N-30D 1 csf53101.txt CORNERSTONE STRATEGY FUND 05/31/01 ANNUAL REPORT [USAA logo appears here. (R)] USAA CORNERSTONE STRATEGY Fund [Image appears here.] Annual Report -------------------------------------------------------------------------------- May 31, 2001 Table of CONTENTS -------------------------------------------------------------------------------- USAA FAMILY OF FUNDS 2 MESSAGE FROM THE PRESIDENT 4 INVESTMENT OVERVIEW 7 MANAGERS' COMMENTARY ON THE FUND 9 PORTFOLIO HIGHLIGHTS 19 FINANCIAL INFORMATION Distributions to Shareholders 21 Independent Auditors' Report 22 Portfolio of Investments 23 Notes to Portfolio of Investments 39 Statement of Assets and Liabilities 40 Statement of Operations 41 Statements of Changes in Net Assets 42 Notes to Financial Statements 43 2 USAA -------------------------------------------------------------------------------- Family of FUNDS For more complete information about the mutual funds managed and distributed by USAA Investment Management Company (USAA Investments), including charges and operating expenses, please call 1-800-531-8181 for a prospectus. Read it carefully before you invest. -------------------------------------------------------------------------------- EQUITY MONEY MARKET INDEX -------------------------------------------------------------------------------- Aggressive Growth* Money Market Extended Market Index Capital Growth Tax Exempt Money Market Global Titans Index Emerging Markets Treasury Money Market Trust Nasdaq-100 Index First Start Growth State Money Market S&P 500 Index Gold ---------------------------------------------------- Growth TAXABLE BOND ASSET ALLOCATION ---------------------------------------------------- Growth & Income GNMA Trust Balanced Strategy Income Stock High-Yield Opportunities Cornerstone Strategy International Income Growth and Tax Strategy Science & Technology Intermediate-Term Bond Growth Strategy Small Cap Stock Short-Term Bond Income Strategy World Growth ------------------------ TAX-EXEMPT BOND ------------------------ Long-Term Intermediate-Term Short-Term State Bond/Income -------------------------------------------------------------------------------- NONDEPOSIT INVESTMENT PRODUCTS ARE NOT INSURED BY THE FDIC, ARE NOT DEPOSITS OR OTHER OBLIGATIONS OF, OR GUARANTEED BY, USAA FEDERAL SAVINGS BANK, ARE SUBJECT TO INVESTMENT RISKS, AND MAY LOSE VALUE. - AN INVESTMENT IN A MONEY MARKET FUND IS NOT INSURED OR GUARANTEED BY THE FDIC OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH MONEY MARKET FUNDS SEEK TO PRESERVE THE VALUE OF YOUR INVESTMENT AT $1 PER SHARE, IT IS POSSIBLE TO LOSE MONEY BY INVESTING IN A FUND. - CALIFORNIA, FLORIDA, NEW YORK, AND VIRGINIA FUNDS AVAILABLE TO RESIDENTS ONLY. - THE SCIENCE & TECHNOLOGY FUND MAY BE MORE VOLATILE THAN A FUND THAT DIVERSIFIES ACROSS MANY INDUSTRIES. - FOREIGN INVESTING IS SUBJECT TO ADDITIONAL RISKS, SUCH AS CURRENCY FLUCTUATIONS, MARKET ILLIQUIDITY, AND POLITICAL INSTABILITY. - SOME INCOME MAY BE SUBJECT TO STATE OR LOCAL TAXES, OR THE FEDERAL ALTERNATIVE MINIMUM TAX. - 'S&P 500' IS A TRADEMARK OF THE MCGRAW-HILL COMPANIES, INC. AND HAS BEEN LICENSED FOR OUR USE. 'NASDAQ-100(R)', 'NASDAQ-100 INDEX(R)', AND 'NASDAQ(R)', ARE TRADEMARKS OR SERVICE MARKS OF THE NASDAQ STOCK MARKET, INC. (WHICH WITH ITS AFFILIATES ARE THE "CORPORATIONS") AND HAVE BEEN LICENSED FOR OUR USE. THE CORPORATIONS MAKE NO WARRANTIES AND BEAR NO LIABILITY WITH RESPECT TO THE USAA NASDAQ-100 INDEX FUND. 'DOW JONES' AND 'DOW JONES GLOBAL TITANS INDEX(SM)' ARE SERVICE MARKS OF DOW JONES & COMPANY, INC. AND HAVE BEEN LICENSED FOR OUR USE. THESE INDEX PRODUCTS ARE NOT SPONSORED, SOLD, OR PROMOTED BY THE TRADEMARK OR SERVICE MARK OWNERS, AND NEITHER THE TRADEMARK OR SERVICE MARK OWNERS NOR ANY OF THEIR SUBSIDIARIES OR AFFILIATES MAKE ANY REPRESENTATION REGARDING THE ADVISABILITY OF INVESTING IN THESE PRODUCTS. - INDEX PRODUCTS INCUR FEES AND EXPENSES AND MAY NOT ALWAYS BE INVESTED IN ALL SECURITIES OF THE INDEX THAT THEY ATTEMPT TO MIRROR. IT IS NOT POSSIBLE TO INVEST DIRECTLY IN AN INDEX. *CLOSED TO NEW INVESTORS. 3 IMPORTANT -------------------------------------------------------------------------------- INFORMATION Through our ongoing efforts to reduce expenses and respond to shareholder requests, your annual and semiannual report mailings are streamlined. One copy of each report is sent to each address, rather than to every registered owner. For many shareholders and their families, this eliminates duplicate copies, saving paper and postage costs to the Fund. If you are the primary shareholder on at least one account, prefer not to participate in streamlining, and would like to continue receiving one report per registered account owner, you may request this in writing to: USAA INVESTMENT MANAGEMENT COMPANY Attn: Report Mail 9800 Fredericksburg Road San Antonio, TX 78284-8916 or phone a mutual fund representative at 1-800-531-8448 during business hours THIS REPORT IS FOR THE INFORMATION OF THE SHAREHOLDERS AND OTHERS WHO HAVE RECEIVED A COPY OF THE CURRENTLY EFFECTIVE PROSPECTUS OF THE USAA CORNERSTONE STRATEGY FUND, MANAGED BY USAA INVESTMENT MANAGEMENT COMPANY (USAA INVESTMENTS). IT MAY BE USED AS SALES LITERATURE ONLY WHEN PRECEDED OR ACCOMPANIED BY A CURRENT PROSPECTUS, WHICH GIVES FURTHER DETAILS ABOUT THE FUND. USAA with the eagle is registered in the U.S. Patent & Trademark Office. (C)2001, USAA. All rights reserved. 4 MESSAGE -------------------------------------------------------------------------------- from the PRESIDENT [Photograph of the President and Vice Chairman of the Board, Christopher W. Claus, appears here.] "AS AN INVESTOR MYSELF, I KNOW HOW OVERWHELMING IT CAN BE TO MAKE SMART INVESTMENT DECISIONS IN VOLATILE MARKET CONDITIONS." -------------------------------------------------------------------------------- Since our last annual report, one thing has become very clear: We are facing one of the most challenging investment climates in several years. The slowing effects of 1999's higher interest rate environment on our economy, the swift, steep fall of technology stocks, and the evaporation of corporate earnings in several sectors have undoubtedly received a great deal of attention from media, investment companies, and economists alike--maybe a bit too much attention. As an investor myself, I know how overwhelming it can be to make smart investment decisions in volatile market conditions. It's a challenge for all investors--whether they invest in equity funds, fixed-income vehicles, or a combination of both. USAA Investments approaches this challenge the same way you and other investors do. Here are a few of the steps we take to deal with down markets. 5 ...CONTINUED -------------------------------------------------------------------------------- WE LOOK FOR OPPORTUNITIES. We seek opportunities in EVERY market situation. For example, we look for companies with strong business fundamentals to invest in--companies that are best positioned to thrive when the economy improves--and take advantage of the low stock prices available in down markets. WE DIVERSIFY. We diversify our stock portfolios by investing in a wide range of sectors (basic materials, health care, technology, energy, consumer staples, etc.), and we diversify our overall investment portfolio by investing in both fixed-income and equity investments. WE MEASURE OUR PERFORMANCE. We believe it's important to provide strong performance to our members in ALL market conditions. One way we gauge our performance is through rankings of our funds by established financial benchmarking services. We are ranked by reputable financial information companies such as Morningstar, Inc., known for its Overall Morningstar Rating(TM) of mutual funds, and Lipper Analytical Services, a Reuters company that tracks the performance of more than 47,000 mutual funds worldwide. WE RELY ON INVESTMENT PROFESSIONALS. We depend on a team of highly qualified portfolio managers and securities analysts to research the markets and make sound buying and selling decisions, whether it's for an equity fund, fixed-income vehicle, money market instrument, or asset allocation fund. 6 ...CONTINUED -------------------------------------------------------------------------------- from the PRESIDENT WE STAY FOCUSED ON OUR GOALS. We advise our investors that TIME IN the market is more effective than TIMING the market. What that really means is sticking to the goals you've set in your investment plan. Our goal is to offer competitive mutual fund products and services to shareholders who seek the long-term rewards of investing. This goal guides all of our actions. WE MAINTAIN A POSITIVE OUTLOOK. We keep current economic and market conditions in perspective and look for indications of positive changes ahead. For example, at this writing, the Federal Reserve Board (the Fed) had made five interest rate reductions of 0.5% each since the beginning of 2001. While we may still see the effects of the previous year's tightening cycle now, these reductions are designed to stimulate the economy and, as a result, may help bolster corporate profits and the financial markets. We at USAA Investments are committed to helping you determine, plan, and potentially reach your investment goals. As always, I appreciate the opportunity to serve you, and I thank you for your trust and continued business. Sincerely, \s\ Christopher W. Claus Christopher W. Claus PRESIDENT AND VICE CHAIRMAN OF THE BOARD FOR MORE COMPLETE INFORMATION ABOUT THE MUTUAL FUNDS MANAGED AND DISTRIBUTED BY USAA INVESTMENT MANAGEMENT COMPANY (USAA INVESTMENTS), INCLUDING CHARGES AND OPERATING EXPENSES, PLEASE CALL FOR A PROSPECTUS. READ IT CAREFULLY BEFORE INVESTING. PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. 7 INVESTMENT -------------------------------------------------------------------------------- OVERVIEW USAA CORNERSTONE STRATEGY FUND OBJECTIVE -------------------------------------------------------------------------------- Achieve a positive, inflation-adjusted rate of return and a reasonably stable value of Fund shares, thereby preserving purchasing power of shareholders' capital. TYPES OF INVESTMENTS -------------------------------------------------------------------------------- Invests principally in U.S. stocks, international stocks, U.S. government securities, real estate securities, and gold securities. -------------------------------------------------------------------------------- 5/31/01 5/31/00 -------------------------------------------------------------------------------- Net Assets $1,016.1 Million $1,097.2 Million Net Asset Value Per Share $25.26 $26.27 -------------------------------------------------------------------------------- Average Annual Total Returns as of 5/31/01 -------------------------------------------------------------------------------- 1 YEAR 5 YEARS 10 YEARS 0.58% 7.61% 9.70% TOTAL RETURN EQUALS INCOME YIELD PLUS SHARE PRICE CHANGE AND ASSUMES REINVESTMENT OF ALL DIVIDENDS AND CAPITAL GAIN DISTRIBUTIONS. NO ADJUSTMENT HAS BEEN MADE FOR TAXES PAYABLE BY SHAREHOLDERS ON THEIR REINVESTED INCOME DIVIDENDS AND CAPITAL GAIN DISTRIBUTIONS. THE PERFORMANCE DATA QUOTED REPRESENT PAST PERFORMANCE AND ARE NOT AN INDICATION OF FUTURE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE OF AN INVESTMENT WILL FLUCTUATE, AND AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. 8 ...CONTINUED -------------------------------------------------------------------------------- OVERVIEW CUMULATIVE PERFORMANCE COMPARISON --------------------------------- A chart in the form of a line graph appears here, illustrating the comparison of a $10,000 hypothetical investment in the USAA Cornerstone Strategy Fund, the S&P 500 Index, and the Lipper Global Flexible Portfolio Funds Average for the period of 5/31/91 through 5/31/01. The data points from the graph are as follows: USAA CORNERSTONE S&P 500 LIPPER STRATEGY FUND INDEX AVERAGE ------------- ------- ------- 05/31/91 $10,000 $10,000 $10,000 11/30/91 10,055 9,777 10,165 05/31/92 10,915 10,983 11,002 11/30/92 11,083 11,580 11,077 05/31/93 12,902 12,256 12,400 11/30/93 13,468 12,747 13,283 05/31/94 13,951 12,777 13,704 11/30/94 13,605 12,880 13,522 05/31/95 14,847 15,353 14,653 11/30/95 15,910 17,636 15,585 05/31/96 17,488 19,714 16,984 11/30/96 19,096 22,547 18,212 05/31/97 20,451 25,518 19,373 11/30/97 22,258 28,974 20,506 05/31/98 23,957 33,341 22,443 11/30/98 22,625 35,836 21,908 05/31/99 23,779 40,353 23,669 11/30/99 23,852 43,323 25,951 05/31/00 25,085 44,578 27,820 11/30/00 24,556 41,493 26,914 05/31/01 25,230 39,876 27,238 DATA FROM 5/31/91 THROUGH 5/31/01. The graph illustrates the comparison of a $10,000 hypothetical investment in the USAA Cornerstone Strategy Fund to the S&P 500 Index and the Lipper Global Flexible Portfolio Funds Average, an average performance level of all global flexible portfolio funds, reported by Lipper Analytical Services, Inc., an independent organization that monitors the performance of mutual funds. The S&P 500 Index is an unmanaged index representing the weighted average performance of a group of 500 widely held, publicly traded stocks. It is not possible to invest directly in the S&P 500 Index. 9 MANAGERS' -------------------------------------------------------------------------------- COMMENTARY on the Fund [Photograph of the Portfolio Managers appears here.] From left to right: Mark W. Johnson, CFA (Gold and Real Estate Securities); Kevin P. Moore (International Stocks); Donna Baggerly, CFA (U.S. Government Securities); Albert C. Sebastian, CFA (International Stocks); and R. David Ullom, CFA (Allocation Manager and U.S. Stocks). -------------------------------------------------------------------------------- HOW DID THE USAA CORNERSTONE STRATEGY FUND PERFORM? For the latest fiscal year, June 1, 2000, through May 31, 2001, the USAA Cornerstone Strategy Fund recorded a total return of 0.58%. This performance compares to average total returns of -5.08% for the Fund's peer group, the Lipper Global Flexible Portfolio Funds Average. The performance of the USAA Cornerstone Strategy Fund was achieved during a period in which most major markets throughout the world suffered losses. In particular, three of the four sectors of the Fund posted positive total returns for the latest 12 months. In this regard, the USAA Cornerstone Strategy Fund accomplished what it was designed to do, which is to provide positive real (inflation-adjusted) rates of return. As a shareholder, you should note that in connection with changes in the markets, we have made changes in the sector PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. REFER TO THE BOTTOM OF PAGE 8 FOR THE LIPPER AVERAGE DEFINITION. 10 ...CONTINUED -------------------------------------------------------------------------------- COMMENTARY on the Fund allocations within the Fund's portfolio. During the latest six months, we have raised the Fund's allocation to U.S. stocks and international securities while lowering the allocation to real estate and U.S. government securities. These changes reflect a more positive outlook for the global equity markets, because interest rates have fallen and valuations have become more reasonable. WHAT MARKET CONDITIONS AFFECTED THE FUND DURING THE PERIOD? U.S. STOCKS -------------------------------------------------------------------------------- The U.S. stock sector of the Fund performed well during the latest fiscal year. While the overall market, measured by the S&P 500 Index, was down 10.55%, the U.S. stock portion of the Fund generated a positive total return. The primary reason for this performance was the sector's overweighting in financial stocks and underweighting in the technology sector. Also, the overall positions in energy, basic materials, and capital goods helped contribute to performance. INTERNATIONAL -------------------------------------------------------------------------------- The international portion of the Fund was positively affected by its overweight position in European and Canadian equities and its underweight position in Japan. Overall, international equity returns were negatively affected by weaker currencies versus the U.S. dollar. REFER TO THE BOTTOM OF PAGE 8 FOR THE S&P 500 Index definition. 11 ...CONTINUED -------------------------------------------------------------------------------- DEVELOPED MARKETS (EXCEPT JAPAN) -------------------------------------------------------------------------------- European equity markets were down for the period but outperformed other international markets. The more defensive sectors, such as health care, utilities, financials, and consumer staples registered positive returns because of downgraded expectations about economic growth. Energy and mining stocks also had positive returns based on firmer commodity prices. Information technology and telecommunication services were by far the worst-performing sectors for the period. Overall, our position in Canadian equities had a positive return for the period. Poor performance in the information technology area was offset by the performance of our holdings in the financial, energy, and industrial sectors. Canadian National Railway, our largest position in Canada, performed particularly well. JAPAN -------------------------------------------------------------------------------- Japan underperformed most other markets for the period as the inflated valuations surrounding many Internet-related stocks proved unsustainable. A number of prominent bankruptcies, as well as a deterioration in the asset quality in the banking sector, negatively affected equity performance. The consumer-discretionary, information technology, and telecommunication services sectors were the worst-performing sectors for the period. 12 ...CONTINUED -------------------------------------------------------------------------------- COMMENTARY on the Fund EMERGING MARKETS -------------------------------------------------------------------------------- The year was one of tremendous turbulence in emerging markets. In July of 2000, Mexico swore in the first president in more than 70 years who did not belong to the long-ruling political party PARTIDO REVOLUCIONARIO INSTITUCIONAL (PRI). In addition, Taiwan also swore in its first president since the founding of the country who was not a member of the long-ruling party KUOMINTANG (KMT). Turkey and Argentina had to deal with debt and foreign payment pressure that resulted in assistance from the International Monetary Fund. The slowing U.S. economy and the crashing of U.S. technology stocks put considerable pressure on the equity markets in Asia. U.S. GOVERNMENT SECURITIES -------------------------------------------------------------------------------- The government sector of the Fund slightly underperformed the Lipper General U.S. Government Funds Average for the period. The sector benefited from its overweighted position in mortgage pass-through securities. However, in the second half of the period, performance was negatively affected by an increased allocation to agencies and Treasuries that underperformed mortgage pass-through securities. During the reporting period, interest rates were lower across the Treasury yield curve, with short-term interest rates falling more than long-term interest rates as the Federal Reserve Board (the Fed) cut interest rates. The Fed has been very aggressive, cutting interest rates five times since January for a total of 2.5% to stimulate the slowing economy. The bond market currently believes that the Fed is almost done cutting interest rates and THE LIPPER GENERAL U.S. GOVERNMENT FUNDS AVERAGE IS AN AVERAGE PERFORMANCE LEVEL OF ALL U.S. GOVERNMENT FUNDS, REPORTED BY LIPPER ANALYTICAL SERVICES, INC. 13 ...CONTINUED -------------------------------------------------------------------------------- expects the economy to improve in the fourth quarter. As a result, this positive outlook has already been priced into the bond market, causing interest rates on bonds to rise since the end of March. REAL ESTATE -------------------------------------------------------------------------------- Real estate securities performed well during the fiscal year. Shares of real estate investment trusts (REITs), measured by the National Association of Real Estate Investment Trusts (NAREIT) equity index, rose 20.56% on a total-return basis. This was well above the -10.55% return on the S&P 500 Index, to say nothing of the -37.9% Nasdaq Composite Index return. These stellar results occurred as the sector continued to recover from its oversold condition at the end of 1999, as investors cast about for stocks with lower volatility in the face of poor overall market conditions and the "tech wreck," and as real estate companies continued to report solid operating results. GOLD -------------------------------------------------------------------------------- Gold prices fell 1.7%, from $272.25 per ounce to $267.50 per ounce during the fiscal year. The common stocks of gold mining companies rose. The Fund had no exposure to gold stocks during this period. THE NASDAQ COMPOSITE INDEX IS A MARKET-VALUE-WEIGHTED INDEX THAT MEASURES ALL DOMESTIC AND NON-U.S.-BASED SECURITIES LISTED ON THE NASDAQ STOCK MARKET. THE NATIONAL ASSOCIATION OF REAL ESTATE INVESTMENT TRUSTS IS THE NATIONAL TRADE ASSOCIATION FOR REAL ESTATE COMPANIES. MEMBERS ARE REAL ESTATE INVESTMENT TRUSTS (REITS) AND OTHER BUSINESSES THAT OWN, OPERATE, AND FINANCE INCOME-PRODUCING REAL ESTATE, AS WELL AS THOSE FIRMS AND INDIVIDUALS WHO ADVISE, STUDY, AND SERVICE THESE BUSINESSES. 14 ...CONTINUED -------------------------------------------------------------------------------- COMMENTARY on the Fund WHAT WERE YOUR STRATEGIES FOR BUYING AND SELLING DURING THE PERIOD? U.S. STOCKS -------------------------------------------------------------------------------- Over the course of the last few months, we have slowly raised the U.S. stock portion of the Fund's exposure to technology. It appears that most of the market concerns regarding future growth prospects are priced into most technology shares. At the same time, we have gradually reduced exposure to energy and consumer cyclicals. INTERNATIONAL -------------------------------------------------------------------------------- We have continued our strategy of being overweight in Canada and Europe. Specifically, we added to our banking and our railroad exposure in Canada. In Japan, we have very little exposure to the banking and insurance sectors, and have recently added companies to our defensive names, such as Takeda Chemicals and West Japan Railway. Overall, we have continued to be overweight in information technology, with Nokia remaining the largest position in the international portion of the Fund. EMERGING MARKETS -------------------------------------------------------------------------------- During the past year, we focused on buying companies that we felt would weather the downturn in global economic growth better than most other companies. We also concentrated on companies that had strong growth prospects linked to industry-specific and/or country-specific factors. For example, we believe that power demand in China will rise considerably during the next several years, so we invested in several Chinese power YOU WILL FIND A COMPLETE LIST OF SECURITIES THAT THE FUND OWNS ON PAGES 23-38. 15 ...CONTINUED -------------------------------------------------------------------------------- companies. We sell companies when we believe that their valuations have become too high and/or there is a material change to their operating outlook. U.S. GOVERNMENT SECURITIES -------------------------------------------------------------------------------- With interest rates falling, mortgage prepayment risk increased during the second half of the period. Prepayment risk occurs in a falling interest rate environment when homeowners refinance their mortgages into lower rate loans. Holders of mortgage securities must then reinvest the proceeds at lower interest rates. As a result, the allocation to higher-coupon mortgages was reduced, and agencies and Treasuries were purchased. It appears that the Fed is nearly finished cutting interest rates, and interest rates are beginning to trend higher. Because we expect mortgage prepayments to begin to slow as mortgage rates rise, we recently increased our exposure to mortgages and decreased our exposure to Treasuries. When interest rates rise as the economy strengthens, mortgage pass-through securities should outperform Treasuries because of their higher yields and reduced prepayment risk. With the Fed's cutting interest rates aggressively, we are concerned that once the interest rate cuts work through the economy, inflation may increase. As a result, we purchased U.S. Treasury inflation-indexed notes, commonly referred to as Treasury inflation-protected securities (TIPS). TIPS offer a real or after-inflation rate of return because the principal value and interest payments increase as inflation increases. As a result, TIPS perform well in an inflationary environment. 16 ...CONTINUED -------------------------------------------------------------------------------- COMMENTARY on the Fund Investments in this portfolio segment were 33.4% GNMA mortgage pass-through securities, 23.4% FNMA pass-through securities, 22.7% FHLMC notes, 8.2% FNMA notes, 6.4% U.S. Treasury bonds, and 5.9% TIPS. REAL ESTATE -------------------------------------------------------------------------------- Our strategy is to focus on companies with some sort of sustainable competitive advantage on the asset side; a prudent use of leverage on the liability side; a management that possesses strategic vision, executional competence, and integrity; identifiable internal and external growth platforms; and a reasonable valuation. WHAT IS THE OUTLOOK? U.S. STOCKS -------------------------------------------------------------------------------- We continue to create a more balanced portfolio as to the weightings in each of the major economic sectors of the market. We foresee major markets' having a broader appreciation potential as opposed to the experience of the 1998-2000 period. INTERNATIONAL -------------------------------------------------------------------------------- Although the economic slowdown has spread to regions outside the United States, we continue to view Europe and Canada positively. Canada looks particularly attractive because it has a large current account and budget surplus, and is planning to implement financial reform and tax reduction this year. Although the fiscal position of Europe is not as favorable as 17 ...CONTINUED -------------------------------------------------------------------------------- Canada, many European countries will nevertheless reduce tax rates this year. Also, lawmakers recently agreed on rules that would make hostile takeovers easier in the European Union. We continue to underweight Japanese equities because of the high level of financial and government debt. Japan has few policy tools at its disposal because of its large budget deficit and its need to recapitalize the banking sector. EMERGING MARKETS -------------------------------------------------------------------------------- We believe that valuations in many emerging markets are quite attractive which, combined with our belief that global growth will accelerate into 2002, will provide a positive backdrop for emerging markets. While there is still no conclusive evidence that global economic growth has begun to rebound, we believe that the aggressive interest rate cuts in the United States support a rebound in growth going forward. Because the performance of emerging markets is closely linked to global growth, we believe the outlook is positive for emerging markets. U.S. GOVERNMENT SECURITIES -------------------------------------------------------------------------------- The bond market has already priced in economic recovery in the fourth quarter. Therefore, the future performance of the bond market depends on how quickly the economy will recover from the current slowdown. Recent economic data have been mixed. Investors are trying to determine if the economy will experience a "V-shaped" recovery (one that rebounds quickly), a "U-shaped" recovery (one that takes place over several quarters), or an "L-shaped" recovery (one that takes several years). 18 ...CONTINUED -------------------------------------------------------------------------------- COMMENTARY on the Fund Currently, your Fund is neutrally positioned and should perform relatively well whether interest rates rise or fall. If interest rates rise, the higher-coupon mortgages should perform well. TIPS should also perform well if interest rates rise because of rising inflation. If interest rates fall, then the lower-coupon mortgages and construction loans should perform well. REAL ESTATE -------------------------------------------------------------------------------- The deeply oversold nature of these stocks as of 18 months ago has now been largely corrected. Moreover, the current economic softness is clearly affecting occupancy and rents, which should lead to softer operating results in upcoming quarters. Consequently, we anticipate returns in the next year should be pretty much in line with the stock market, although the low-beta nature of these securities should lead to more muted performance during periods of volatility. FOREIGN INVESTING IS SUBJECT TO ADDITIONAL RISKS, SUCH AS CURRENCY FLUCTUATIONS, MARKET ILLIQUIDITY, AND POLITICAL INSTABILITY. 19 PORTFOLIO -------------------------------------------------------------------------------- HIGHLIGHTS -------------------------------------- TOP 3 HOLDINGS IN EACH SECTOR (% of Net Assets) -------------------------------------- INTERNATIONAL SECURITIES Nokia Corp. ADR 0.9% Canadian National Railway Co. 0.8% Total Fina S.A. ADR 0.6% REAL ESTATE Equity Office Properties Trust 1.1% Archstone Communities Trust 0.9% Simon Property Group, Inc. 0.9% U.S. GOVERNMENT FNMA @ 7.00% 2.2% GNMA @ 8.00% 1.7% GNMA @ 7.50% 1.6% U.S. STOCKS General Electric Co. 1.5% Microsoft Corp. 1.3% Verizon Communications, Inc. 1.2% -------------------------------------- 20 PORTFOLIO -------------------------------------------------------------------------------- HIGHLIGHTS ASSET ALLOCATION 5/31/01 A pie chart is shown here depicting the Asset Allocation as of May 31, 2001 of the USAA Cornerstone Strategy Fund to be: U.S. Stocks - 42.5%; International Securities - 27.8%; U.S. Government & Agency Issues - 15.5%; Real Estate Securities - 12.3%; and Money Market Instruments - 4.6%. PERCENTAGES ARE OF THE NET ASSETS OF THE FUND AND MAY NOT EQUAL 100%. ------------------------------------- TOP 10 INDUSTRIES* (% of Net Assets) ------------------------------------- Real Estate Investment Trusts 11.7% Drugs 4.4% Banks - Money Center 3.9% Banks - Major Regional 3.7% Telephones 3.5% Insurance - Multiline Companies 3.2% Health Care - Diversified 2.6% Computer Software & Service 2.3% Oil - International Integrated 2.3% Finance - Diversified 1.9% ------------------------------------- *EXCLUDING U.S. GOVERNMENT. YOU WILL FIND A COMPLETE LIST OF SECURITIES THAT THE FUND OWNS ON PAGES 23-38. 21 DISTRIBUTIONS -------------------------------------------------------------------------------- to SHAREHOLDERS USAA CORNERSTONE STRATEGY FUND The following per share information describes the federal tax treatment of distributions made during the fiscal year ended May 31, 2001. These figures are provided for information purposes only and should not be used for reporting to federal or state revenue agencies. Distributions for the calendar year will be reported to you on Form 1099-DIV in January 2002. ---------------------------------- Ordinary income* $ .48610 Long-term capital gains .69955 -------- Total $1.18565 ======== ---------------------------------- 26.64% of ordinary income distributions qualifies for deduction by corporations. Total equalization debit used this year was $5,169,000. * INCLUDES DISTRIBUTION OF SHORT-TERM CAPITAL GAINS, IF ANY, WHICH ARE TAXABLE AS ORDINARY INCOME. 22 INDEPENDENT -------------------------------------------------------------------------------- AUDITORS' Report KPMG THE SHAREHOLDERS AND BOARD OF TRUSTEES USAA CORNERSTONE STRATEGY FUND We have audited the accompanying statement of assets and liabilities, including the portfolio of investments, of the USAA Cornerstone Strategy Fund, a series of the USAA Investment Trust, as of May 31, 2001, and 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 then ended, and the financial highlights, presented in Note 9 to the financial statements, for each of the years in the five-year period then ended. These financial statements and financial highlights are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements and 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 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. 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 and financial highlights referred to above present fairly, in all material respects, the financial position of the USAA Cornerstone Strategy Fund as of May 31, 2001, the results of its operations for the year then ended, the changes in its net assets for each of the years in the two-year period then ended, and the financial highlights for each of the years in the five-year period then ended, in conformity with accounting principles generally accepted in the United States of America. KPMG LLP San Antonio, Texas July 3, 2001 23 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS USAA CORNERSTONE STRATEGY Fund May 31, 2001 MARKET NUMBER VALUE OF SHARES SECURITY (000) -------------------------------------------------------------------------------- INTERNATIONAL SECURITIES (27.8%) INTERNATIONAL COMMON STOCKS (27.4%) ARGENTINA (0.0%) A 214,600 Perez Companc S.A."B" $ 331 -------------------------------------------------------------------------------- AUSTRALIA (0.0%) A 843,000 Pasminco Ltd. * 192 -------------------------------------------------------------------------------- AUSTRIA (0.3%) 38,300 Boehler Uddeholm AG 1,391 12,900 VA Technologie AG 413 35,900 Vienna Airport (Flughafen Wien) 1,154 -------------------------------------------------------------------------------- 2,958 -------------------------------------------------------------------------------- BRAZIL (0.0%) A 12,400 Telesp Celular Participacoes S.A. ADR 216 -------------------------------------------------------------------------------- CANADA (3.2%) 112,800 Anderson Exploration Ltd. * 2,582 74,000 Bank of Montreal 1,873 103,356 C-MAC Industries, Inc. * 3,204 99,100 Canadian Imperial Bank of Commerce 3,222 195,600 Canadian National Railway Co. 7,852 75,200 Manulife Financial Corp. 2,028 120,500 Nexen, Inc. 3,081 98,600 Nortel Networks Corp. 1,314 57,300 Sun Life Financial Services 1,255 157,800 Suncor Energy, Inc. 4,259 64,900 Toronto-Dominion Bank 1,678 -------------------------------------------------------------------------------- 32,348 -------------------------------------------------------------------------------- CHINA (0.2%) 1,400,000 Beijing Datang Power 521 145,800 China Mobile Ltd. * 708 1,132,000 China Petroleum and Chemical Corp. "H" 218 290,000 China Unicom Ltd. * 472 10,600 CNOOC Ltd. ADR * 212 130,000 Legend Holdings Ltd. 89 -------------------------------------------------------------------------------- 2,220 -------------------------------------------------------------------------------- 24 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 MARKET NUMBER VALUE OF SHARES SECURITY (000) -------------------------------------------------------------------------------- CZECH REPUBLIC (0.0%) A 56,000 Ceske Energeticke Zavody A.S. * $ 151 -------------------------------------------------------------------------------- DENMARK (0.5%) 425,584 Nordea AB 2,365 60,000 TDC A/S "B" * 2,518 -------------------------------------------------------------------------------- 4,883 -------------------------------------------------------------------------------- FINLAND (1.4%) 122,368 Metso OYJ 1,309 328,700 Nokia Corp. ADR 9,611 86,100 Perlos Corp. 1,081 304,000 Sampo Leonia Insurance Co. "A" 2,571 -------------------------------------------------------------------------------- 14,572 -------------------------------------------------------------------------------- FRANCE (2.5%) 37,900 Accor S.A. 1,542 55,265 Aventis S.A. 4,094 73,657 CNP Assurances 2,292 70,400 Coflexip ADR 5,131 16,000 Eramet Group 578 133,000 Gemplus International S.A. * 479 16,970 ISIS S.A. 1,742 47,900 Renault S.A. 2,234 50,000 Rhodia S.A. 588 88,674 Total Fina S.A. ADR 6,539 -------------------------------------------------------------------------------- 25,219 -------------------------------------------------------------------------------- GERMANY (1.2%) 39,000 Bayerische HypoVereinsbank AG 1,874 66,800 Continental AG 924 93,700 E. On AG 4,662 72,400 Merck KGaA 2,394 12,900 SAP AG 1,804 -------------------------------------------------------------------------------- 11,658 -------------------------------------------------------------------------------- 25 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 MARKET NUMBER VALUE OF SHARES SECURITY (000) -------------------------------------------------------------------------------- HONG KONG (0.2%) 173,000 Amoy Properties Ltd. $ 189 94,000 Cheung Kong Holdings Ltd. 1,027 33,400 Dah Sing Financial Group 178 700,000 Giordano International Ltd. 397 196,000 Li & Fung Ltd. 343 30,000 Sun Hung Kai Properties Ltd. 282 -------------------------------------------------------------------------------- 2,416 -------------------------------------------------------------------------------- HUNGARY (0.0%) A 3,600 Magyar Tavkozlesi Rt. (MATAV) ADR 55 6,000 MOL Magyar Olaj - es Gazipari Rt. 87 -------------------------------------------------------------------------------- 142 -------------------------------------------------------------------------------- INDIA (0.2%) 16,700 Cipla Ltd. * 393 22,000 Hindalco Industries Ltd. 405 7,380 Infosys Technologies Ltd. 593 14,100 ITC Ltd. 239 40,800 Larsen & Toubro Ltd. 216 17,000 Reliance Industries Ltd. 142 4,400 Wipro Ltd. 157 -------------------------------------------------------------------------------- 2,145 -------------------------------------------------------------------------------- ISRAEL (0.1%) 5,900 Check Point Software Technologies Ltd. * 318 8,400 Teva Pharmaceutical Industries Ltd. ADR 485 -------------------------------------------------------------------------------- 803 -------------------------------------------------------------------------------- ITALY (1.1%) 66,700 ENI S.p.A. ADR 4,316 285,000 Italgas S.p.A. 2,427 125,500 Telecom Italia S.p.A. 1,198 626,200 Telecom Italia S.p.A. Savings 3,288 -------------------------------------------------------------------------------- 11,229 -------------------------------------------------------------------------------- JAPAN (3.6%) 36,000 Asatsu DK 840 47,000 Daibiru Corp. 312 82,000 Fujitsu Ltd. 1,064 32,000 Ito-Yokado Co. Ltd. 1,677 42,400 Meitec Corp. 1,441 26 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 MARKET NUMBER VALUE OF SHARES SECURITY (000) -------------------------------------------------------------------------------- 170,000 Mitsui Fudosan Co. Ltd. $ 1,616 24,500 Murata Manufacturing Co. Ltd. 1,950 317,000 Nikko Securities Co. Ltd. 2,573 347 Nippon Telegraph & Telephone Corp. (NTT) 2,148 98 NTT Mobile Communication Network, Inc. 1,880 52,530 Paris Miki, Inc. 1,560 6,300 Pasona Softbank, Inc. 62 43,900 Sanix, Inc. 2,219 36,000 Shin-Etsu Chemical Co. Ltd. 1,393 47,600 Sony Corp. 3,672 209,000 Sumitomo Corp. 1,496 78,000 Sumitomo Electric Industries Ltd. 1,042 91,000 Takeda Chemical Industries Ltd. 4,631 340,000 Toshiba Corp. 1,931 627 West Japan Railway 3,170 -------------------------------------------------------------------------------- 36,677 -------------------------------------------------------------------------------- KOREA (0.3%) 17,200 H&CB 379 18,000 Hyundai Motor Co. Ltd 355 35,361 Korea Telecom Corp. ADR 824 9,000 Korea Telecom Freetel * 282 3,900 Samsung Electronics Co. Ltd. 645 5,000 Samsung SDI Co. Ltd. 239 7,000 Samsung Securities Co. Ltd. 210 38,200 Shinhan Bank 359 1,100 Sk Telecom Co. Ltd. 189 -------------------------------------------------------------------------------- 3,482 -------------------------------------------------------------------------------- MALAYSIA (0.1%) 159,900 Public Bank Bhd 107 208,000 Public Bank Bhd (Local) 125 105,000 Sime Darby Bhd 107 64,700 Telekom Malaysia Bhd 136 -------------------------------------------------------------------------------- 475 -------------------------------------------------------------------------------- MEXICO (0.5%) 21,000 America Movil S.A. de C.V. ADR * 428 20,100 Cemex S.A. de C.V. ADR 532 19,600 Coca Cola Femsa S.A. de C.V. ADR 438 17,500 Fomento Economico Mexicano S.A. de C.V. ADR 750 27 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 MARKET NUMBER VALUE OF SHARES SECURITY (000) -------------------------------------------------------------------------------- 355,800 Grupo Financiero Banamex Accival S.A. de C.V. "O" $ 915 434,100 Grupo Financiero BBVA Bancomer S.A. de C.V. * 400 8,800 Grupo Modelo S.A. de C.V. "C" 24 30,100 Telefonos de Mexico S.A. de C.V. ADR 1,038 23,200 Tubos de Acero de Mexico S.A. ADR 296 -------------------------------------------------------------------------------- 4,821 -------------------------------------------------------------------------------- NETHERLANDS (2.6%) 114,200 Akzo Nobel N.V. 4,925 85,700 Fortis NL N.V. 2,111 30,000 Gucci Group N.V. 2,710 86,580 ING Group N.V. 5,638 66,247 Koninklijke KPN N.V. * 618 163,089 Koninklijke Philips Electronics N.V. 4,518 88,700 Oce-van der Grinten N.V. 1,099 131,200 Versatel Telecom * 555 53,700 VNU N.V. 2,102 101,200 Vopak Kon 2,289 -------------------------------------------------------------------------------- 26,565 -------------------------------------------------------------------------------- NORWAY (0.3%) 140,000 DNB Holdings ASA 591 321,500 Storebrand ASA 2,397 -------------------------------------------------------------------------------- 2,988 -------------------------------------------------------------------------------- POLAND (0.0%) A 40,700 Telekomunikacja Polska S.A. 212 -------------------------------------------------------------------------------- PORTUGAL (0.8%) 730,879 Banco Comercial Portugues S.A. * 2,886 207,000 Brisa-Auto Estrada de Portugal S.A. 1,875 245,300 Portugal Telecom S.A. ADR * 1,958 91,465 Telecel-Comunicacoes Pessoais S.A. * 857 -------------------------------------------------------------------------------- 7,576 -------------------------------------------------------------------------------- RUSSIA (0.1%) 10,000 LUKoil Holdings ADR 521 -------------------------------------------------------------------------------- SINGAPORE (0.0%) A 120,400 Overseas Union Bank 462 -------------------------------------------------------------------------------- 28 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 MARKET NUMBER VALUE OF SHARES SECURITY (000) -------------------------------------------------------------------------------- SOUTH AFRICA (0.2%) 38,900 ABSA Group Ltd. $ 170 3,400 Anglo American Platinum Corp. 178 38,300 Anglo American plc 619 5,000 Impala Platinum Holdings Ltd. 295 13,900 Nedcor Ltd. 264 29,000 SASOL Ltd. 286 17,800 South African Breweries plc 132 103,100 Standard Bank Investment Corp. Ltd. 433 -------------------------------------------------------------------------------- 2,377 -------------------------------------------------------------------------------- SPAIN (1.0%) 165,887 Altadis S.A. 2,058 209,333 Banco Bilbao Vizcaya Argentaria 2,850 155,750 Repsol S.A. 2,774 56,512 Telefonica de Espana S.A. ADR * 2,508 -------------------------------------------------------------------------------- 10,190 -------------------------------------------------------------------------------- SWEDEN (1.1%) 168,100 Autoliv, Inc. GDR 3,083 791,178 Nordea AB 4,397 150,320 Skandinaviska Enskilda Banken "A" 1,386 554,215 Swedish Match AB 2,557 -------------------------------------------------------------------------------- 11,423 -------------------------------------------------------------------------------- SWITZERLAND (0.9%) 92,600 Novartis AG 3,516 33,400 STMicroelectronics N. V. 1,188 2,438 Sulzer AG P.C. 932 76,631 Syngenta AG * 3,773 -------------------------------------------------------------------------------- 9,409 -------------------------------------------------------------------------------- TAIWAN (0.2%) 38,000 Ambit Microsystems Corp. 204 28,000 Asustek Computer, Inc. 136 613,000 Bank Sinopac * 277 565,000 China Steel Corp. 303 137,000 Chinatrust Commercial Bank * 96 63,750 Compal Electronics, Inc. 85 78,000 Delta Electronics, Inc. 173 26,000 Quanta Computer, Inc. 86 29 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 MARKET NUMBER VALUE OF SHARES SECURITY (000) -------------------------------------------------------------------------------- 198,000 Taiwan Semiconductor Manufacturing Co. * $ 523 228,700 United Microelectronics * 351 30,000 Via Technologies, Inc. * 230 -------------------------------------------------------------------------------- 2,464 -------------------------------------------------------------------------------- UNITED KINGDOM (4.8%) 80,800 AstraZeneca Group plc 3,810 240,000 Bank of Scotland 2,723 728,200 Billiton plc 3,704 44,900 BOC Group plc 675 166,900 Cable & Wireless plc 1,089 445,600 Cadbury Schweppes plc 2,876 192,234 Celltech Group plc 3,227 223,200 CGNU plc 2,924 1,378,000 Cookson Group plc 3,224 900,000 Corporate Services Group plc * 644 46,400 GlaxoSmithkline plc ADR 2,538 650,000 Old Mutual plc 1,431 155,700 Powergen plc 1,598 326,000 Reckitt Benckiser plc 4,313 268,866 Reuters Group plc 3,755 176,880 Royal Bank of Scotland Group plc 4,063 570,100 Tomkins plc 1,528 10,000 Vodafone Group plc ADR 259 356,197 WPP Group plc 3,874 -------------------------------------------------------------------------------- 48,255 -------------------------------------------------------------------------------- Total international common stocks (cost: $233,467) 279,380 -------------------------------------------------------------------------------- INTERNATIONAL PREFERRED STOCKS (0.3%) BRAZIL 8,890,000 Banco Itau S.A. 720 14,600 Companhia Brasileira de Distribuicao Grupo Pao de Acucar ADR 381 20,100 Companhia de Bebidas das Americas ADR 451 9,300,000 Companhia Energetica de Minas Gerais - CEMIG 91 17,000 Petroleo Brasileiro S.A. 431 12,800 Tele Norte Leste Participacoes S.A. ADR 203 19,500 Uniao de Bancos Brasileiros S.A. (Unibanco) GDR 498 -------------------------------------------------------------------------------- Total international preferred stocks (cost: $2,293) 2,775 -------------------------------------------------------------------------------- 30 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 PRINCIPAL MARKET AMOUNT COUPON VALUE (000) SECURITY RATE MATURITY (000) -------------------------------------------------------------------------------- INTERNATIONAL BONDS (0.1%) JAPAN $ 600 MBL International Finance (Bermuda) Trust, Convertible Note (cost: $600) 3.00% 11/30/2002 $ 607 -------------------------------------------------------------------------------- Total international securities (cost: $236,360) 282,762 -------------------------------------------------------------------------------- NUMBER OF SHARES ----------- REAL ESTATE SECURITIES (12.3%) LEISURE TIME (0.2%) 90,000 Vail Resorts, Inc. * 1,859 -------------------------------------------------------------------------------- LODGING/HOTEL (0.8%) 200,000 Starwood Hotels & Resorts Worldwide, Inc. 7,566 -------------------------------------------------------------------------------- REAL ESTATE INVESTMENT TRUSTS (11.3%) 350,000 Archstone Communities Trust 8,764 200,000 Arden Realty Group, Inc. 4,924 170,000 AvalonBay Communities, Inc. 7,876 170,000 Boston Properties, Inc. 6,780 110,000 Chelsea Property Group, Inc. 4,785 70,000 Correctional Properties Trust 896 160,000 Cousins Properties, Inc. 4,198 270,000 Duke-Weeks Realty Corp. 6,307 380,000 Equity Office Properties Trust 11,058 160,000 Federal Realty Investment Trust 3,336 230,000 Golf Trust of America, Inc. 1,771 200,000 Highwoods Properties, Inc. 4,990 190,000 Liberty Property Trust 5,506 230,000 Meristar Hospitality Corp. 5,256 140,000 Pan Pacific Retail Properties, Inc. 3,262 300,000 Philips International Realty Corp. 1,236 140,000 Post Properties, Inc. 5,106 160,000 Prentiss Properties Trust 4,064 140,000 Reckson Associates Realty Corp. "B" 3,234 320,000 Simon Property Group, Inc. 8,678 81,000 Spieker Properties, Inc. 4,601 31 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 MARKET NUMBER VALUE OF SHARES SECURITY (000) -------------------------------------------------------------------------------- 100,000 Sun Communities, Inc. $ 3,370 140,000 Vornado Realty Trust 5,250 -------------------------------------------------------------------------------- 115,248 -------------------------------------------------------------------------------- Total real estate securities (cost: $105,255) 124,673 -------------------------------------------------------------------------------- U.S. STOCKS (42.5%) AEROSPACE/DEFENSE (1.1%) 151,400 B.F. Goodrich Co. 6,325 81,060 Boeing Co. 5,098 -------------------------------------------------------------------------------- 11,423 -------------------------------------------------------------------------------- ALUMINUM (1.0%) 232,000 Alcoa, Inc. 10,011 -------------------------------------------------------------------------------- AUTOMOBILES (0.3%) 124,040 Ford Motor Co. 3,020 -------------------------------------------------------------------------------- AUTO PARTS (0.7%) 132,525 ArvinMeritor, Inc. 2,054 153,000 Lear Corp. * 5,337 -------------------------------------------------------------------------------- 7,391 -------------------------------------------------------------------------------- BANKS - MAJOR REGIONAL (2.6%) 230,000 Fleet Boston Financial Corp. 9,566 125,000 PNC Financial Services Group 8,656 260,000 SouthTrust Corp. 6,492 30,000 SunTrust Banks, Inc. 1,843 -------------------------------------------------------------------------------- 26,557 -------------------------------------------------------------------------------- BANKS - MONEY CENTER (1.7%) 129,000 Bank of America Corp. 7,643 70,000 First Union Corp. 2,258 159,000 J. P. Morgan Chase & Co. 7,815 -------------------------------------------------------------------------------- 17,716 -------------------------------------------------------------------------------- BEVERAGES - ALCOHOLIC (0.3%) 60,000 Anheuser-Busch Companies, Inc. 2,640 -------------------------------------------------------------------------------- BEVERAGES - NONALCOHOLIC (0.4%) 75,000 Coca-Cola Co. 3,555 -------------------------------------------------------------------------------- 32 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 MARKET NUMBER VALUE OF SHARES SECURITY (000) -------------------------------------------------------------------------------- BROADCASTING - RADIO & TV (0.3%) 156,000 AT&T Corp. "A" * $ 2,629 -------------------------------------------------------------------------------- CHEMICALS (0.3%) 199,200 Lyondell Chemical Co. 3,297 -------------------------------------------------------------------------------- COMMUNICATION EQUIPMENT (0.5%) 80,000 JDS Uniphase Corp. * 1,337 64,000 QUALCOMM, Inc. * 3,887 -------------------------------------------------------------------------------- 5,224 -------------------------------------------------------------------------------- COMPUTER - HARDWARE (1.5%) 104,000 Dell Computer Corp. * 2,534 150,000 Hewlett-Packard Co. 4,398 78,000 IBM Corp. 8,720 -------------------------------------------------------------------------------- 15,652 -------------------------------------------------------------------------------- COMPUTER - NETWORKING (0.5%) 270,000 Cisco Systems, Inc. * 5,200 -------------------------------------------------------------------------------- COMPUTER - PERIPHERALS (0.3%) 84,000 EMC Corp. * 2,654 -------------------------------------------------------------------------------- COMPUTER SOFTWARE & SERVICE (2.0%) 76,000 Computer Associates International, Inc. 2,156 196,000 Microsoft Corp. * 13,559 310,200 Oracle Corp. * 4,746 -------------------------------------------------------------------------------- 20,461 -------------------------------------------------------------------------------- DRUGS (1.9%) 134,000 Merck & Co., Inc. 9,781 118,500 Pharmacia Corp. 5,754 60,000 Watson Pharmaceuticals, Inc. * 3,606 -------------------------------------------------------------------------------- 19,141 -------------------------------------------------------------------------------- ELECTRIC UTILITIES (0.3%) 65,000 Reliant Energy, Inc. 2,995 -------------------------------------------------------------------------------- ELECTRICAL EQUIPMENT (1.7%) 305,000 General Electric Co. 14,945 100,000 SCI Systems, Inc. * 2,361 -------------------------------------------------------------------------------- 17,306 -------------------------------------------------------------------------------- 33 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 MARKET NUMBER VALUE OF SHARES SECURITY (000) -------------------------------------------------------------------------------- ELECTRONICS - INSTRUMENTATION (0.1%) 23,646 Agilent Technologies, Inc. * $ 793 -------------------------------------------------------------------------------- ELECTRONICS - SEMICONDUCTORS (1.2%) 64,000 Analog Devices, Inc. * 2,851 255,400 Intel Corp. 6,898 67,000 Texas Instruments, Inc. 2,286 -------------------------------------------------------------------------------- 12,035 -------------------------------------------------------------------------------- ENTERTAINMENT (1.2%) 116,000 AOL Time Warner, Inc. * 6,059 180,000 Walt Disney Co. 5,691 -------------------------------------------------------------------------------- 11,750 -------------------------------------------------------------------------------- EQUIPMENT - SEMICONDUCTORS (0.3%) 60,000 Applied Materials, Inc. * 2,996 -------------------------------------------------------------------------------- FINANCE - CONSUMER (0.6%) 80,000 PMI Group, Inc. 5,584 -------------------------------------------------------------------------------- FINANCE - DIVERSIFIED (1.5%) 174,543 Citigroup, Inc. 8,945 104,000 Morgan Stanley Dean Witter & Co. 6,761 -------------------------------------------------------------------------------- 15,706 -------------------------------------------------------------------------------- FOODS (0.7%) 220,000 Ralston Purina Group 6,818 -------------------------------------------------------------------------------- HEALTH CARE - DIVERSIFIED (2.6%) 126,000 Abbott Laboratories 6,549 120,000 American Home Products Corp. 7,596 162,000 Bristol-Myers Squibb Co. 8,787 40,000 Johnson & Johnson, Inc. 3,878 -------------------------------------------------------------------------------- 26,810 -------------------------------------------------------------------------------- HOUSEHOLD PRODUCTS (0.8%) 98,000 Kimberly-Clark Corp. 5,924 38,000 Procter & Gamble Co. 2,441 -------------------------------------------------------------------------------- 8,365 -------------------------------------------------------------------------------- 34 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 MARKET NUMBER VALUE OF SHARES SECURITY (000) -------------------------------------------------------------------------------- INSURANCE - LIFE/HEALTH (0.1%) 25,000 MetLife, Inc. $ 796 -------------------------------------------------------------------------------- INSURANCE - MULTILINE COMPANIES (1.5%) 118,500 American International Group, Inc. 9,598 65,000 CIGNA Corp. 6,141 -------------------------------------------------------------------------------- 15,739 -------------------------------------------------------------------------------- INSURANCE - PROPERTY/CASUALTY (0.8%) 170,000 Allstate Corp. 7,653 -------------------------------------------------------------------------------- LEISURE TIME (0.3%) 130,000 Brunswick Corp. 2,938 -------------------------------------------------------------------------------- MACHINERY - DIVERSIFIED (0.9%) 80,000 Caterpillar, Inc. 4,333 130,000 Deere & Co. 4,857 -------------------------------------------------------------------------------- 9,190 -------------------------------------------------------------------------------- MANUFACTURING - DIVERSIFIED INDUSTRIES (1.2%) 94,500 Eaton Corp. 7,390 35,000 Parker-Hannifin Corp. 1,691 57,000 Tyco International Ltd. 3,274 -------------------------------------------------------------------------------- 12,355 -------------------------------------------------------------------------------- MANUFACTURING - SPECIALIZED (1.2%) 145,000 Avery Dennison Corp. 8,480 60,333 Energizer Holdings, Inc. * 1,391 85,000 Jabil Circuit, Inc. * 2,497 -------------------------------------------------------------------------------- 12,368 -------------------------------------------------------------------------------- NATURAL GAS UTILITIES (1.1%) 120,700 El Paso Corp. 7,351 105,000 NICOR, Inc. 4,073 -------------------------------------------------------------------------------- 11,424 -------------------------------------------------------------------------------- OIL - DOMESTIC INTEGRATED (1.3%) 185,000 Conoco, Inc. "A" 5,720 235,000 Occidental Petroleum Corp. 7,043 -------------------------------------------------------------------------------- 12,763 -------------------------------------------------------------------------------- OIL - INTERNATIONAL INTEGRATED (0.9%) 124,000 Texaco, Inc. 8,854 -------------------------------------------------------------------------------- 35 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 MARKET NUMBER VALUE OF SHARES SECURITY (000) -------------------------------------------------------------------------------- OIL & GAS - DRILLING/EQUIPMENT (0.5%) 122,300 Helmerich & Payne, Inc. $ 4,836 -------------------------------------------------------------------------------- OIL & GAS - EXPLORATION & PRODUCTION (0.4%) 70,850 Anadarko Petroleum Corp. 4,436 -------------------------------------------------------------------------------- PAPER & FOREST PRODUCTS (0.4%) 250,000 Smurfit-Stone Container Corp. * 3,743 -------------------------------------------------------------------------------- RAILROADS/SHIPPING (0.5%) 225,000 Norfolk Southern Corp. 4,988 -------------------------------------------------------------------------------- RESTAURANTS (0.3%) 132,000 Wendy's International, Inc. 3,254 -------------------------------------------------------------------------------- RETAIL - BUILDING SUPPLIES (0.2%) 43,000 Home Depot, Inc. 2,119 -------------------------------------------------------------------------------- RETAIL - GENERAL MERCHANDISING (0.9%) 185,000 Wal-Mart Stores, Inc. 9,574 -------------------------------------------------------------------------------- SAVINGS & LOAN HOLDING CO. (0.6%) 184,500 Washington Mutual, Inc. 6,572 -------------------------------------------------------------------------------- SERVICES - COMPUTER SYSTEMS (0.3%) 52,000 SunGard Data Systems, Inc. * 3,093 -------------------------------------------------------------------------------- SERVICES - DATA PROCESSING (0.3%) 40,000 First Data Corp. 2,624 -------------------------------------------------------------------------------- TELECOMMUNICATIONS - CELLULAR/WIRELESS (0.5%) 215,000 Sprint PCS * 4,730 -------------------------------------------------------------------------------- TELECOMMUNICATIONS - LONG DISTANCE (0.3%) 161,000 Sprint Corp. - FON Group 3,270 -------------------------------------------------------------------------------- TELEPHONES (1.6%) 100,000 SBC Communications, Inc. 4,305 226,400 Verizon Communications, Inc. 12,418 -------------------------------------------------------------------------------- 16,723 -------------------------------------------------------------------------------- Total U.S. stocks (cost: $333,274) 431,771 -------------------------------------------------------------------------------- 36 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 PRINCIPAL MARKET AMOUNT COUPON VALUE (000) SECURITY RATE MATURITY (000) -------------------------------------------------------------------------------- U.S. GOVERNMENT & AGENCY ISSUES (15.5%) GOVERNMENT NATIONAL MORTGAGE ASSOCIATION PASS-THROUGH SECURITIES (5.2%) $ 9,369 Government National Mortgage Assn. c 6.00% 9/15/2028 $ 9,105 6,049 Government National Mortgage Assn. 6.50 5/15/2023 - 4/15/2024 6,029 16,084 Government National Mortgage Assn. b 7.50 3/15/2017 - 6/20/2030 16,552 17,077 Government National Mortgage Assn. b 8.00 6/15/2016 - 8/20/2030 17,717 1,386 Government National Mortgage Assn. 8.50 9/15/2009 - 2/15/2017 1,476 107 Government National Mortgage Assn. 9.00 6/15/2016 - 10/15/2016 115 1,326 Government National Mortgage Assn. 9.50 6/15/2009 - 8/15/2017 1,461 247 Government National Mortgage Assn. 10.00 11/15/2009 - 4/15/2016 273 16 Government National Mortgage Assn. 11.50 3/15/2013 18 -------------------------------------------------------------------------------- 52,746 -------------------------------------------------------------------------------- FEDERAL NATIONAL MORTGAGE ASSOCIATION PASS-THROUGH SECURITIES (3.6%) 14,600 Federal National Mortgage Assn. c 6.50 2/01/2030 14,448 22,199 Federal National Mortgage Assn. c 7.00 2/01/2030 - 8/01/2030 22,417 -------------------------------------------------------------------------------- 36,865 -------------------------------------------------------------------------------- FEDERAL NATIONAL MORTGAGE ASSOCIATION NOTES (1.3%) 7,100 Federal National Mortgage Assn. 7.13 6/15/2010 7,600 5,000 Federal National Mortgage Assn. 7.25 1/15/2010 5,407 -------------------------------------------------------------------------------- 13,007 -------------------------------------------------------------------------------- FEDERAL HOME LOAN MORTGAGE CORPORATION NOTES (3.5%) 13,400 Federal Home Loan Mortgage Corp. 5.25 1/15/2006 13,289 6,000 Federal Home Loan Mortgage Corp. 6.75 3/15/2031 6,145 15,600 Federal Home Loan Mortgage Corp. 6.88 9/15/2010 16,468 -------------------------------------------------------------------------------- 35,902 -------------------------------------------------------------------------------- U.S. TREASURY BOND (1.0%) 10,000 U.S. Treasury Bond 6.00 2/15/2026 10,066 -------------------------------------------------------------------------------- U.S TREASURY INFLATION-INDEXED NOTE (0.9%) 9,111 U.S. Treasury Note 3.50 1/15/2011 9,284 -------------------------------------------------------------------------------- Total U.S. government & agency issues (cost: $156,125) 157,870 -------------------------------------------------------------------------------- 37 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 PRINCIPAL MARKET AMOUNT COUPON VALUE (000) SECURITY RATE MATURITY (000) -------------------------------------------------------------------------------- MONEY MARKET INSTRUMENT (4.6%) $ 46,668 Federal National Mortgage Assn. Discount Note (cost: $46,663) 4.09% 6/01/2001 $ 46,663 -------------------------------------------------------------------------------- Total investments (cost: $877,677) $1,043,739 ================================================================================ 38 PORTFOLIO -------------------------------------------------------------------------------- of INVESTMENTS (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 PORTFOLIO SUMMARY BY CONCENTRATION -------------------------------------------------------------------------------- Real Estate Investment Trusts 11.7% Government National Mortgage Association 5.2 Federal National Mortgage Association 9.5 Drugs 4.4 Banks - Money Center 3.9 Banks - Major Regional 3.7 Federal Home Loan Mortgage Corporation 3.5 Telephones 3.5 Insurance - Multiline Companies 3.2 Health Care - Diversified 2.6 Computer Software & Service 2.3 Oil - International Integrated 2.3 Electronics - Semiconductors 1.9 Finance - Diversified 1.9 U.S. Treasury 1.9 Electrical Equipment 1.8 Manufacturing - Diversified Industries 1.8 Railroads/Shipping 1.8 Oil - Domestic Integrated 1.7 Communication Equipment 1.6 Computer - Hardware 1.6 Natural Gas Utilities 1.4 Entertainment 1.2 Household Products 1.2 Manufacturing - Specialized 1.2 Oil & Gas - Drilling/Equipment 1.2 Aerospace/Defense 1.1 Auto Parts 1.1 Chemicals - Specialty 1.1 Aluminum 1.0 Electric Utilities 1.0 Insurance - Property/Casualty 1.0 Machinery - Diversified 1.0 Oil & Gas - Exploration & Production 1.0 Other 16.4 ----- Total 102.7% ===== 39 NOTES -------------------------------------------------------------------------------- to Portfolio of INVESTMENTS USAA CORNERSTONE STRATEGY Fund May 31, 2001 GENERAL NOTES -------------------------------------------------------------------------------- Market values of securities are determined by procedures and practices discussed in Note 1 to the financial statements. The percentages shown represent the percentage of the investments to net assets. ADR - American Depositary Receipts are receipts issued by a U.S. bank evidencing ownership of foreign shares. Dividends are paid in U.S. dollars. GDR - Global Depositary Receipts are receipts issued by a U.S. or foreign bank evidencing ownership of foreign shares. Dividends are paid in U.S. dollars. SPECIFIC NOTES -------------------------------------------------------------------------------- (a) Represents less than 0.1% of net assets. (b) At May 31, 2001, the cost of securities purchased on a delayed- delivery basis was $31,947,000. (c) At May 31, 2001, a portion of these securities was segregated to cover delayed-delivery purchases. * Non-income-producing security. SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 40 STATEMENT -------------------------------------------------------------------------------- of ASSETS and LIABILITIES (in thousands) USAA CORNERSTONE STRATEGY Fund May 31, 2001 ASSETS Investments in securities, at market value (identified cost of $877,677) $ 1,043,739 Cash 39 Cash denominated in foreign currencies (identified cost of $273) 261 Receivables: Capital shares sold 23 Dividends and interest 3,674 Securities sold 46,780 ----------- Total assets 1,094,516 ----------- LIABILITIES Securities purchased 76,570 Unrealized depreciation on foreign currency contracts held, at value 2 Capital shares redeemed 667 USAA Investment Management Company 654 USAA Transfer Agency Company 169 Accounts payable and accrued expenses 353 ----------- Total liabilities 78,415 ----------- Net assets applicable to capital shares outstanding $ 1,016,101 =========== REPRESENTED BY: Paid-in capital $ 829,694 Accumulated undistributed net investment income 12,206 Accumulated net realized gain on investments 8,205 Net unrealized appreciation of investments 166,062 Net unrealized depreciation on foreign currency translations (66) ----------- Net assets applicable to capital shares outstanding $ 1,016,101 =========== Capital shares outstanding, unlimited number of shares authorized, no par value 40,218 =========== Net asset value, redemption price, and offering price per share $ 25.26 ===========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 41 STATEMENT -------------------------------------------------------------------------------- of OPERATIONS (in thousands) USAA CORNERSTONE STRATEGY Fund Year ended May 31, 2001 NET INVESTMENT INCOME Income: Dividends (net of foreign taxes withheld of $796) $ 20,001 Interest 15,052 --------- Total income 35,053 --------- Expenses: Management fees 7,907 Transfer agent's fees 2,225 Custodian's fees 484 Postage 480 Shareholder reporting fees 65 Trustees' fees 5 Registration fees 32 Professional fees 52 Other 19 --------- Total expenses 11,269 Expenses paid indirectly (4) --------- Net expenses 11,265 --------- Net investment income 23,788 --------- NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS AND FOREIGN CURRENCY Net realized gain (loss) on: Investments 14,107 Foreign currency transactions (86) Change in net unrealized appreciation/depreciation of: Investments (31,095) Foreign currency translations (140) --------- Net realized and unrealized loss (17,214) --------- Increase in net assets resulting from operations $ 6,574 ========= SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 42 STATEMENTS -------------------------------------------------------------------------------- of Changes in NET ASSETS (in thousands) USAA CORNERSTONE STRATEGY Fund Years ended May 31, 2001 2000 ---------------------- FROM OPERATIONS Net investment income $ 23,788 $ 28,400 Net realized gain on investments 14,107 51,745 Net realized loss on foreign currency transactions (86) (186) Change in net unrealized appreciation/depreciation of: Investments (31,095) (18,951) Foreign currency translations (140) 111 ---------------------- Increase in net assets resulting from operations 6,574 61,119 ---------------------- DISTRIBUTIONS TO SHAREHOLDERS FROM: Net investment income (19,685) (35,168) ---------------------- Net realized gains (29,286) (75,478) ---------------------- FROM CAPITAL SHARE TRANSACTIONS Proceeds from shares sold 66,095 82,776 Reinvested dividends 47,564 107,815 Cost of shares redeemed (152,331) (301,711) ---------------------- Decrease in net assets from capital share transactions (38,672) (111,120) ---------------------- Net decrease in net assets (81,069) (160,647) NET ASSETS Beginning of period 1,097,170 1,257,817 ---------------------- End of period $1,016,101 $1,097,170 ====================== Accumulated undistributed net investment income: End of period $ 12,206 $ 8,189 ====================== CHANGE IN SHARES OUTSTANDING Shares sold 2,594 3,177 Shares issued for dividends reinvested 1,813 4,115 Shares redeemed (5,954) (11,611) ---------------------- Decrease in shares outstanding (1,547) (4,319) ====================== SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 43 NOTES -------------------------------------------------------------------------------- to FINANCIAL Statements USAA CORNERSTONE STRATEGY Fund May 31, 2001 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -------------------------------------------------------------------------------- USAA INVESTMENT TRUST (the Trust), registered under the Investment Company Act of 1940, as amended, is a diversified, open-end management investment company organized as a Massachusetts business trust consisting of 11 separate funds. The information presented in this annual report pertains only to the USAA Cornerstone Strategy Fund (the Fund). The Fund's investment objective is to achieve a positive, inflation-adjusted rate of return and a reasonably stable value of Fund shares, thereby preserving purchasing power of shareholders' capital. A. SECURITY VALUATION - The value of each security is determined (as of the close of trading on the New York Stock Exchange on each business day the Exchange is open) as set forth below: 1. Portfolio securities, except as otherwise noted, traded primarily on a domestic securities exchange are valued at the last sales price on that exchange. Portfolio securities traded primarily on foreign securities exchanges are generally valued at the closing values of such securities on the exchange where primarily traded. If no sale is reported, the average of the bid and asked prices is generally used depending upon local custom or regulation. 2. Over-the-counter securities are priced at the last sales price or, if not available, at the average of the bid and asked prices. 3. Securities purchased with maturities of 60 days or less are stated at amortized cost, which approximates market value. 4. Other debt and government securities are valued each business day by a pricing service (the Service) approved by the 44 NOTES -------------------------------------------------------------------------------- to FINANCIAL Statements (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 Trust's Board of Trustees. The Service uses the mean between quoted bid and asked prices or the last sale price to price securities when, in the Service's judgment, these prices are readily available and are representative of the securities' market values. For many securities, such prices are not readily available. The Service generally prices these securities based on methods that include consideration of yields or prices of securities of comparable quality, coupon, maturity, and type; indications as to values from dealers in securities; and general market conditions. 5. Securities that cannot be valued by the methods set forth above, and all other assets, are valued in good faith at fair value, using methods determined by USAA Investment Management Company (the Manager) under the general supervision of the Board of Trustees. B. FEDERAL TAXES - The Fund's policy is to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute substantially all of its income to its shareholders. Therefore, no federal income or excise tax provision is required. The Fund elected to utilize equalization debits by which a portion of the cost of redemptions, which occurred during the year ended May 31, 2001, reduced accumulated net realized gain. As a result of this and other permanent differences between book and tax basis accounting, reclassifications were made to the statement of assets and liabilities to increase paid-in capital by $5,169,000, decrease accumulated undistributed net investment income by $86,000, and decrease accumulated net realized gain on investments by $5,083,000. 45 NOTES -------------------------------------------------------------------------------- to FINANCIAL Statements (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 C. INVESTMENTS IN SECURITIES - Security transactions are accounted for on the date the securities are purchased or sold (trade date). Gain or loss from sales of investment securities is computed on the identified cost basis. Dividend income, less foreign taxes, if any, is recorded on the ex-dividend date. If the ex-dividend date has passed, certain dividends from foreign securities are recorded upon notification. Interest income is recorded on the accrual basis. Discounts and premiums are amortized over the life of the respective securities. D. FOREIGN CURRENCY TRANSLATIONS - The Fund's assets may be invested in the securities of foreign issuers. Because the Fund's accounting records are maintained in U.S. dollars, foreign currency amounts are translated into U.S. dollars on the following basis: 1. Market value of securities, other assets, and liabilities at the mean between the bid and asked translation rates of such currencies against U.S. dollars on a daily basis. 2. Purchases and sales of securities, income, and expenses at the rate of exchange obtained from an independent pricing service on the respective dates of such transactions. Net realized and unrealized foreign currency gains/losses occurring during the holding period of investments are a component of realized gain/loss on investments and unrealized appreciation/depreciation on investments, respectively. Net realized foreign currency gains/losses arise from sales of foreign currency, currency gains/losses realized between the trade and settlement dates on security transactions, and from 46 NOTES -------------------------------------------------------------------------------- to FINANCIAL Statements (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 the difference between amounts of dividends, interest, and foreign withholding taxes recorded on the Fund's books and the U.S. dollar equivalent of the amounts received. Net realized foreign currency gains/losses have been reclassified from accumulated net realized gain/loss to accumulated undistributed net investment income on the statement of assets and liabilities as such amounts are treated as ordinary income/loss for tax purposes. See Note 1(B). Net unrealized foreign currency exchange gains/losses arise from changes in the value of assets and liabilities other than investments in securities resulting from changes in the exchange rate. E. EXPENSES PAID INDIRECTLY - The Fund's custodian bank has agreed to reduce its fees when the Fund maintains a cash balance in the non-interest-bearing custody account. For the year ended May 31, 2001, custodian fee offset arrangements reduced expenses by $4,000. F. USE OF ESTIMATES - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that may affect the reported amounts in the financial statements. (2) LINES OF CREDIT -------------------------------------------------------------------------------- The Fund participates with other USAA funds in two joint, short-term, revolving, committed loan agreements totaling $500 million-- $400 million with USAA Capital Corporation (CAPCO), an affiliate of the Manager, and $100 million with Bank of America. The purpose of the agreements is to meet temporary or emergency cash 47 NOTES -------------------------------------------------------------------------------- to FINANCIAL Statements (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 needs, including redemption requests that might otherwise require the untimely disposition of securities. Before January 10, 2001, the Fund had two agreements with CAPCO--$250 million committed and $500 million uncommitted. Subject to availability under its agreement with CAPCO, the Fund may borrow from CAPCO an amount up to 5% of the Fund's total assets at CAPCO's borrowing rate with no markup. Subject to availability under its agreement with Bank of America, the Fund may borrow from Bank of America, at Bank of America's borrowing rate plus a markup, an amount which, when added to outstanding borrowings under the CAPCO agreement, does not exceed 25% of the Fund's total assets. The Fund had no borrowings under any of these agreements during the year ended May 31, 2001. (3) DISTRIBUTIONS -------------------------------------------------------------------------------- Distributions of net investment income and realized gains from security transactions not offset by capital losses are made annually in the succeeding fiscal year or as otherwise required to avoid the payment of federal taxes. (4) INVESTMENT TRANSACTIONS -------------------------------------------------------------------------------- Cost of purchases and proceeds from sales/maturities of securities, excluding short-term securities, for the year ended May 31, 2001, were $564,675,000 and $626,557,000, respectively. The cost of securities at May 31, 2001, for federal income tax purposes, was $879,664,000. Gross unrealized appreciation and depreciation of investments at May 31, 2001, for tax purposes, were $211,886,000 and $47,811,000, respectively. 48 NOTES -------------------------------------------------------------------------------- to FINANCIAL Statements (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 (5) FOREIGN CURRENCY CONTRACTS -------------------------------------------------------------------------------- A forward currency contract (currency contract) is a commitment to purchase or sell a foreign currency at a specified date, at a negotiated price. The Fund currently enters into currency contracts only in connection with the purchase or sale of a security denominated in a foreign currency. These contracts allow the Fund to "lock in" the U.S. dollar price of the security. Currency contracts are valued on a daily basis using foreign currency exchange rates obtained from an independent pricing service. Risks of entering into currency contracts include the potential inability of the counterparty to meet the terms of the contract and the Fund's giving up the opportunity for potential profit. At May 31, 2001, the terms of open foreign currency contracts were as follows (in thousands): Foreign Currency Contracts to Buy:
-------------------------------------------------------------------------------------- U.S. DOLLAR EXCHANGE CONTRACTS TO VALUE AS OF IN EXCHANGE UNREALIZED UNREALIZED DATE RECEIVE 5/31/01 FOR U.S. DOLLAR APPRECIATION DEPRECIATION -------------------------------------------------------------------------------------- 06/01/01 299 $127 $128 $ - $(1) Brazilian Real 06/05/01 444 288 288 - - Canadian Dollar 06/05/01 165 140 140 - - Euro Currency ====================================================================================== $555 $556 $ - $(1) ======================================================================================
49 NOTES -------------------------------------------------------------------------------- to FINANCIAL Statements (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 Foreign Currency Contracts to Sell:
-------------------------------------------------------------------------------------- U.S. DOLLAR EXCHANGE CONTRACTS TO VALUE AS OF IN EXCHANGE UNREALIZED UNREALIZED DATE DELIVER 5/31/01 FOR U.S. DOLLAR APPRECIATION DEPRECIATION -------------------------------------------------------------------------------------- 06/01/01 11,748 $99 $98 $ - $(1) Japanese Yen --------------------------------------------------------------------------------------
(6) TRANSACTIONS WITH MANAGER -------------------------------------------------------------------------------- A. MANAGEMENT FEES - The Manager carries out the Fund's investment policies and manages the Fund's portfolio. The Fund's management fees are computed at 0.75% of its annual average net assets. B. TRANSFER AGENT'S FEES - USAA Transfer Agency Company, d/b/a USAA Shareholder Account Services, an affiliate of the Manager, provides transfer agent services to the Fund based on an annual charge of $26 per shareholder account plus out-of-pocket expenses. C. UNDERWRITING SERVICES - The Manager provides exclusive underwriting and distribution of the Fund's shares on a continuing best-efforts basis. The Manager receives no commissions or fees for this service. (7) TRANSACTIONS WITH AFFILIATES -------------------------------------------------------------------------------- Certain trustees and officers of the Fund are also directors, officers, and/or employees of the Manager. None of the affiliated Trustees or Fund officers received any compensation from the Fund. 50 NOTES -------------------------------------------------------------------------------- to FINANCIAL Statements (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 (8) NEW ACCOUNTING PRONOUNCEMENT -------------------------------------------------------------------------------- In November 2000, the American Institute of Certified Public Accountants issued a revised audit and accounting guide, AUDITS OF INVESTMENT COMPANIES, effective for fiscal years beginning after December 15, 2000. The revised guide requires the Fund to amortize premiums and discounts on all debt securities, a practice that the Fund has been following. The guide also requires the Fund to classify as interest income any gains or losses realized on mortgage-backed securities. This requirement will not affect the Fund's net asset value but will change the classification of certain amounts in the statement of operations. In addition, the Fund will record an adjustment to decrease the cost of securities and decrease accumulated net realized gain on investments by $1,000 to reflect the cumulative effect of this change up to the date of adoption of June 1, 2001. 51 NOTES -------------------------------------------------------------------------------- to FINANCIAL Statements (continued) USAA CORNERSTONE STRATEGY Fund May 31, 2001 (9) FINANCIAL HIGHLIGHTS -------------------------------------------------------------------------------- Per share operating performance for a share outstanding throughout each period is as follows:
Year Ended May 31, ------------------------------------------------------------------ 2001 2000 1999 1998 1997 ------------------------------------------------------------------ Net asset value at beginning of period $ 26.27 $ 27.29 $ 29.89 $ 27.96 $ 25.47 Net investment income .58 .63 .88 .77 .74 Net realized and unrealized gain (loss) (.40) .80 (1.14) 3.78 3.37 Distributions from net investment income (.48) (.78) (.81) (.72) (.78) Distributions of realized capital gains (.71) (1.67) (1.53) (1.90) (.84) ------------------------------------------------------------------ Net asset value at end of period $ 25.26 $ 26.27 $ 27.29 $ 29.89 $ 27.96 ================================================================== Total return (%) * .58 5.49 (.74) 17.15 16.94 Net assets at end of period (000) $1,016,101 $1,097,170 $1,257,817 $1,500,258 $1,263,355 Ratio of expenses to average net assets (%) 1.07a 1.09 1.05 1.01 1.06 Ratio of net investment income to average net assets (%) 2.26 2.43 3.12 2.64 2.88 Portfolio turnover (%) 54.67 37.46 46.27 32.73 35.14
* Assumes reinvestment of all dividend income and capital gain distributions during the period. (a) Reflects total expenses prior to any custodian fee offset arrangement. TRUSTEES Robert G. Davis, CHAIRMAN OF THE BOARD Christopher W. Claus, VICE CHAIRMAN OF THE BOARD Barbara B. Dreeben Robert L. Mason David G. Peebles Michael F. Reimherr Laura T. Starks Richard A. Zucker INVESTMENT ADVISER, USAA Investment Management Company UNDERWRITER, 9800 Fredericksburg Road AND DISTRIBUTOR San Antonio, Texas 78288 TRANSFER AGENT USAA Shareholder Account Services 9800 Fredericksburg Road San Antonio, Texas 78288 LEGAL COUNSEL Goodwin Procter LLP Exchange Place Boston, Massachusetts 02109 CUSTODIAN State Street Bank and Trust Company P.O. Box 1713 Boston, Massachusetts 02105 INDEPENDENT AUDITORS KPMG LLP 112 East Pecan, Suite 2400 San Antonio, Texas 78205 TELEPHONE Call toll free - Central Time ASSISTANCE HOURS Monday - Friday 6 a.m. to 10 p.m. Saturday 8:30 a.m. to 5 p.m. Sunday 11:30 a.m. to 8 p.m. FOR ADDITIONAL 1-800-531-8181, (in San Antonio) 456-7200 INFORMATION ABOUT For account servicing, exchanges, or MUTUAL FUNDS redemptions 1-800-531-8448, (in San Antonio) 456-7202 RECORDED MUTUAL 24-hour service (from any phone) FUND PRICE QUOTES 1-800-531-8066, (in San Antonio) 498-8066 MUTUAL FUND (from touch-tone phones only) USAA TOUCHLINE(R) For account balance, last transaction, fund prices, or to exchange or redeem fund shares 1-800-531-8777, (in San Antonio) 498-8777 INTERNET ACCESS USAA.COM Recycled Paper [USAA logo appears here.] WE KNOW WHAT IT MEANS TO SERVE.(R) --------------------------------------------------- INSURANCE - BANKING - INVESTMENTS - MEMBER SERVICES 23405-0701 (C)2001, USAA. All rights reserved.