 01-01-16 7.00 11,378,905 12,039,388 07-01-16 8.00 243 263 01-01-17 8.00 1,951 2,110 02-01-17 5.50 25,521,098 26,191,683 03-01-17 8.50 35,618 39,135 06-01-17 8.50 16,149 17,559 07-01-17 6.00 13,743,511 14,270,551 07-01-17 7.00 13,847,890 14,647,014 09-01-19 8.50 39,334 42,685 04-01-20 9.00 383,304 425,355 04-01-21 9.00 338,188 375,653 03-01-22 8.50 736,055 797,996 04-01-22 6.50 25,440,628 26,491,676 08-01-22 8.50 698,948 756,933 10-01-22 6.50 15,146,816 15,772,589 06-01-24 7.50 3,168,088 3,373,965 02-01-25 8.00 1,178,049 1,269,776 04-01-32 7.00 4,624,940 4,825,836 05-01-32 7.00 16,874,438 17,607,421 06-01-32 7.00 15,471,362 16,143,399 07-01-32 7.00 18,049,886 18,833,928 09-01-32 6.50 3,882,672(b) 4,016,095 Collateralized Mtge Obligation 12-15-13 5.50 17,175,000 17,779,089 02-15-16 5.50 15,500,000 16,086,072 12-15-17 5.00 34,270,000(b) 35,041,074 02-25-42 6.50 6,878,113 7,210,670 Federal Housing Admin 01-01-24 7.43 3,896,601 3,955,050 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 10 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Mortgage-backed securities (cont.) Federal Natl Mtge Assn 02-15-05 7.13% $8,000,000 $8,806,360 07-26-07 4.32 13,910,000 14,151,756 05-15-08 6.00 21,450,000 23,666,643 05-15-11 6.00 11,400,000 12,474,781 08-25-12 4.72 15,500,000 15,075,917 01-01-14 6.00 8,272,549 8,641,501 04-01-14 6.00 9,450,620 9,872,113 04-01-14 6.50 170,015 178,869 05-01-14 6.00 6,585,672 6,869,290 05-01-16 6.50 10,837,243 11,371,595 03-01-17 6.50 12,255,157 12,859,161 12-01-26 8.00 1,705,237 1,837,535 04-01-27 7.50 2,423,289 2,569,235 08-01-27 8.00 1,827,439 1,963,089 01-01-28 6.50 1,334,943 1,382,671 05-01-28 6.50 6,549,968 6,775,349 09-01-28 6.00 52,015,000(b) 52,957,511 12-01-28 6.50 11,575,171 11,973,466 02-01-29 6.50 8,637,342 8,934,548 03-01-29 6.50 9,022,275 9,324,210 06-01-29 7.00 9,545,792 9,972,780 12-01-29 7.50 5,194,098 5,492,453 01-01-30 8.00 1,623,253 1,736,643 03-01-30 8.00 4,576,465 4,896,146 12-01-30 6.00 8,000,000(b) 8,175,040 06-01-31 6.50 8,418,399 8,699,662 06-01-31 7.00 11,938,906 12,539,106 02-01-32 7.50 1,659,045 1,753,403 03-01-32 7.50 1,741,278 1,840,271 04-01-32 7.50 2,561,642 2,707,335 05-01-32 7.50 3,090,331 3,266,094 06-01-32 7.00 20,927,690 21,849,817 06-01-32 7.50 9,066,321 9,581,968 08-01-32 6.50 13,313,228 13,762,550 08-01-32 7.00 19,742,527 20,612,432 09-01-32 6.50 30,785,568 31,817,656 Collateralized Mtge Obligation 07-30-12 5.50 17,726,500 18,414,742 03-25-15 5.00 15,260,000 15,480,594 10-25-19 8.50 1,448,659 1,614,908 10-01-32 5.00 11,000,000 11,353,724 Principal Only 09-01-18 5.73 156,697(f) 142,041 Govt Natl Mtge Assn 05-15-26 7.50 3,315,733 3,537,891 11-15-31 6.50 23,591,927 24,548,625 Total 793,178,772 Airlines (0.8%) American Airlines 05-23-11 6.82 7,000,000 5,949,999 Continental Airlines Series 2001-1 06-15-21 6.70 4,397,566 3,837,053 Delta Air Lines 09-18-11 7.11 2,080,000 2,079,181 Total 11,866,233 Automotive & related (0.8%) DaimlerChrysler North America Holdings Company Guaranty 01-18-31 8.50 2,210,000 2,614,870 Ford Motor 07-16-31 7.45 2,400,000(g) 2,025,977 Ford Motor Credit 10-25-11 7.25 8,700,000 8,202,464 Total 12,843,311 Banks and savings & loans (1.2%) Bank of America 09-15-12 4.88 2,500,000 2,456,400 Bank One Sub Nts 11-15-11 5.90 4,200,000 4,447,212 J.P. Morgan Chase 05-30-07 5.25 1,800,000 1,851,741 Sub Nts 03-15-12 6.63 3,500,000 3,696,105 US Bank National Association Minnesota 08-01-11 6.38 2,150,000 2,342,447 Washington Mutual Bank 06-15-11 6.88 3,000,000 3,281,895 Total 18,075,800 Beverages & tobacco (0.2%) Diageo Capital (U.S. Dollar) 11-19-07 3.50 2,560,000(c) 2,507,315 Building materials & construction (0.4%) Tyco Intl Group (U.S. Dollar) Company Guaranty 02-15-11 6.75 4,690,000(c) 4,244,450 Weyerhaeuser 03-15-12 6.75 2,000,000 2,132,306 Total 6,376,756 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 11 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Chemicals (0.2%) Dow Chemical 10-01-12 6.00% $2,950,000(g) $2,935,781 Communications equipment & services (0.9%) AT&T Wireless Services Sr Nts 03-01-11 7.88 2,250,000 2,160,000 03-01-31 8.75 2,570,000 2,377,250 Deutsche Telekom Intl Finance (U.S. Dollar) 06-15-10 8.50 2,000,000(c) 2,201,934 Verizon Global Funding 06-15-12 6.88 6,500,000 6,973,467 Total 13,712,651 Energy (1.0%) Amerada Hess 03-15-33 7.13 3,140,000 3,269,801 ConocoPhillips 10-15-32 5.90 4,400,000(d) 4,246,484 FirstEnergy Series B 11-15-11 6.45 4,950,000 4,879,562 Marathon Oil 06-01-07 5.38 3,350,000 3,467,853 Total 15,863,700 Financial services (8.3%) American General Finance 10-01-12 5.38 2,850,000 2,742,869 California State Teachers' Retirement System Trust Series 2002-C6 11-20-09 4.46 9,750,000(b) 9,673,828 CIT Group 09-25-07 5.75 2,950,000 2,969,638 Citibank Credit Card Insurance Trust Series 2001-8 Cl A 12-07-06 4.10 6,480,000 6,679,876 Citigroup 02-21-12 6.00 7,400,000 7,787,982 Sub Nts 08-27-12 5.63 5,900,000 6,006,495 Credit Suisse First Boston USA 01-15-12 6.50 10,400,000 10,784,946 GMAC 02-01-12 7.00 11,300,000 11,027,364 Goldman Sachs Group 01-15-12 6.60 5,400,000 5,846,494 Household Finance 10-15-11 6.38 8,500,000 8,340,914 John Hancock Financial Services Sr Nts 12-01-08 5.63 2,850,000 2,882,387 MBNA 10-15-08 5.75 15,000,000 16,163,930 Merrill Lynch 11-15-07 4.00 1,860,000 1,834,021 Series B 11-20-09 4.75 2,440,000 2,417,911 Morgan Stanley, Dean Witter & Co 04-01-12 6.60 7,000,000 7,516,600 Pemex Master Trust 02-01-09 7.88 7,050,000(d) 7,376,063 Prudential Bache Collateralized Mtge Obligation 04-01-19 7.97 1,484,978 1,488,196 Railcar Leasing 01-15-13 7.13 12,150,000(d) 13,415,908 Total 124,955,422 Food (0.2%) General Mills 02-15-07 5.13 2,850,000 2,959,192 Health care (0.5%) American Home Products 03-15-04 5.88 7,000,000 7,226,674 Health care services (0.1%) Tenet Healthcare Sr Nts 06-01-12 6.50 1,440,000 1,281,600 Household products (0.5%) Procter & Gamble 06-15-07 4.75 7,300,000 7,657,693 Insurance (0.5%) Hartford Life Sr Nts 03-01-31 7.38 3,130,000 3,157,397 Transamerica Capital III Company Guaranty 11-15-37 7.63 3,875,000 3,759,990 Total 6,917,387 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 12 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Bonds (continued) Issuer Coupon Principal Value(a) rate amount Leisure time & entertainment (0.2%) Viacom Company Guaranty 08-15-12 5.63% $2,470,000 $2,556,030 Media (0.7%) Comcast Cable Communications 05-01-27 8.50 4,900,000 4,960,623 Time Warner Entertainment 03-15-23 8.38 5,000,000 5,372,210 Total 10,332,833 Miscellaneous (0.2%) EOP Operating LP Company Guaranty 02-15-12 6.75 2,980,000 3,126,872 Multi-industry conglomerates (0.8%) General Electric Capital 06-15-12 6.00 11,460,000 12,025,093 Paper & packaging (0.2%) Abitibi-Consolidated (U.S. Dollar) 08-01-10 8.55 2,930,000(c) 3,094,786 Retail (0.9%) Federated Dept Stores Sr Nts 09-01-08 6.63 4,500,000 4,808,431 Kroger Company Guaranty 06-15-12 6.20 2,980,000 3,074,406 Sears Roebuck Acceptance 04-15-12 6.70 2,950,000 2,788,676 Target 11-01-32 6.35 3,090,000 3,161,005 Total 13,832,518 Transportation (0.4%) CSX 03-15-12 6.30 3,000,000 3,201,522 Union Pacific 01-15-11 6.65 2,850,000 3,118,547 Total 6,320,069 Utilities -- electric (1.3%) Dominion Resources Sr Nts Series B 06-30-12 6.25 3,090,000 3,210,192 Duke Energy 01-15-12 6.25 1,500,000(g) 1,561,578 IPALCO Enterprises 11-14-08 7.38 5,430,000 4,669,800 Northern States Power 1st Mtge 08-29-12 8.00 7,200,000(d) 7,746,624 Tiers-Mirant 06-15-04 7.20 5,500,000(d) 2,365,000 Total 19,553,194 Utilities -- telephone (1.0%) AT&T Sr Nts 11-15-06 7.00 2,980,000 3,054,500 British Telecom (U.S. Dollar) 12-15-10 8.13 1,930,000(c) 2,256,755 Citizens Communications Sr Nts 08-15-31 9.00 4,500,000 4,870,539 France Telecom (U.S. Dollar) 03-01-11 9.25 2,500,000(c) 2,803,040 Sprint Capital Company Guaranty 11-15-28 6.88 2,840,000 2,099,490 Total 15,084,324 Total bonds (Cost: $1,420,441,522) $1,442,893,521 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 13 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Short-term securities (13.0%) Issuer Annualized Amount Value(a) yield on date payable at of purchase maturity U.S. government agencies (9.7%) Federal Home Loan Bank Disc Nt 12-06-02 1.64% $300,000 $299,904 Federal Natl Mtge Assn Disc Nts 12-04-02 1.70 15,000,000 14,996,751 12-10-02 1.64 40,000,000 39,979,956 12-12-02 1.45 35,000,000 34,981,675 12-18-02 1.69 30,000,000 29,975,014 01-14-03 1.24 5,500,000 5,491,498 02-19-03 1.26 20,500,000 20,444,671 Total 146,169,469 Commercial paper (3.3%) CXC 01-14-03 1.75 20,100,000(e) 20,061,218 Morgan Stanley 12-03-02 1.75 10,000,000 9,998,055 01-23-03 1.32 20,000,000 19,953,595 Total 50,012,868 Total short-term securities Cost: $196,185,165) $196,182,337 Total investments in securities (Cost: $1,616,626,687)(i) $1,639,075,858 See accompanying notes to investments in securities. -------------------------------------------------------------------------------- 14 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Notes to investments in securities (a) Securities are valued by procedures described in Note 1 to the financial statements. (b) At Nov. 30, 2002, the cost of securities purchased, including interest purchased, on a when-issued and/or other forward-commitment basis was $74,924,423. (c) Foreign security values are stated in U.S. dollars. For debt securities, principal amounts are denominated in the currency indicated. As of Nov. 30, 2002, the value of foreign securities represented 2.5% 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 yield based upon the estimated timing of future cash flows as of Nov. 30, 2002. (g) 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 Notes, March 2003, 5-year $19,600,000 Sale contracts Swap Futures, April 2003, 10-year 34,000,000 U.S. Treasury Bonds, March 2003, 20-year 31,400,000 U.S. Treasury Notes, March 2003, 10-year 71,900,000 (h) U.S. Treasury inflation-protection securities (TIPS) are securities in which the principal amount is adjusted for inflation and the semiannual interest payments equal a fixed percentage of the inflation-adjusted principal amount. (i) At Nov. 30, 2002, the cost of securities for federal income tax purposes was approximately $1,616,627,000 and the approximate aggregate gross unrealized appreciation and depreciation based on that cost was: Unrealized appreciation $ 35,664,000 Unrealized depreciation (13,215,000) ----------- Net unrealized appreciation $ 22,449,000 ------------ -------------------------------------------------------------------------------- 15 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT
Financial Statements Statement of assets and liabilities Quality Income Portfolio Nov. 30, 2002 (Unaudited) Assets Investments in securities, at value (Note 1)* (identified cost $1,616,626,687) $1,639,075,858 Cash in bank on demand deposit 620,386 Dividends and accrued interest receivable 12,861,269 Receivable for investment securities sold 42,425,971 ---------- Total assets 1,694,983,484 ------------- Liabilities Payable for investment securities purchased 114,107,883 Payable upon return of securities loaned (Note 4) 66,164,750 Accrued investment management services fee 42,406 Other accrued expenses 108,133 ------- Total liabilities 180,423,172 ----------- Net assets $1,514,560,312 ============== * Including securities on loan, at value (Note 4) $ 63,939,732 --------------
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 16 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT
Statement of operations Quality Income Portfolio Six months ended Nov. 30, 2002 (Unaudited) Investment income Income: Interest $ 40,349,999 Less foreign taxes withheld (2,203) ------ Total income 40,347,796 ---------- Expenses (Note 2): Investment management services fee 3,973,715 Compensation of board members 9,288 Custodian fees 63,380 Audit fees 16,250 Other 14,176 ------ Total expenses 4,076,809 Earnings credits on cash balances (Note 2) (1,010) ------ Total net expenses 4,075,799 --------- Investment income (loss) -- net 36,271,997 ---------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions (Note 3) (48,000,169) Futures contracts (15,793,716) Options contracts written (Note 5) 534,578 ------- Net realized gain (loss) on investments (63,259,307) Net change in unrealized appreciation (depreciation) on investments and on translation of assets and liabilities in foreign currencies 32,656,454 ---------- Net gain (loss) on investments and foreign currencies (30,602,853) ----------- Net increase (decrease) in net assets resulting from operations $ 5,669,144 ============
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 17 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT
Statements of changes in net assets Quality Income Portfolio Nov. 30, 2002 May 31, 2002 Six months ended Year ended (Unaudited) Operations Investment income (loss) -- net $ 36,271,997 $ 78,356,400 Net realized gain (loss) on investments (63,259,307) 26,212,306 Net change in unrealized appreciation (depreciation) on investments and on translation of assets and liabilities in foreign currencies 32,656,454 (22,814,230) ---------- ----------- Net increase (decrease) in net assets resulting from operations 5,669,144 81,754,476 --------- ---------- Proceeds from contributions 26,059,631 162,938,975 Fair value of withdrawals (100,858,031) (152,745,069) ------------ ------------ Net contributions (withdrawals) from partners (74,798,400) 10,193,906 ----------- ---------- Total increase (decrease) in net assets (69,129,256) 91,948,382 Net assets at beginning of period 1,583,689,568 1,491,741,186 ------------- ------------- Net assets at end of period $1,514,560,312 $1,583,689,568 ============== ==============
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 18 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Notes to Financial Statements Quality Income Portfolio (Unaudited as to Nov. 30, 2002) 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. -------------------------------------------------------------------------------- 19 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT 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. 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. -------------------------------------------------------------------------------- 20 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Securities purchased on a forward-commitment basis Delivery and payment for securities that have been purchased by the Portfolio on a forward-commitment basis including when issued securities, and other forward-commitments 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 net assets the same as owned securities. The Portfolio designates cash or liquid securities at least equal to the amount of its forward-commitments. As of Nov. 30, 2002, the Portfolio has entered into outstanding when-issued securities of $70,755,167 and other forward-commitments of $4,169,256. 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. 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 amortization of premium and discount using the effective interest method, is accrued daily. 2. FEES AND EXPENSES The Trust, on behalf of the Portfolio, has an Investment Management Services Agreement with American Express Financial Corporation (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 six months ended Nov. 30, 2002, the Portfolio's custodian fees were reduced by $1,010 as a result of earnings credits from overnight cash balances. According to a Placement Agency Agreement, American Express Financial Advisors Inc. acts as placement agent of the Trust's units. -------------------------------------------------------------------------------- 21 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT 3. SECURITIES TRANSACTIONS Cost of purchases and proceeds from sales of securities (other than short-term obligations) aggregated $2,073,057,984 and $2,168,684,901, respectively, for the six months ended Nov. 30, 2002. For the same period, the portfolio turnover rate was 137%. Realized gains and losses are determined on an identified cost basis. 4. LENDING OF PORTFOLIO SECURITIES As of Nov. 30, 2002, securities valued at $63,939,732 were on loan to brokers. For collateral, the Portfolio received $66,164,750 in cash. Income from securities lending amounted to $100,292 for the six months ended Nov. 30, 2002. 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. 5. OPTIONS CONTRACTS WRITTEN Contracts and premiums associated with options contracts written on interest rate futures are as follows:
Six months ended Nov. 30, 2002 Puts Calls Contracts Premiums Contracts Premiums Balance May 31, 2002 -- $ -- -- $ -- Opened 765 680,659 8,794 1,770,044 Closed (765) 680,659 (3,014) (1,481,044) Expired -- -- (5,780) (289,000) ------ -------- Balance Nov. 30, 2002 -- $ -- -- $ -- -- -------- -- -----------
See "Summary of significant accounting policies." 6. INTEREST RATE FUTURES CONTRACTS As of Nov. 30, 2002, investments in securities included securities valued at $2,703,463 that were pledged as collateral to cover initial margin deposits on 196 open purchase contracts and 1,373 open sale contracts. The notional market value of the open purchase contracts as of Nov. 30, 2002 was $21,648,813 with a net unrealized loss of $66,626. The notional market value of the open sale contracts as of Nov. 30, 2002, was $150,797,519 with a net unrealized gain of $954,392. See "Summary of significant accounting policies." -------------------------------------------------------------------------------- 22 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT
Financial Statements Statement of assets and liabilities AXP Selective Fund Nov. 30, 2002 (Unaudited) Assets Investment in Portfolio (Note 1) $1,514,444,931 Capital shares receivable 276,663 ------- Total assets 1,514,721,594 ------------- Liabilities Dividends payable to shareholders 905,472 Capital shares payable 238,158 Accrued distribution fee 32,247 Accrued service fee 980 Accrued transfer agency fee 8,640 Accrued administrative services fee 4,000 Other accrued expenses 170,942 ------- Total liabilities 1,360,439 --------- Net assets applicable to outstanding capital stock $1,513,361,155 -------------- Represented by Capital stock -- $.01 par value (Note 1) $ 1,768,438 Additional paid-in capital 1,557,643,589 Excess of distributions over net investment income (2,887,203) Accumulated net realized gain (loss) (66,498,875) Unrealized appreciation (depreciation) on investments and on translation of assets and liabilities in foreign currencies 23,335,206 ---------- Total -- representing net assets applicable to outstanding capital stock $1,513,361,155 ============== Net assets applicable to outstanding shares: Class A $ 992,686,355 Class B $ 331,130,691 Class C $ 9,708,893 Class Y $ 179,835,216 Net asset value per share of outstanding capital stock: Class A shares 115,999,689 $ 8.56 Class B shares 38,695,465 $ 8.56 Class C shares 1,134,558 $ 8.56 Class Y shares 21,014,044 $ 8.56 ---------- --------------
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 23 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT
Statement of operations AXP Selective Fund Six months ended Nov. 30, 2002 (Unaudited) Investment income Income: Interest $ 40,348,314 Less foreign taxes withheld (2,203) ------ Total income 40,346,111 ---------- Expenses (Note 2): Expenses allocated from Portfolio 4,075,499 Distribution fee Class A 1,276,609 Class B 1,697,743 Class C 48,123 Transfer agency fee 1,006,351 Incremental transfer agency fee Class A 56,500 Class B 34,544 Class C 1,314 Service fee -- Class Y 90,555 Administrative services fees and expenses 376,171 Compensation of board members 7,555 Printing and postage 104,288 Registration fees 71,017 Audit fees 5,375 Other 12,652 ------ Total expenses 8,864,296 Earnings credits on cash balances (Note 2) (12,759) ------- Total net expenses 8,851,537 --------- Investment income (loss) -- net 31,494,574 ---------- Realized and unrealized gain (loss) -- net Net realized gain (loss) on: Security transactions (47,995,518) Futures contracts (15,793,745) Options contracts written 534,578 ------- Net realized gain (loss) on investments (63,254,685) Net change in unrealized appreciation (depreciation) on investments and on translation of assets and liabilities in foreign currencies 32,654,065 ---------- Net gain (loss) on investments and foreign currencies (30,600,620) ----------- Net increase (decrease) in net assets resulting from operations $ 893,954 ============
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 24 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT
Statements of changes in net assets AXP Selective Fund Nov. 30, 2002 May 31, 2002 Six months ended Year ended (Unaudited) Operations and distributions Investment income (loss) -- net $ 31,494,574 $ 69,091,733 Net realized gain (loss) on investments (63,254,685) 26,210,072 Net change in unrealized appreciation (depreciation) on investments and on translation of assets and liabilities in foreign currencies 32,654,065 (22,812,371) ---------- ----------- Net increase (decrease) in net assets resulting from operations 893,954 72,489,434 ------- ---------- Distributions to shareholders from: Net investment income Class A (23,563,094) (47,043,251) Class B (6,542,470) (11,539,596) Class C (181,737) (244,581) Class Y (4,324,871) (10,201,699) Net realized gain Class A -- (3,121,437) Class B -- (955,224) Class C -- (21,274) Class Y -- (705,355) -- -------- Total distributions (34,612,172) (73,832,417) ----------- ----------- Capital share transactions (Note 3) Proceeds from sales Class A shares (Note 2) 92,796,785 217,863,403 Class B shares 57,839,942 163,154,275 Class C shares 2,231,427 7,922,122 Class Y shares 32,042,423 96,619,335 Reinvestment of distributions at net asset value Class A shares 18,909,267 39,469,070 Class B shares 5,939,424 11,261,219 Class C shares 163,164 241,633 Class Y shares 4,376,243 10,975,199 Payments for redemptions Class A shares (139,251,217) (218,862,352) Class B shares (Note 2) (67,741,059) (94,748,640) Class C shares (Note 2) (1,897,183) (2,556,903) Class Y shares (40,581,611) (137,754,814) ----------- ------------ Increase (decrease) in net assets from capital share transactions (35,172,395) 93,583,547 ----------- ---------- Total increase (decrease) in net assets (68,890,613) 92,240,564 Net assets at beginning of period 1,582,251,768 1,490,011,204 ------------- ------------- Net assets at end of period $1,513,361,155 $1,582,251,768 ============== ============== Undistributed (excess of distributions over) net investment income $ (2,887,203) $ 230,395 -------------- --------------
See accompanying notes to financial statements. -------------------------------------------------------------------------------- 25 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Notes to Financial Statements AXP Selective Fund (Unaudited as to Nov. 30, 2002) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Fund is a series of AXP Income Series, Inc. (formerly AXP Selective Fund, Inc.) and is registered under the Investment Company Act of 1940 (as amended) as a diversified, open-end management investment company. AXP Income Series, Inc. has 10 billion authorized shares of capital stock that can be allocated among the separate series as designated by the board. 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 Nov. 30, 2002 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. -------------------------------------------------------------------------------- 26 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT 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. 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. Dividends to shareholders Dividends from net investment income, declared daily and payable monthly, when available, 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 incremental transfer agency fee is the amount charged to the specific classes for the additional expense above the fee for Class Y. 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. -------------------------------------------------------------------------------- 27 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT
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. Sales charges received by the Distributor for distributing Fund shares were $539,196 for Class A, $223,761 for Class B and $3,456 for Class C for the six months ended Nov. 30, 2002. During the six months ended Nov. 30, 2002, the Fund's transfer agency fees were reduced by $12,759 as a result of earnings credits from overnight cash balances. 3. CAPITAL SHARE TRANSACTIONS Transactions in shares of capital stock for the periods indicated are as follows: Six months ended Nov. 30, 2002 Class A Class B Class C Class Y Sold 10,753,213 6,699,228 258,662 3,721,326 Issued for reinvested distributions 2,200,227 691,247 18,989 509,168 Redeemed (16,164,223) (7,862,409) (220,250) (4,710,791) ----------- ---------- -------- ---------- Net increase (decrease) (3,210,783) (471,934) 57,401 (480,297) ---------- -------- ------ -------- Year ended May 31, 2002 Class A Class B Class C Class Y Sold 24,549,245 18,395,624 893,392 10,879,769 Issued for reinvested distributions 4,462,460 1,273,680 27,348 1,240,318 Redeemed (24,742,938) (10,713,888) (289,398) (15,570,378) ----------- ----------- -------- ----------- Net increase (decrease) 4,268,767 8,955,416 631,342 (3,450,291) --------- --------- ------- ----------
4. BANK BORROWINGS The Fund has a revolving credit agreement with Deutsche Bank, whereby the Fund is permitted to have bank borrowings for temporary or emergency purposes to fund shareholder redemptions. The agreement went into effect Sept. 24, 2002. The Fund must maintain asset coverage for borrowings of at least 300%. The agreement, which enables the Fund to participate with other American Express mutual funds, permits borrowings up to $500 million, collectively. Interest is charged to each Fund based on its borrowings at a rate equal to either the LIBOR plus 0.50%, the IBOR plus 0.50% or the higher of the Federal Funds Rate plus 0.25% and the Prime Lending Rate. Borrowings are payable within 60 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 0.09% per annum. Prior to this agreement, the Fund had a revolving credit agreement that permitted borrowings up to $200 million with U.S. Bank, N.A. The Fund had no borrowings outstanding during the six months ended Nov. 30, 2002. -------------------------------------------------------------------------------- 28 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT
5. 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, 2002(f) 2002 2001 2000 1999 Net asset value, beginning of period $8.74 $8.74 $8.32 $8.96 $9.23 Income from investment operations: Net investment income (loss) .18 .40 .52 .52 .54 Net gains (losses) (both realized and unrealized) (.16) .02 .42 (.46) (.20) Total from investment operations .02 .42 .94 .06 .34 Less distributions: Dividends from net investment income (.20) (.40) (.52) (.53) (.54) Distributions from realized gains -- (.02) -- (.17) (.07) Total distributions (.20) (.42) (.52) (.70) (.61) Net asset value, end of period $8.56 $8.74 $8.74 $8.32 $8.96 Ratios/supplemental data Net assets, end of period (in millions) $993 $1,042 $1,004 $949 $1,170 Ratio of expenses to average daily net assets(c) .99%(d) .98% .97% .97% .89% Ratio of net investment income (loss) to average daily net assets 4.21%(d) 4.45% 6.01% 6.17% 5.85% Portfolio turnover rate (excluding short-term securities) 137% 389% 150% 62% 30% Total return(e) .23%(g) 4.85% 11.52% .83% 3.68% Class B Per share income and capital changes(a) Fiscal period ended May 31, 2002(f) 2002 2001 2000 1999 Net asset value, beginning of period $8.74 $8.74 $8.32 $8.96 $9.23 Income from investment operations: Net investment income (loss) .15 .33 .45 .46 .47 Net gains (losses) (both realized and unrealized) (.16) .02 .42 (.47) (.20) Total from investment operations (.01) .35 .87 (.01) .27 Less distributions: Dividends from net investment income (.17) (.33) (.45) (.46) (.47) Distributions from realized gains -- (.02) -- (.17) (.07) Total distributions (.17) (.35) (.45) (.63) (.54) Net asset value, end of period $8.56 $8.74 $8.74 $8.32 $8.96 Ratios/supplemental data Net assets, end of period (in millions) $331 $342 $264 $187 $210 Ratio of expenses to average daily net assets(c) 1.75%(d) 1.73% 1.73% 1.73% 1.65% Ratio of net investment income (loss) to average daily net assets 3.45%(d) 3.67% 5.25% 5.41% 5.10% Portfolio turnover rate (excluding short-term securities) 137% 389% 150% 62% 30% Total return(e) (.15%)(g) 4.06% 10.69% .06% 2.89%
See accompanying notes to financial highlights. -------------------------------------------------------------------------------- 29 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT
Class C Per share income and capital changes(a) Fiscal period ended May 31, 2002(f) 2002 2001(b) Net asset value, beginning of period $8.74 $8.74 $8.40 Income from investment operations: Net investment income (loss) .15 .33 .42 Net gains (losses) (both realized and unrealized) (.16) .02 .34 Total from investment operations (.01) .35 .76 Less distributions: Dividends from net investment income (.17) (.33) (.42) Distributions from realized gains -- (.02) -- Total distributions (.17) (.35) (.42) Net asset value, end of period $8.56 $8.74 $8.74 Ratios/supplemental data Net assets, end of period (in millions) $10 $9 $4 Ratio of expenses to average daily net assets(c) 1.76%(d) 1.74% 1.73%(d) Ratio of net investment income (loss) to average daily net assets 3.37%(d) 3.64% 5.16%(d) Portfolio turnover rate (excluding short-term securities) 137% 389% 150% Total return(e) (.16%)(g) 4.06% 9.27%(g)
Class Y Per share income and capital changes(a) Fiscal period ended May 31, 2002(f) 2002 2001 2000 1999 Net asset value, beginning of period $8.74 $8.74 $8.32 $8.96 $9.23 Income from investment operations: Net investment income (loss) .19 .42 .53 .54 .55 Net gains (losses) (both realized and unrealized) (.16) .02 .42 (.47) (.20) Total from investment operations .03 .44 .95 .07 .35 Less distributions: Dividends from net investment income (.21) (.42) (.53) (.54) (.55) Distributions from realized gains -- (.02) -- (.17) (.07) Total distributions (.21) (.44) (.53) (.71) (.62) Net asset value, end of period $8.56 $8.74 $8.74 $8.32 $8.96 Ratios/supplemental data Net assets, end of period (in millions) $180 $188 $218 $167 $196 Ratio of expenses to average daily net assets(c) .83%(d) .81% .82% .81% .81% Ratio of net investment income (loss) to average daily net assets 4.37%(d) 4.61% 6.16% 6.33% 5.93% Portfolio turnover rate (excluding short-term securities) 137% 389% 150% 62% 30% Total return(e) .31%(g) 5.02% 11.70% .97% 3.77%
See accompanying notes to financial highlights. -------------------------------------------------------------------------------- 30 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT 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. (f) Six months ended Nov. 30, 2002 (Unaudited). (g) Not annualized. -------------------------------------------------------------------------------- 31 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT
Results of Meeting of Shareholders AXP SELECTIVE FUND REGULAR MEETING OF SHAREHOLDERS HELD ON NOVEMBER 13, 2002 (UNAUDITED) A brief description of each proposal voted upon at the meeting and the number of votes cast for, against or withheld, as well as the number of abstentions and broker non-votes as to each proposal is set forth below. Proposal 1 To elect the thirteen nominees specified below as Board members*. Shares Voted "For" Shares Withholding Authority to Vote Arne H. Carlson 116,223,559.472 3,951,170.540 Philip J. Carroll, Jr. 116,627,457.461 3,547,272.551 Livio D. DeSimone 116,564,522.263 3,610,207.749 Barbara H. Fraser 116,607,977.812 3,566,752.200 Ira D. Hall 116,612,355.115 3,562,374.897 Heinz F. Hutter 116,608,806.600 3,565,923.412 Anne P. Jones 116,583,232.199 3,591,497.813 Stephen R. Lewis, Jr. 116,712,343.408 3,462,386.604 Alan G. Quasha 116,744,752.802 3,429,977.210 Stephen W. Roszell 116,694,300.405 3,480,429.607 Alan K. Simpson 116,252,475.884 3,922,254.128 Alison Taunton-Rigby 116,626,776.114 3,547,953.898 William F. Truscott 116,732,404.014 3,442,325.998
-------------------------------------------------------------------------------- 32 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT Proposal 2 To Amend the Articles of Incorporation/Declaration of Trust*: 2(a). To allow one vote/dollar instead of one vote/share. Shares Voted "For" Shares Voted "Against" Abstentions Broker Non-Votes 97,797,787.666 8,903,759.632 3,923,369.714 9,549,813.000 2(b). To change the name of the corporation. Shares Voted "For" Shares Voted "Against" Abstentions Broker Non-Votes 107,654,012.942 8,269,622.154 4,251,094.916 0.000 * Denotes Registrant-wide proposals and voting results. -------------------------------------------------------------------------------- 33 -- AXP SELECTIVE FUND -- 2002 SEMIANNUAL REPORT American Express(R) Funds Growth Funds AXP(R) Emerging Markets Fund AXP Equity Select Fund AXP Focused Growth Fund AXP Global Growth Fund AXP Growth Fund AXP Growth Dimensions Fund AXP New Dimensions Fund(R) AXP Partners International Aggressive Growth Fund AXP Partners Small Cap Growth Fund AXP Strategy Aggressive Fund Blend Funds AXP Blue Chip Advantage Fund AXP Discovery Fund* AXP European Equity Fund AXP Global Balanced Fund AXP International Fund AXP Large Cap Equity Fund AXP Managed Allocation Fund AXP Mid Cap Index Fund AXP Partners International Core Fund AXP Partners International Small Cap Fund AXP Partners Small Cap Core Fund AXP Research Opportunities Fund AXP S&P 500 Index Fund AXP Small Cap Advantage Fund AXP Small Company Index Fund AXP Stock Fund Value Funds AXP Diversified Equity Income Fund AXP Equity Value Fund AXP Large Cap Value Fund AXP Mid Cap Value Fund AXP Mutual AXP Partners Fundamental Value Fund AXP Partners International Select Value Fund AXP Partners Select Value Fund AXP Partners Small Cap Value Fund AXP Partners Value Fund AXP Progressive Fund* Income/Tax-Exempt Income Funds AXP Bond Fund AXP Cash Management Fund** AXP Extra Income Fund AXP Federal Income Fund AXP Global Bond Fund AXP High Yield Tax-Exempt Fund AXP Insured Tax-Exempt Fund AXP Intermediate Tax-Exempt Fund AXP Selective Fund AXP State Tax-Exempt Funds AXP Tax-Exempt Bond Fund AXP Tax-Free Money Fund** AXP U.S. Government Mortgage Fund Sector Funds AXP Global Technology Fund AXP Precious Metals Fund AXP Utilities Fund These funds are also listed in the categories above. AXP(R) Partners Funds AXP Partners Fundamental Value Fund AXP Partners International Aggressive Growth Fund AXP Partners International Core Fund AXP Partners International Select Value Fund AXP Partners International Small Cap Fund AXP Partners Select Value Fund AXP Partners Small Cap Core Fund AXP Partners Small Cap Growth Fund AXP Partners Small Cap Value Fund AXP Partners Value Fund International Funds AXP Emerging Markets Fund AXP European Equity Fund AXP Global Balanced Fund AXP Global Bond Fund AXP Global Growth Fund AXP International Fund AXP Partners International Aggressive Growth Fund AXP Partners International Core Fund AXP Partners International Select Value Fund AXP Partners International Small Cap Fund * Closed to new investors. ** An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund. For more complete information about our funds, including fees and expenses, please call (800) 862-7919 for prospectuses. Read them carefully before you invest. (1/03) AXP Selective Fund 70100 AXP Financial Center Minneapolis, MN 55474 americanexpress.com American Express(R) Funds AMERICAN EXPRESS(R) 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-6385 T (1/03)