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SUPPLEMENT DATED JULY 1, 1997
TO
STATEMENT OF ADDITIONAL INFORMATION DATED MAY 1, 1997
MORGAN STANLEY UNIVERSAL FUNDS, INC. (THE "FUND")
P.O. BOX 2798
BOSTON, MA 02208-2798
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The Statement of Additional Information ("SAI") is being supplemented to
reflect the creation of an additional prospectus of the Fund. The following
sentence is added at the end of the second column on the first page of the SAI:
Prospectus dated July 1, 1997 for the Emerging Markets Debt Portfolio.
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EMERGING MARKETS DEBT PORTFOLIO
A PORTFOLIO OF THE
MORGAN STANLEY UNIVERSAL FUNDS, INC.
MORGAN STANLEY ASSET MANAGEMENT INC.
MORGAN STANLEY UNIVERSAL FUNDS, INC. (THE "FUND") IS A MUTUAL FUND DESIGNED TO
PROVIDE INVESTMENT VEHICLES FOR VARIABLE ANNUITY CONTRACTS AND VARIABLE LIFE
INSURANCE POLICIES AND FOR CERTAIN TAX-QUALIFIED INVESTORS. THIS PROSPECTUS
PERTAINS TO THE FUND'S EMERGING MARKETS DEBT PORTFOLIO WHICH IS MANAGED BY
MORGAN STANLEY ASSET MANAGEMENT INC. THE FUND ALSO OFFERS 16 OTHER PORTFOLIOS
MANAGED BY EITHER MORGAN STANLEY ASSET MANAGEMENT INC. ("MSAM") OR MILLER
ANDERSON & SHERRERD, LLP, AN AFFILIATE OF MSAM.
SHARES OF THE EMERGING MARKETS DEBT PORTFOLIO MAY BE PURCHASED ONLY BY THE
SEPARATE ACCOUNTS OF INSURANCE COMPANIES FOR THE PURPOSE OF FUNDING VARIABLE
ANNUITY CONTRACTS AND VARIABLE LIFE INSURANCE POLICIES AND BY CERTAIN TAX-
QUALIFIED INVESTORS. THE EMERGING MARKETS DEBT PORTFOLIO MAY NOT BE AVAILABLE
IN YOUR STATE DUE TO VARIOUS INSURANCE REGULATIONS. PLEASE CHECK WITH YOUR
INSURANCE COMPANY FOR AVAILABILITY OF THE EMERGING MARKETS DEBT PORTFOLIO IN
YOUR STATE. IF THE EMERGING MARKETS DEBT PORTFOLIO IS NOT AVAILABLE IN YOUR
STATE THIS PROSPECTUS IS NOT TO BE CONSIDERED A SOLICITATION.
THIS PROSPECTUS CONTAINS IMPORTANT INFORMATION ABOUT THE EMERGING MARKETS DEBT
PORTFOLIO'S INVESTMENTS AND SERVICES. YOU SHOULD READ IT BEFORE INVESTING, AND
KEEP IT ON FILE FOR FUTURE REFERENCE ALONG WITH THE PROSPECTUS OF THE SEPARATE
ACCOUNT OF THE SPECIFIC INSURANCE PRODUCT WHICH ACCOMPANIES THIS PROSPECTUS.
A STATEMENT OF ADDITIONAL INFORMATION ("SAI") DATED MAY 1, 1997, HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION AND IS INCORPORATED HEREIN BY
REFERENCE, AND, THEREFORE, LEGALLY FORMS A PART OF THE PROSPECTUS. FOR A COPY
OF THE SAI, AT NO CHARGE, CONTACT THE FUND BY CALLING 1-800-422-6464, EXT. 7182
OR CONTACT YOUR INSURANCE COMPANY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
THE EMERGING MARKETS DEBT PORTFOLIO MAY INVEST WITHOUT LIMITATION IN LOWER-
QUALITY DEBT SECURITIES, SOMETIMES CALLED "JUNK BONDS." YOU SHOULD CONSIDER
THAT THESE SECURITIES CARRY GREATER RISKS, SUCH AS THE RISK OF DEFAULT, THAN
OTHER DEBT SECURITIES. REFER TO "SECURITIES AND INVESTMENT TECHNIQUES--HIGH
YIELD SECURITIES" FOR FURTHER INFORMATION.
THE EMERGING MARKETS DEBT PORTFOLIO MAY INVEST IN EQUITY SECURITIES OF RUSSIAN
COMPANIES. RUSSIA'S SYSTEM OF SHARE REGISTRATION AND CUSTODY INVOLVES CERTAIN
RISKS OF LOSS THAT ARE NOT NORMALLY ASSOCIATED WITH INVESTMENTS IN OTHER
SECURITIES MARKETS. SEE "SECURITIES AND INVESTMENT TECHNIQUES--RUSSIAN
SECURITIES" FOR FURTHER INFORMATION.
Prospectus dated July 1, 1997
MORGAN STANLEY UNIVERSAL FUNDS, INC.
P.O. Box 2798, Boston, MA 02208-2798
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THE FUND
The Fund is an open-end management investment company, or mutual fund. The
following pages describe the types of securities and investment techniques that
the Fund's Emerging Markets Debt Portfolio (the "Portfolio") uses to seek its
objective, as well as the risks inherent in those types of securities and
investment techniques.
MANAGEMENT
Morgan Stanley Asset Management Inc. ("MSAM") advises the Portfolio.
MSAM conducts a worldwide investment advisory business. As of May 31, 1997,
MSAM and its investment advisory affiliates managed assets of approximately
$303 billion.
OFFERING OF SHARES
The Fund is intended to be a funding vehicle for all types of variable annuity
contracts and variable life insurance policies offered by insurance companies.
Shares of the Fund may also be offered to certain tax-qualified investors,
including qualified pension and retirement plans. It is possible that material
conflicts among the various insurance companies and other investors in the Fund
may arise. The Fund's Board of Directors will monitor events in order to
identify the existence of any material conflicts and to determine what action,
if any, should be taken in response to any such conflicts.
PROSPECTUS OUTLINE PAGE
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PORTFOLIO SUMMARY 3
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The Portfolio's investment objective and a summary of strategy, potential
investors, and investment characteristics and risks.
THE PORTFOLIO'S INVESTMENTS 3
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A more detailed review of how the Portfolio invests and investment
characteristics and risks.
SECURITIES AND INVESTMENT TECHNIQUES 5
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More information about the types of investment strategies used by the
Portfolio and information about investment risks and limitations.
FUNDAMENTAL INVESTMENT LIMITS 17
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Certain policies that may be changed only by shareholders.
MANAGEMENT OF THE FUND 17
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General information on organization and operations of the Fund, including
details about MSAM and the portfolio manager, as well as fees, expenses, and
performance calculations.
ACCOUNT POLICIES 21
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Information on net asset value calculation, income and gain distributions,
taxes and share purchases and redemptions.
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PORTFOLIO SUMMARY
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Certain investment terms used below have initial capital letters ("Emerging
Market Country Securities," for example). These terms are further described
under "Securities and Investment Techniques" below.
EMERGING MARKETS DEBT PORTFOLIO
OBJECTIVE AND STRATEGY: High total return by investing primarily in Fixed
Income Securities of government and government-related issuers located in
emerging market countries, which securities provide a high level of current
income, while at the same time holding the potential for capital appreciation
if the perceived creditworthiness of the issuer improves due to improving
economic, financial, political, social or other conditions in the country in
which the issuer is located.
INVESTOR PROFILE: The Portfolio is designed for those who seek a high level of
current income from Emerging Market Country Securities that are Fixed Income
Securities, while holding the potential for capital appreciation.
RISK PROFILE: Very high potential risk and reward. The Portfolio's performance
is subject to high risk and will not be required to meet a minimum rating
standard and may purchase securities that are not rated for creditworthiness by
any internationally recognized credit rating organization. These types of debt
obligations are predominantly speculative with respect to the capacity to pay
interest and repay principal in accordance with their terms and generally
involve a greater risk of default and of volatility in price than securities in
higher rating categories. In addition, Foreign Investment involves different or
increased risks. The performance of the Portfolio will be affected by foreign
currency values, the greater volatility of securities exchanges, risks in
connection with registration, clearing and settlement of securities
transactions and the overall political, economic and regulatory environment in
the countries in which the Portfolio invests. The risks of Foreign Investment
are exacerbated in the case of Emerging Market Country Securities.
THE PORTFOLIO'S INVESTMENTS
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INVESTMENT CHARACTERISTICS AND RISKS
The value of the Portfolio's investments and the income they generate will vary
from day-to-day and generally reflect market conditions, interest rates, and
other company, political, or economic news in the Emerging Markets Countries in
which the Portfolio invests.
The Portfolio spreads investment risk by limiting, to varying degrees, its
holdings in any one company or industry. Nevertheless, the Portfolio will
experience price volatility the extent of which will be affected by the types
of securities and techniques the Portfolio uses. In the short term, the prices
of Fixed Income Securities fluctuate and generally move in the opposite
direction from interest rates.
Foreign Investment may involve risks in addition to those of U.S. investments.
The performance of the Portfolio will be affected by foreign currency values,
the greater volatility of securities exchanges, and the overall political,
economic and regulatory environment in the countries in which investments are
made.
Because the Portfolio is non-diversified and is permitted greater flexibility
to invest its assets in the obligations of a single issuer, it is exposed to
increased risk of loss if such an investment underperforms expectations. See
"Non-Diversified Status" in this Prospectus and "Investment Limitations" in the
"SAI".
Investments in securities rated below investment grade, sometimes called high
risk or High Yield Securities or junk bonds, carry a high degree of risk and
are considered speculative. MSAM may use various investment techniques to hedge
risks, including investment in Derivatives, but there is no guarantee that
these strategies will work as intended.
The Portfolio will be invested according to its investment strategy. However,
the Portfolio also has the ability to invest without limitation in high-quality
Money Market Instruments or Temporary Investments for temporary, defensive
purposes. See "Securities and Investment Techniques" below.
When Portfolio shares are redeemed, they may be worth more or less than their
original cost. An investment in the Portfolio is not in itself a balanced
investment plan. As with any mutual fund, there is no assurance that the
Portfolio will achieve its goal.
INVESTMENT OBJECTIVE AND POLICIES
The Portfolio seeks high total return by investing primarily in Fixed Income
Securities of issuers in emerging market countries. Under normal circumstances,
the Portfolio will invest at least 65% of its total assets in government Fixed
Income Securities, including Loan Participations and Assignments between
governments and financial institutions, securities issued by government owned,
controlled or sponsored entities and securities of entities organized to
restructure outstanding debt of such issuers.
The Portfolio may also invest in Fixed Income Securities of corporate issuers
located in or organized under the laws of emerging market countries, Brady
Bonds, Zero Coupon, Pay-In-Kind or Deferred Payment Securities, ADRs, Foreign
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Currency Transactions, Investment Company Securities, Investment Funds, Loan
Participations and Assignments, Money Market Instruments, Repurchase
Agreements, Reverse Repurchase Agreements, Temporary Investments, Non-Publicly
Traded Securities, Private Placements, Restricted Securities, When-Issued or
Delayed Delivery Securities, Derivatives, and may engage in Loans of Portfolio
Securities. The Portfolio may also invest up to 5% of its total assets in MBSs,
CMOs and in other ABSs issued by non-governmental entities, such as banks and
other financial institutions. Also, the Portfolio is authorized to borrow up to
33 1/3% of its total assets (including the amount borrowed), less all
liabilities and indebtedness other than the borrowing, for investment purposes
to increase the opportunity for greater return and for payment of dividends.
Such borrowings would constitute leverage, which is a speculative
characteristic. Leveraging will magnify declines as well as increases in the
Net Asset Value ("NAV") of the Portfolio's shares and increases in the yield on
the Portfolio's investments. For additional information about investments, see
"Securities and Investment Practices" and "Non-Diversified Status" below.
MSAM's approach is to invest the Portfolio's assets in Emerging Market Country
Fixed Income Securities that provide a high level of current income, while at
the same time holding the potential for capital appreciation if the perceived
creditworthiness of the issuer improves due to improving economic, financial,
political, social or other conditions in the country in which the issuer is
located. As used in this Prospectus, emerging markets describes any country
which is generally considered to be an emerging or developing country by the
international financial community such as the International Bank for
Reconstruction and Redevelopment (commonly known as the World Bank) and the
International Finance Corporation. Emerging markets can include every nation in
the world except the United States, Canada, Japan, Australia, and most Western
European nations. There are currently over 130 countries which, in the opinion
of MSAM, are generally considered to be emerging or developing countries by the
international financial community. Currently, investing in many emerging market
countries is not feasible or may involve unacceptable political risks.
Initially, MSAM expects that its investments in Emerging Market Country Fixed
Income Securities will be made primarily in some or all of the following
emerging market countries:
Algeria Argentina Brazil Bulgaria
Chile China Colombia Costa Rica
Czech Republic Democratic Republic Dominican Ecuador
Egypt of Congo Republic Greece
Hungary India Indonesia Ivory Coast
Jamaica Jordan Malaysia Mexico
Morocco Nicaragua Nigeria Pakistan
Panama Paraguay Peru Philippines
Poland Portugal Russia Slovakia
South Thailand Trinidad & Tunisia
Africa Uruguay Tobago Venezuela
Turkey
In selecting Emerging Market Country Fixed Income Securities for investment by
the Portfolio, MSAM will apply a market risk analysis contemplating assessment
of factors such as liquidity, volatility, tax implications, interest rate
sensitivity, counterparty risks and technical market considerations. As
opportunities to invest in debt securities in other countries develop, MSAM
expects to expand and further diversify the universe of emerging market
countries in which the Portfolio invests. While the Portfolio generally is not
restricted in the portion of its assets which may be invested in a single
country or region, it is anticipated that, under normal conditions, the
Portfolio's assets will be invested in issuers in at least three countries.
Interests in issuers organized and operated for the purpose of restructuring
the investment characteristics of instruments issued by governments, government
agencies or instrumentalities, political subdivisions or government owned,
controlled or sponsored entities involves the deposit with or purchase by an
entity of specific instruments and the issuance by that entity of one or more
classes of securities backed by, or representing interests in, the underlying
instruments. Certain issuers of such structured securities may be deemed to be
"Investment Companies" as defined in the Investment Company Act of 1940, as
amended (the "1940 Act"). As a result, the Portfolio's investment in such
securities may be limited by certain investment restrictions contained in the
1940 Act.
The Portfolio's investments in Fixed Income Securities of governments, and
government-related and restructured Fixed Income Securities are subject to
special risks, including the inability or unwillingness of the issuer to repay
principal and interest, requests to reschedule or restructure outstanding debt
and requests to extend additional loan amounts. The Portfolio may have limited
recourse in the event of default on such Fixed Income Securities. Also, the
registration, clearing and settlement of securities transactions in Russia are
subject to significant risks not normally associated with securities
transactions in the United States and other more developed markets. See
"Securities and Investment Techniques--Russian Securities."
The portion of the Portfolio's assets invested in securities denominated in
currencies other than the U.S. dollar is not restricted and will vary depending
on market conditions. Although the Portfolio is permitted to engage in
investment practices to hedge against currency exchange rate risks with respect
to such assets, the Portfolio may be limited in its ability to hedge against
these risks.
Emerging Market Country Fixed Income Securities in which the Portfolio may
invest will be subject to high risk and will not be required to meet a minimum
rating standard and may not be rated for creditworthiness by any
internationally recognized credit rating organization. These types of Fixed
Income Securities are predominantly speculative and generally involve a greater
risk of default and of volatility in
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price than securities in higher rating categories. Ratings of Fixed Income
Securities of foreign issuers, to the extent that those ratings are undertaken,
are related to evaluations of the country in which the issuer of the instrument
is located and generally take into account the currency in which the Fixed
Income Securities of a foreign issuer is denominated.
SECURITIES AND INVESTMENT TECHNIQUES
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The following pages contain more detailed information about types of
instruments in which the Portfolio may invest, and strategies MSAM may employ
in pursuit of the Portfolio's investment objective. A summary of risks and
restrictions associated with these instruments and investment practices is
included as well. A complete listing of the Portfolio's policies and
limitations and more detailed information about the Portfolio's investments is
contained in the SAI. Policies and limitations are considered at the time of
purchase; the sale of instruments is not required in the event of a subsequent
change in circumstances, for example, a rating downgrade.
The investments of life insurance company separate accounts made under variable
annuity contracts and variable life insurance policies are subject to state
insurance laws and regulations. The Fund and the Portfolio will, when required,
comply with investment restrictions imposed under such laws and regulations on
life insurance company separate accounts investing in the Portfolio.
MSAM may not buy all of these instruments or use all of these techniques to the
full extent permitted unless it believes that doing so will help the Portfolio
achieve its investment objective. Current holdings and recent investment
strategies are described in the Portfolio's financial reports, which will be
sent to the Portfolio's shareholders twice a year. For a copy of the SAI or
financial report, at no charge, contact the Fund or your insurance company.
INSTRUMENTS AND INVESTMENTS
AGENCIES. Agencies are securities which are not guaranteed by, or backed by the
full faith and credit of, the U.S. Government, but which are issued, sponsored
or guaranteed by a federal agency or federally sponsored agency such as the
Student Loan Marketing Association, Resolution Funding Corporation, or any of
several other agencies. For further information on these securities, see
"Description of U.S. Government Securities" in the SAI.
ABSS. Asset-backed securities ("ABSs") are securities collateralized by shorter
term loans such as automobile loans, home equity loans, computer leases or
credit card receivables. The payments from the collateral are passed through to
the security holder. The collateral behind ABSs tends to have prepayment rates
that usually do not vary with interest rates. In addition the short-term nature
of the loans reduces the impact of any change in prepayment level. Due to
amortization, the average life for ABSs is also the conventional proxy for
maturity.
Due to the possibility that prepayments (on automobile loans and other
collateral) will alter the cash flow on ABSs, it is not possible to determine
in advance the actual final maturity date or average life. Faster prepayment
will shorten the average life and slower prepayments will lengthen it. However,
it is possible to determine what the range of that movement could be and to
calculate the effect that it will have on the price of the security. In
selecting these securities, MSAM will look for those securities that offer a
higher yield to compensate for any variation in average maturity.
BRADY BONDS. Brady Bonds are Fixed Income Securities which are created through
the exchange of existing commercial bank loans to foreign entities for new
obligations in connection with debt restructuring under a plan introduced by
Nicholas F. Brady when he was the U.S. Secretary of the Treasury (the "Brady
Plan"). Brady Bonds have been issued only recently, and, accordingly, do not
have a long payment history. They may be collateralized or uncollateralized and
issued in various currencies (although most are dollar-denominated) and they
are actively traded in the over-the-counter secondary market. For further
information on these securities, see the SAI. The Portfolio will invest in
Brady Bonds only if they are consistent with quality specifications.
CASH EQUIVALENTS. Cash Equivalents are short-term Fixed Income Securities
comprising:
(1)Time deposits, certificates of deposit (including marketable variable rate
certificates of deposit) and bankers' acceptances issued by a commercial bank
or savings and loan association. Time deposits are non-negotiable deposits
maintained in a banking institution for a specified period of time at a stated
interest rate. Certificates of deposit are negotiable short-term obligations
issued by commercial banks or savings and loan associations against funds
deposited in the issuing institution. Variable rate certificates of deposit are
certificates of deposit on which the interest rate is periodically adjusted
prior to their stated maturity based upon a specified market rate. A bankers'
acceptance is a time draft drawn on a commercial bank by a borrower, usually in
connection with an international commercial transaction (to finance the import,
export, transfer or storage of goods).
The Portfolio may invest in obligations of U.S. banks, obligations of foreign
branches of U.S. banks ("Eurodollars") and obligations of U.S. branches of
foreign banks ("Yankee dollars"). Investments in Eurodollars and Yankee dollars
involve some of the same risks of investing in international securities that
are discussed in "Foreign Investment" below.
The Portfolio will not invest in any security issued by a commercial bank
unless (i) the bank has total assets of at least $1 billion, or the equivalent
in other currencies, or, in
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the case of domestic banks which do not have total assets of at least $1
billion, the aggregate investment made in any one such bank is limited to
$100,000 and the principal amount of such investment is insured in full by the
Federal Deposit Insurance Corporation ("FDIC"), (ii) in the case of U.S. banks,
it is a member of the FDIC, and (iii) in the case of foreign branches of U.S.
banks, the security is deemed by MSAM to be of an investment quality comparable
with other Fixed Income Securities which may be purchased by the Portfolio.
(2)Commercial paper rated at time of purchase by one or more nationally
recognized statistical ratings organization ("NRSRO") to be in one of their two
highest categories, (e.g., A-1 or A-2 by Standard & Poor's Ratings Group
("S&P") or Prime 1 or Prime 2 by Moody's Investors Service, Inc. ("Moody's")),
or, if not rated, issued by a corporation having an outstanding unsecured debt
issue rated high-grade by an NRSRO (e.g., A or better by Moody's, S&P or Fitch
Investors Service, Inc. ("Fitch")).
(3)Short-term corporate obligations rated high-grade at the time of purchase by
an NRSRO (e.g., A or better by Moody's, S&P or Fitch).
(4)U.S. Governments and Agencies.
(5)Repurchase Agreements collateralized by securities listed above.
CMOS. Collateralized Mortgage Obligations ( "CMOs") are Derivatives which are
collateralized by mortgage pass-through securities. Cash flows from the
mortgage pass-through securities are allocated to various tranches (a "tranche"
is essentially a separate security) in a predetermined, specified order. Each
tranche has a stated maturity--the latest date by which the tranche can be
completely repaid, assuming no prepayments--and has an average life--the
average of the time to receipt of a principal payment weighted by the size of
the principal payment. The average life is typically used as a proxy for
maturity because the debt is amortized (repaid a portion at a time), rather
than paid off entirely at maturity, as would be the case in a straight debt
instrument.
Due to the possibility that prepayments (on home mortgages and other
collateral) will alter the cash flow on CMOs, it is not possible to determine
in advance the actual final maturity date or average life. Faster prepayment
will shorten the average life and slower prepayments will lengthen it. However,
it is possible to determine what the range of that movement could be and to
calculate the effect that it will have on the price of the security. In
selecting these securities, MSAM will look for those securities that offer a
higher yield to compensate for any variation in average maturity.
Prepayment risk has two important effects. First, like Fixed Income Securities
in general, MBSs will generally decline in price when interest rates rise.
However, when interest rates fall, MBSs may not enjoy as large a gain in market
value due to prepayment risk. Second, when interest rates fall, additional
mortgage prepayments must be reinvested at lower interest rates. In part to
compensate for these risks, MBSs will generally offer higher yields than
comparable bonds. See "MBSs" below.
COMMON STOCKS. Common Stocks are Equity Securities which represent an ownership
interest in a corporation, entitling the shareholder to voting rights and
receipt of dividends paid based on proportionate ownership.
CONVERTIBLE SECURITIES. Convertible Securities are securities, such as
convertible Corporate Bonds, convertible Preferred Stocks, Warrants or other
securities which may be exchanged under certain circumstances for a fixed
number of shares of Common Stock.
CORPORATE BONDS. Corporate Bonds are Fixed Income Securities issued by private
corporations. Bondholders, as creditors, have a prior legal claim over common
and preferred stockholders of the corporation as to both income and assets for
the principal and interest due to the bondholder. The Portfolio will buy
Corporate Bonds subject to any quality constraints. If a security held by the
Portfolio is down-graded, the Portfolio may retain the security.
DEPOSITARY RECEIPTS. Depositary Receipts are securities representing ownership
interests in securities of foreign companies (an "underlying issuer") and are
deposited with the depositary. Depositary Receipts are not necessarily
denominated in the same currency as the underlying securities. Depositary
Receipts include American Depositary Receipts ("ADRs"), Global Depositary
Receipts ("GDRs") and other types of Depositary Receipts (which, together with
ADRs and GDRs, are hereinafter collectively referred to as "Depositary
Receipts"). ADRs are dollar-denominated Depositary Receipts typically issued by
a U.S. financial institution which evidence ownership interests in a security
or pool of securities issued by a foreign issuer. ADRs are listed and traded in
the United States. GDRs and other types of Depositary Receipts are typically
issued by foreign banks or trust companies, although they also may be issued by
U.S. financial institutions, and evidence ownership interests in a security or
pool of securities issued by either a foreign or a U.S. corporation. Generally,
Depositary Receipts in registered form are designed for use in the U.S.
securities market and Depositary Receipts in bearer form are designed for use
in securities markets outside the United States.
Depositary Receipts may be "sponsored" or "unsponsored". Sponsored Depositary
Receipts are established jointly by a depositary and the underlying issuer,
whereas unsponsored Depositary Receipts may be established by a depositary
without participation by the underlying issuer. Holders of an unsponsored
Depositary Receipt generally bear all the costs associated with establishing
the unsponsored Depositary Receipt. In addition, the issuers of the securities
underlying unsponsored Depositary Receipts are not obligated to
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disclose material information in the U.S. and, therefore, there may be less
information available regarding such issuers and there may not be a correlation
between such information and the market value of the Depositary Receipts. For
purposes of the Portfolio's investment policies, the Portfolio's investments in
Depositary Receipts will be deemed to be investments in the underlying
securities except as noted.
DERIVATIVES. The Portfolio is permitted to invest in various derivative
instruments for both hedging and non-hedging purposes. Derivatives include
Options, Futures, Structured Notes, Caps, Floors, Collars and Swaps.
Additionally, the Portfolio may invest in other Derivatives that are developed
over time if their use would be consistent with the objectives of the
Portfolio. The Portfolio will limit its use of the foregoing Derivatives for
non-hedging purposes to 33 1/3% of its total assets measured by the aggregate
notional amount of outstanding Derivatives. The Portfolio's investments in
Derivatives for hedging purposes and in forward foreign currency contracts are
not subject to the foregoing limits.
The Portfolio may use Derivatives under a number of different circumstances to
further its investment objective. The Portfolio may use Derivatives when doing
so provides more liquidity than the direct purchase of the securities
underlying such Derivatives. For example, the Portfolio may purchase
Derivatives to quickly gain exposure to a market in response to changes in the
Portfolio's asset allocation policy or upon the inflow of investable cash when
the Derivative provides greater liquidity than the underlying securities
market. The Portfolio may also use Derivatives when it is restricted from
directly owning the underlying securities due to foreign investment
restrictions or other reasons or when doing so provides a price advantage over
purchasing the underlying securities directly, either because of a pricing
differential between the Derivatives and securities markets or because of lower
transaction costs associated with the Derivatives transaction. Derivatives may
also be used by the Portfolio for hedging purposes and under other
circumstances in which the Portfolio's portfolio manager believes it
advantageous to do so consistent with the Portfolio's investment objective. The
Portfolio will not, however, use Derivatives in a manner that creates leverage,
except to the extent that the use of leverage is expressly permitted by the
Portfolio's investment policies, and then only in a manner consistent with such
policies.
Some of the Derivatives in which the Portfolio may invest and the risks related
thereto are described in more detail below. See elsewhere in this Prospectus
and the SAI for more information regarding any investment policies or
limitations applicable to the use of Derivatives.
Options. The Portfolio may seek to increase its returns or may hedge its
portfolio investments through Options transactions with respect to securities,
instruments, indices or baskets thereof in which the Portfolio may invest, as
well as with respect to foreign currency. Purchasing a put Option gives the
Portfolio the right to sell a specified security, currency or basket of
securities or currencies at the exercise price until the expiration of the
Option. Purchasing a call Option gives the Portfolio the right to purchase a
specified security, currency or basket of securities or currencies at the
exercise price until the expiration of the Option.
The Portfolio also may write (i.e., sell) put and call Options on investments
held in its portfolio, as well as with respect to foreign currency. When the
Portfolio writes an Option it receives a premium, which increases the
Portfolio's return on the underlying security or instrument in the event the
Option expires unexercised or is closed out at a profit. However, by writing a
call Option, the Portfolio will limit its opportunity to profit from an
increase in the market value of the underlying security or instrument above the
exercise price of the Option for as long as the Portfolio's obligation as
writer of the Option continues. The Portfolio may only write Options that are
"covered." A covered call Option means that so long as the Portfolio is
obligated as the writer of the Option, it will earmark or segregate sufficient
liquid assets to cover its obligations under the Option or own (i) the
underlying security or instrument subject to the Option, (ii) securities or
instruments convertible or exchangeable without the payment of any
consideration into the security or instrument subject to the Option, or (iii) a
call Option on the same underlying security with a strike price no higher than
the price at which the underlying instrument was sold pursuant to a short
Option position.
By writing (or selling) a put Option, the Portfolio incurs an obligation to buy
the security or instrument underlying the Option from the purchaser of the put
at the Option's exercise price at any time during the Option period, at the
purchaser's election. The Portfolio may also write Options that may be
exercisable by the purchaser only on a specific date. When the Portfolio writes
a put Option, it will earmark or segregate sufficient liquid assets to cover
its obligations under the Option or will own a put Option on the same
underlying security with an equal or higher strike price.
The Portfolio may engage in transactions in Options which are traded on
recognized exchanges or over-the-counter. There currently are limited Options
markets in many countries, particularly emerging countries such as Latin
American countries, and the nature of the strategies adopted by MSAM and the
extent to which those strategies are used will depend on the development of
such Option markets. The primary risks associated with the use of Options are
(i) imperfect correlation between the change in market value of investments
held, purchased or sold by the Portfolio and the prices of Options relating to
such investments; and (ii) possible lack of a liquid secondary market for an
Option.
Futures. The Portfolio may purchase and sell futures contracts and options on
futures contracts, including but not limited to securities index futures,
foreign currency exchange futures, interest rate futures contracts and other
financial futures (collectively, "Futures"). Futures contracts provide for the
sale by one party and purchase by another party of a
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specified amount of a specific security, instrument or basket thereof, at a
specific future date and at a specified price. An option on a futures contract
is a legal contract that gives the holder the right to buy or sell a specified
amount of futures contracts at a fixed or determinable price upon the exercise
of the option.
The Portfolio may sell securities index futures contracts and/or options
thereon in anticipation of or during a market decline to attempt to offset the
decrease in market value of investments in its portfolio, or purchase
securities index futures in order to gain market exposure. Subject to
applicable laws, the Portfolio may engage in transactions in securities index
futures contracts (and options thereon) which are traded on a recognized
securities or futures exchange, or
may purchase or sell such instruments in the over-the-counter market. There
currently are limited securities index futures and options on such futures in
many countries, particularly emerging countries. The nature of the strategies
adopted by MSAM, and the extent to which those strategies are used, may depend
on the development of such markets.
The Portfolio may engage in transactions involving foreign currency exchange
futures contracts. Such contracts involve an obligation to purchase or sell a
specific currency at a specified future date and at a specified price. The
Portfolio may engage in such transactions to hedge its respective holdings and
commitments against changes in the level of future currency rates or to adjust
their exposure to a particular currency. For more information, see "Foreign
Currency Transactions" below.
The Portfolio may engage in transactions in interest rate futures transactions.
Interest rate futures contracts involve an obligation to purchase or sell a
specific debt security, instrument or basket thereof at a specified future date
at a specified price. The value of the contract rises and falls inversely with
changes in interest rates. The Portfolio may engage in such transactions to
hedge its holdings of debt instruments against future changes in interest
rates.
Financial futures are futures contracts relating to financial instruments, such
as U.S. Government securities, foreign currencies, and certificates of deposit.
Such contracts involve an obligation to purchase or sell a specific security,
instrument or basket thereof at a specified future date at a specified price.
Like interest rate futures contracts, the value of financial futures contracts
rises and falls inversely with changes in interest rates. The Portfolio may
engage in financial futures contracts for hedging and non-hedging purposes.
Under rules adopted by the Commodity Futures Trading Commission, the Portfolio
may enter into futures contracts and options thereon for both hedging and non-
hedging purposes, provided that not more than 5% of the Portfolio's total
assets at the time of entering the transaction are required as margin and
option premiums to secure obligations under such contracts relating to non-
hedging activities.
Gains and losses on futures contracts and options thereon depend on MSAM's
ability to predict correctly the direction of securities prices, interest rates
and other economic factors. Other risks associated with the use of futures and
options are (i) imperfect correlation between the change in market value of
investments held by the Portfolio and the prices of futures and options
relating to investments purchased or sold by the Portfolio, and (ii) possible
lack of a liquid secondary market for a futures contract and the resulting
inability to close a futures position. The risk that the Portfolio will be
unable to close out a futures position or options contract will be minimized by
only entering into futures contracts or options transactions for which there
appears to be a liquid exchange or secondary market. The risk of loss in
trading on futures contracts in some strategies can be substantial, due both to
the low margin deposits required and the extremely high degree of leverage
involved in futures pricing.
Structured Notes. Structured Notes are Derivatives on which the amount of
principal repayment and/or interest payments is based upon the movement of one
or more factors. These factors include, but are not limited to, currency
exchange rates, interest rates (such as the prime lending rate and LIBOR) and
stock indices such as the S&P 500. In some cases, the impact of the movements
of these factors may increase or decrease through the use of multipliers or
deflators. The Portfolio may use Structured Notes to tailor its investments to
the specific risks and returns MSAM wishes to accept while avoiding or reducing
certain other risks.
Caps, Floors and Collars. The Portfolio may invest in Caps, Floors and Collars,
which are instruments analogous to Options. In particular, a Cap is the right
to receive the excess of a reference rate over a given rate and is analogous to
a put Option. A Floor is the right to receive the excess of a given rate over a
reference rate and is analogous to a call Option. Finally, a Collar is an
instrument that combines a Cap and a Floor. That is, the buyer of a Collar buys
a Cap and writes a Floor, and the writer of a Collar writes a Cap and buys a
Floor. The risks associated with Caps, Floors and Collars are similar to those
associated with Options. In addition, Caps, Floors and Collars are subject to
risk of default by the counterparty because they are privately negotiated
instruments.
Swaps. Swap Contracts ("Swaps") are Derivatives in the form of a contract or
other similar instrument in which two parties agree to exchange the returns
generated by a security, instrument, basket thereof or index for the returns
generated by another security, instrument, basket thereof or index. The payment
streams are calculated by reference to a specific security, index or instrument
and an agreed upon notional amount. The relevant indices include but are not
limited to, currencies, fixed interest rates, prices and total return on
interest rate indices, fixed income indices, stock indices and commodity
indices (as well as amounts derived from
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arithmetic operations on these indices). For example, the Portfolio may agree
to swap the return generated by a fixed income index for the return generated
by a second fixed income index. The currency Swaps in which the Portfolio may
enter will generally involve an agreement to pay interest streams in one
currency based on a specified index in exchange for receiving interest streams
denominated in another currency. Such Swaps may involve initial and final
exchanges that correspond to the agreed upon notional amount.
The Portfolio will usually enter into Swaps on a net basis, i.e., the two
return streams are netted out in a cash settlement on the payment date or dates
specified in the instrument, with the Portfolio receiving or paying, as the
case may be, only the net amount of the two returns. The Portfolio's
obligations under a Swap agreement will be accrued daily (offset against any
amounts owing to the Portfolio) and any accrued, but unpaid, net amounts owed
to a Swap counterparty will be covered by the maintenance of a segregated
account consisting of cash or liquid securities. The Portfolio will not enter
into any Swap agreement unless the counterparty meets the rating requirements
set forth in guidelines established by the Fund's Board of Directors.
Interest rate and total rate of return Swaps do not involve the delivery of
securities, other underlying assets, or principal. Accordingly, the risk of
loss with respect to interest rate and total rate of return Swaps is limited to
the net amount of payments that the Portfolio is contractually obligated to
make. If the other party to an interest rate or total rate of return Swap
defaults, the Portfolio's risk of loss consists of the net amount of payments
that the Portfolio is contractually entitled to receive. In contract, currency
Swaps may involve the delivery of the entire principal value of one designated
currency in exchange for the other designated currency. Therefore, the entire
principal value of a currency Swap may be subject to the risk that the other
party of the Swap will default on its contractual delivery obligations. If
there is a default by the counterparty, the Portfolio may have contractual
remedies pursuant to the agreements related to the transaction. The Swaps
market has grown substantially in recent years with a large number of banks and
investment banking firms acting both as principals and as agents utilizing
standardized Swap documentation. As a result, the Swaps market has become
relatively liquid. Swaps that include Caps, Floors and Collars are more recent
innovations for which standardized documentation has not yet been fully
developed and, accordingly, they are less liquid than "traditional" Swaps.
The use of Swaps is a highly specialized activity which involves investment
techniques and risks different from those associated with ordinary portfolio
securities transactions. If MSAM is incorrect in its forecasts of market
values, interest rates, and currency exchange rates, the investment performance
of the Portfolio would be less favorable than it would have been if this
investment technique were not used.
EASTERN EUROPEAN SECURITIES. The economies of Eastern European countries are
currently suffering both from the stagnation resulting from centralized
economic planning and control and the higher prices and unemployment associated
with the transition to market economics. Unstable economic and political
conditions may adversely affect security values. Upon the accession to power of
Communist regimes approximately 40 years ago, the governments of a number of
Eastern European countries expropriated a large amount of property. The claims
of many property owners against those governments were never finally settled.
In the event of the return to power of the Communist Party, there can be no
assurance that the Portfolio's investments in Eastern Europe would not be
expropriated, nationalized or otherwise confiscated.
EMERGING MARKET COUNTRY SECURITIES. An Emerging Market Country Security is one
issued by a company that has one or more of the following characteristics: (i)
its principal securities trading market is in an emerging market, (ii) alone or
on a consolidated basis it derives 50% or more of its annual revenue from
either goods produced, sales made or services performed in emerging markets, or
(iii) it is organized under the laws of, and has a principal office in, an
emerging market country. MSAM will base determinations as to eligibility on
publicly available information and inquiries made to the companies.
The economies of individual emerging market countries may differ favorably or
unfavorably from the U.S. economy in such respects as growth of gross domestic
product, rate of inflation, currency depreciation, capital reinvestment,
resource self-sufficiency and balance of payments position. Further, the
economies of developing countries generally are heavily dependent upon
international trade and, accordingly, have been, and may continue to be,
adversely affected by trade barriers, exchange controls, managed adjustments in
relative currency values and other protectionist measures imposed or negotiated
by the countries with which they trade. These economies also have been, and may
continue to be, adversely affected by economic conditions in the countries with
which they trade.
Investing in emerging market countries may entail purchasing securities issued
by or on behalf of entities that are insolvent, bankrupt, in default or
otherwise engaged in an attempt to reorganize or reschedule their obligations,
and in entities that have little or no proven credit rating or credit history.
In any such case, the issuer's poor or deteriorating financial condition may
increase the likelihood that the Portfolio will experience losses or diminution
in available gains due to bankruptcy, insolvency or fraud.
With respect to any emerging market country, there is the possibility of
nationalization, expropriation or confiscatory taxation, political changes,
government regulation, social instability or diplomatic developments (including
war) that could affect adversely the economies of such countries or the value
of the Portfolio's investments in those countries. In
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addition, it may be difficult to obtain and enforce a judgment in a court
outside of the United States.
EQUITY SECURITIES. Equity Securities commonly include, but are not limited to,
Common Stocks, Preferred Stocks, Depositary Receipts, Rights, Warrants, and
Foreign Equities. Preferred Stock is contained in both the definition of Equity
Securities and Fixed Income Securities because it exhibits characteristics
commonly associated with each type of security. See the "The Portfolio's
Investments" section to determine in which of the above the Portfolio may
invest.
FIXED INCOME SECURITIES. Fixed Income Securities commonly include, but are not
limited to, debentures, U.S. Governments, Zero Coupons, Agencies, Corporate
Bonds, High Yield Securities, MBSs, SMBSs, CMOs, ABSs, Convertible Securities,
Brady Bonds, Floaters, Inverse Floaters, Cash Equivalents, Municipals,
Repurchase Agreements, Preferred Stocks and Foreign Bonds. Preferred Stock is
contained in both the definition of Equity Securities and Fixed Income
Securities since it exhibits characteristics commonly associated with each type
of security. See the "Portfolio's Investments" section to determine in which of
the above the Portfolio may invest.
FLOATERS. Floaters are Fixed Income Securities with a floating or variable rate
of interest, i.e., the rate of interest varies with changes in specified market
rates or indices, such as the prime rate, or at specified intervals. Certain
Floaters may carry a demand feature that permits the holder to tender them back
to the issuer of the underlying instrument, or to a third party, at par value
prior to maturity. When the demand feature of certain Floaters represents an
obligation of a foreign entity, the demand feature will be subject to certain
risks discussed under "Foreign Investment."
FOREIGN BONDS. Foreign Bonds are Fixed Income Securities denominated in foreign
currency and issued and traded primarily outside the United States, including:
(1) obligations issued or guaranteed by foreign national governments, their
agencies, instrumentalities, or political subdivisions; (2) Fixed Income
Securities issued, guaranteed or sponsored by supranational organizations
established or supported by several national governments, including the World
Bank, the European Community, the Asian Development Bank and others; (3) non-
government foreign corporate debt securities; (4) foreign MBSs and various
other MBSs and ABSs denominated in foreign currency; and (5) Brady Bonds.
Investing in foreign companies involves certain special considerations that are
not typically associated with investing in U.S. companies. See "Foreign
Investment" below.
FOREIGN CURRENCY TRANSACTIONS. The Portfolio invests in foreign securities and
will regularly transact security purchases and sales in foreign currencies. The
Portfolio may hold foreign currency or engage in the Foreign Currency
Transactions discussed below.
As a means of reducing the risks associated with investing in securities
denominated in foreign currencies, the Portfolio may purchase or sell foreign
currency on a forward basis ("Forwards" or "forward contracts"), enter into
foreign currency futures contracts and options on futures ("Forex Futures") and
foreign currency options ("Forex Options"). These investment techniques are
designed primarily to hedge against anticipated future changes in currency
prices, that otherwise might adversely affect the value of the Portfolio's
investments.
Forex Futures are standardized contracts for the future delivery of a specified
amount of a foreign currency at a future date at a price set at the time of the
contract. Forex Futures traded in the United States are traded on regulated
futures exchanges. The Portfolio will incur brokerage fees when it purchases or
sells Forex Futures and it will be required to maintain margin deposits.
Parties to a Forex Future must make initial margin deposits to secure
performance of the contract, which generally range from 2% to 5% of the
contract price. There also are requirements to make "variation" margin deposits
as the value of the futures contract fluctuates.
Purposes for which such Forex Futures and Forex Options may be used include
protecting against a decline in a foreign currency against the U.S. dollar
between the trade date and settlement date when the Portfolio purchases or
sells securities, locking in the U.S. dollar value of dividends declared on
securities held by the Portfolio and generally protecting the U.S. dollar value
of securities held by the Portfolio against exchange rate fluctuations. Such
contracts will be used only as a protective measure against the effects of
fluctuating rates of currency exchange and exchange control regulations. While
Forex Futures and Forex Options may limit losses to the Portfolio as a result
of exchange rate fluctuation, they will also limit any gains that may otherwise
have been realized.
Forwards are obligations to purchase or sell an amount of a specified currency
at a future date, which may be any fixed number of days from the date of the
contract agreed upon by the parties, at a price set at the time of the
contract. Forwards are traded in the interbank market conducted directly
between currency traders (usually large commercial banks).
The Portfolio may use Forwards in the normal course of business to lock in an
exchange rate in connection with purchases and sales of securities (transaction
hedge) or to lock in the dollar value of portfolio positions (position hedge).
In addition, the Portfolio may cross-hedge currencies by entering into a
transaction to purchase or sell one or more currencies that are expected to
decline in value relative to other currencies to which the Portfolio has or
expects to have portfolio exposure. The Portfolio may also engage in proxy
hedging which is defined as entering into positions in one currency to hedge
investments denominated in another currency, where the two currencies are
economically linked. Forwards will be used only as a protective measure against
the effects of fluctuating rates of currency exchange and
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exchange control regulations. While such contracts may limit losses to the
Portfolio as a result of exchange rate fluctuation, they will also limit any
gains that may otherwise have been realized.
The Portfolio may also combine forward contracts with investments in securities
denominated in other currencies in order to achieve desired credit and currency
exposures. Such combinations are generally referred to as synthetic securities.
For example, in lieu of purchasing a Foreign Bond, the Portfolio may purchase a
U.S. dollar-denominated security and at the same time enter into a forward
contract to exchange U.S. dollars for the contract's underlying currency at a
future date. By matching the amount of U.S. dollars to be exchanged with the
anticipated value of the U.S. dollar-denominated security, the Portfolio may be
able to lock in the foreign currency value of the security and adopt a
synthetic investment position reflecting the credit quality of the U.S. dollar-
denominated security.
There is a risk in adopting a synthetic investment position to the extent that
the value of a security denominated in the U.S. dollar or other foreign
currency is not exactly matched with the Portfolio's obligation under the
forward contract. On the date of maturity, the Portfolio may be exposed to some
risk of loss from fluctuations in that currency. Although MSAM will attempt to
hold such mismatching to a minimum, there can be no assurance that MSAM will be
able to do so. When the Portfolio enters into a forward contract for purposes
of creating a synthetic security, it will generally be required to hold liquid
assets in a segregated account with a daily value at least equal to its
obligation under the forward contract.
When the Portfolio engages in Forwards it will comply with the segregation
requirements required by the 1940 Act and the rules adopted thereunder. See
"Investment Objectives and Policies--Forward Foreign Currency Exchange
Contracts" in the SAI.
At the maturity of a forward contract, the Portfolio may either accept or make
delivery of the currency specified in the contract or, prior to maturity, enter
into a closing purchase transaction involving the purchase or sale of an
offsetting contract. Closing purchase transactions with respect to Forwards are
usually effected with the currency trader who is a party to the original
forward contract. The Portfolio will only enter into such a forward contract if
it is expected that there will be a liquid market in which to close out such
contract. There can, however, be no assurance that such a liquid market will
exist in which to close a forward contract, in which case the Portfolio may
suffer a loss.
FOREIGN EQUITIES. Foreign Equity Securities ("Foreign Equities") include, but
are not limited to, Common Stock, Preferred Stock, Depositary Receipts, Rights,
Warrants and Convertible Securities of foreign issuers. Investing in foreign
companies involves certain special considerations which are not typically
associated with investing in U.S. companies. See "Foreign Investment" below.
FOREIGN INVESTMENT. Investment in securities and obligations of foreign issuers
and in foreign branches of domestic banks involves somewhat different
investment risks than those affecting obligations of U.S. issuers. There may be
limited publicly available information with respect to foreign issuers, and
foreign issuers are not generally subject to uniform accounting, auditing and
financial standards and requirements comparable to those applicable to U.S.
companies. There may also be less government supervision and regulation of
foreign securities exchanges, brokers and listed companies than in the U.S.
Many foreign securities markets have substantially less volume than U.S.
national securities exchanges, and securities of some foreign issuers are less
liquid and more volatile than securities of comparable domestic issuers.
Brokerage commissions and other transaction costs on foreign securities
exchanges are generally higher than in the United States. Dividends and
interest paid by foreign issuers may be subject to withholding and other
foreign taxes, which may decrease the net return on Foreign Investments as
compared to dividends and interest paid by U.S. companies. Additional risks
include future political and economic developments, the possibility that a
foreign jurisdiction will impose or change withholding taxes on income payable
with respect to foreign securities, and the possible adoption of foreign
governmental restrictions such as exchange controls.
Prior governmental approval for Foreign Investments may be required under
certain circumstances in some emerging countries, and the extent of Foreign
Investment in certain Fixed Income Securities and domestic companies may be
subject to limitation in other emerging countries. Foreign ownership
limitations also may be imposed by the charters of individual companies in
emerging countries to prevent, among other concerns, violation of Foreign
Investment limitations.
Repatriation of investment income, capital and the proceeds of sales by foreign
investors may require governmental registration and/or approval in some
emerging countries. The Portfolio could be adversely affected by delays in, or
a refusal to grant, any required governmental registration or approval for such
repatriation. Any investment subject to such repatriation controls will be
considered illiquid if it appears reasonably likely that this process will take
more than seven days.
Investments in securities of foreign issuers are frequently denominated in
foreign currencies. Because the Portfolio may temporarily hold uninvested
reserves in bank deposits in foreign currencies, the value of the Portfolio's
assets, as measured in U.S. dollars, may be affected favorably or unfavorably
by changes in currency rates and in exchange control regulations and the
Portfolio may incur costs in connection with conversions between various
currencies.
HIGH YIELD SECURITIES. High Yield Securities are generally considered to
include Corporate Bonds, Preferred
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Stocks and Convertible Securities rated Ba through C by Moody's or BB through D
by S&P, and unrated securities considered to be of equivalent quality.
Securities rated less than Baa by Moody's or BBB by S&P are classified as non-
Investment Grade Securities and are commonly referred to as junk bonds or High
Yield Securities. Such securities carry a high degree of risk and are
considered speculative by the major credit rating agencies. The following are
excerpts from the Moody's and S&P definitions for speculative-grade debt
obligations:
Moody's: Ba-rated bonds have "speculative elements" so their future
"cannot be considered assured," and protection of principal and interest
is "moderate" and "not well safeguarded during both good and bad times in
the future." B-rated bonds "lack characteristics of a desirable
investment" and the assurance of interest or principal payments "may be
small." Caa-rated bonds are "of poor standing," and "may be in default"
or may have "elements of danger with respect to principal or interest."
Ca-rated bonds represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked
shortcomings. C-rated bonds are the "lowest rated" class of bonds, and
issues so rated can be regarded as having "extremely poor prospects" of
ever attaining any real investment standing.
S&P: BB-rated bonds have "less near-term vulnerability to default" than
B- or CCC-rated securities but face major ongoing uncertainties . . .
which may lead to inadequate capacity" to pay interest or principal. B-
rated bonds have a "greater vulnerability to default than BB-rated bonds
and the ability to pay interest or principal will likely be impaired by
adverse business conditions." CCC-rated bonds have a currently
identifiable "vulnerability to default" and, without favorable business
conditions, will be "unable to repay interest and principal." The rating
C is reserved for income bonds on which "no interest is being paid." Debt
rated D is in default," and "payment of interest and/or repayment of
principal is in arrears."
While such securities offer high yields, they also normally carry with them a
greater degree of risk than securities with higher ratings. High Yield
Securities may be issued as a consequence of corporate restructuring or similar
events. Also, High Yield Securities are often issued by smaller, less credit
worthy companies, or by highly leveraged (indebted) firms, which are generally
less able than more established or less leveraged firms to make scheduled
payments of interest and principal. The price movement of these securities is
influenced less by changes in interest rates and more by the financial and
business position of the issuing corporation when compared to Investment Grade
Securities.
The risks posed by securities issued under such circumstances are substantial.
If a security held by the Portfolio is down-graded, the Portfolio may retain
the security.
INVERSE FLOATERS. Inverse floating rate obligations ("Inverse Floaters") are
Fixed Income Securities, which have coupon rates that vary inversely at a
multiple of a designated floating rate, such as LIBOR (London Inter-Bank
Offered Rate). Any rise in the reference rate of an inverse floater (as a
consequence of an increase in interest rates) causes a drop in the coupon rate
while any drop in the reference rate of an inverse floater causes an increase
in the coupon rate. Inverse Floaters may exhibit substantially greater price
volatility than fixed rate obligations having similar credit quality,
redemption provisions and maturity, and inverse floater CMOs exhibit greater
price volatility than the majority of mortgage pass-through securities or CMOs.
In addition, some inverse floater CMOs exhibit extreme sensitivity to changes
in prepayments. As a result, the yield to maturity of an inverse floater CMO is
sensitive not only to changes in interest rates but also to changes in
prepayment rates on the related underlying mortgage assets.
INVESTMENT COMPANY SECURITIES. Investments in investment companies are
securities of other open-end or closed-end investment companies. The Investment
Company Act of 1940, as amended (the "1940 Act"), generally prohibits the
Portfolio from acquiring more than 3% of the outstanding voting shares of an
investment company and limits such investments to no more than 5% of the
Portfolio's total assets in any one investment company and no more than 10% in
any combination of investment companies. The 1940 Act also prohibits a
Portfolio from acquiring any security of a registered closed-end investment
company if the Portfolio and other investment companies with the same adviser
would own more than 10% of the outstanding voting shares of the company.
To the extent the Portfolio invests a portion of its assets in Investment
Company Securities, those assets will be subject to the expenses of the
purchased investment company as well as to the expenses of the Portfolio
itself. The Portfolio may not purchase shares of any affiliated investment
company except as permitted under the 1940 Act or by a rule or order of the
Securities and Exchange Commission ("SEC").
INVESTMENT FUNDS. Some emerging market countries have laws and regulations that
currently preclude direct investment in the securities of their companies.
However, indirect investment in the securities of companies listed and traded
on the stock exchanges in these countries is permitted by certain emerging
market countries through Investment Funds that have been specifically
authorized. The Portfolio may invest in these Investment Funds subject to the
provisions of the 1940 Act, as applicable, and other applicable laws as
discussed in "Investment Limitations" in the SAI. The Portfolio will invest in
such Investment Funds only where appropriate given that the Portfolio's
shareholders will bear not only their proportionate share of the expenses of
the Portfolio (including operating expenses and the fees of
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MSAM), but also will indirectly bear similar expenses of the underlying
Investment Funds.
Certain Investment Funds are advised by MSAM. The Portfolio may, to the extent
permitted under the 1940 Act and other applicable law, invest in these
Investment Funds. If the Portfolio does elect to make an investment in such an
Investment Fund, it will only purchase the securities of such Investment Fund
in the secondary market.
INVESTMENT GRADE SECURITIES. Investment Grade Securities are those rated by one
or more NRSRO in one of the four highest rating categories at the time of
purchase (e.g., AAA, AA, A or BBB by S&P or Fitch, or Aaa, Aa, A or Baa by
Moody's). Securities rated BBB or Baa represent the lowest of four levels of
Investment Grade Securities and are regarded as borderline between definitely
sound obligations and those in which the speculative element begins to
predominate. MBSs, including mortgage pass-throughs and CMOs, deemed investment
grade by MSAM, will either carry a guarantee from an agency of the U.S.
Government or a private issuer of the timely payment of principal and interest
(such guarantees do not extend to the market value of such securities or the
net asset value per share of the Portfolio) or, in the case of unrated
securities, be sufficiently seasoned that they are considered by MSAM to be
investment grade quality. MSAM may retain a security if its rating falls below
investment grade if it deems retention of the security to be in the best
interests of the Portfolio. The Portfolio may hold unrated securities if MSAM
considers the risks involved in owning that security to be equivalent to the
risks involved in holding an Investment Grade Security.
LOAN PARTICIPATIONS AND ASSIGNMENTS. Loan Participations are loans or other
direct debt instruments which are interests in amounts owed by a corporate,
governmental or other borrower to another party. They may represent amounts
owed to lenders or lending syndicates, to suppliers of goods or services (trade
claims or other receivables) or to other parties. The Portfolio may invest in
fixed rate and floating rate loans ("Loans") arranged through private
negotiations between an issuer of sovereign debt obligations and one or more
financial institutions ("Lenders"). The Portfolio's investments in Loans are
expected in most instances to be in the form of participation in Loans
("Participations") and assignments of all or a portion of Loans ("Assignments")
from third parties. The Portfolio will have the right to receive payments of
principal, interest and any fees to which it is entitled only from the Lender
selling the Participation and only upon receipt by the Lender of the payments
from the borrower. In the event of the insolvency of the Lender selling a
Participation, the Portfolio may be treated as a general creditor of the Lender
and may not benefit from any set-off between the Lender and the borrower.
Certain Participations may be structured in a manner designed to avoid
purchasers of Participations being subject to the credit risk of the Lender
with respect to the Participation. Even under such a structure, in the event of
the Lender's insolvency, the Lender's servicing of the Participation may be
delayed and the assignability of the Participation may be impaired. The
Portfolio will acquire Participations only if the Lender interpositioned
between the Portfolio and the borrower is determined by MSAM to be
creditworthy.
When the Portfolio purchases Assignments from Lenders it will acquire direct
rights against the borrower on the Loan. However, because Assignments are
arranged through private negotiations between potential assignees and potential
assignors, the rights and obligations acquired by the Portfolio as the
purchaser of an Assignment may differ from, and be more limited than, those
held by the assigning Lender. Because there is no liquid market for such
securities, the Portfolio anticipates that such securities could be sold only
to a limited number of institutional investors. The lack of a liquid secondary
market may have an adverse impact on the value of such securities and the
Portfolio's ability to dispose of particular Assignments or Participations when
necessary to meet the Portfolio's liquidity needs or in response to a specific
economic event such as a deterioration in the creditworthiness of the borrower.
The lack of a liquid secondary market for Assignments and Participations also
may make it more difficult for the Portfolio to assign a value to these
securities for purposes of valuing the Portfolio's securities and calculating
its NAV.
Direct debt instruments involve the risk of loss in case of default or
insolvency of the borrower. Direct debt instruments may offer less legal
protection to the Portfolio in the event of fraud or misrepresentation and may
involve a risk of insolvency of the lending bank or other financial
intermediary. Direct debt instruments may also include standby financing
commitments that obligate the investing Portfolio to supply additional cash to
the borrower on demand. Participations involving emerging market country
issuers may relate to loans as to which there has been or currently exists an
event of default or other failure to make payment when due, and may represent
amounts owed to financial institutions that are themselves subject to political
and economic risks, including the risk of currency devaluation, expropriation,
or failure. Such Participations present additional risks of default or loss.
LOANS OF PORTFOLIO SECURITIES. The Portfolio may lend its securities to
brokers, dealers, domestic and foreign banks or other financial institutions
for the purpose of increasing its net investment income. These loans must be
secured continuously by cash or equivalent collateral, or by a letter of credit
at least equal to the market value of the securities loaned plus accrued
interest or income. There may be a risk of delay in recovery of the securities
or even loss of rights in the collateral should the borrower of the securities
fail financially. The Portfolio will not enter into securities loan
transactions exceeding, in the aggregate, 33 1/3% of its total assets. For more
detailed information about securities lending, see "Securities and Investment
Techniques" in the SAI.
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MONEY MARKET INSTRUMENTS. The Portfolio may invest in Money Market Instruments,
although the Portfolio intends to stay invested in securities satisfying its
primary investment objective to the extent practical. The Portfolio may invest
in Money Market Instruments pending other investment or settlement for
liquidity, or in adverse market conditions. The Money Market Instruments
permitted for the Portfolio include obligations of the U.S. Government and its
agencies and instrumentalities; obligations of foreign sovereignties;
obligations of the International Bank for Reconstruction and Development; other
debt securities; commercial paper, including bank obligations; certificates of
deposit (including Eurodollar certificates of deposit); and Repurchase
Agreements. For more detailed information about these Money Market Instruments,
see "Description of Certain Securities and Ratings" in the SAI.
MBSS. Mortgage-Backed Securities ("MBSs") are instruments that entitle the
holder to a share of all interest and principal payments from pools of
residential and commercial mortgage loans underlying the instruments, and may
take the form of pass-through securities or CMOs. Generally, these securities
are designed to provide monthly payments of interest and principal to the
investor.
Pass-Through Securities. The mortgagee's monthly payments to his or her lending
institution are passed through to investors such as the Portfolio. Most issuers
or poolers provide guarantees of payments, regardless of whether the mortgagor
actually makes the payment. The guarantees made by issuers or poolers are
supported by various forms of credit, collateral, guarantees or insurance,
including individual loan, title, pool and hazard insurance purchased by the
issuer. The pools are assembled by various governmental, Government-related and
private organizations. The Portfolio may invest in securities issued or
guaranteed by the Government National Mortgage Association ("GNMA"), Federal
Home Loan Mortgage Corporation ("FHLMC"), Federal National Mortgage Association
("FNMA"), private issuers and other government agencies. There can be no
assurance that the private insurers can meet their obligations under the
policies. MBSs issued by non-agency issuers, whether or not such securities are
subject to guarantees, may entail greater risk. If there is no guarantee
provided by the issuer, MBSs purchased by the Portfolio will be those which at
time of purchase are rated investment grade by one or more NRSRO, or, if
unrated, are deemed by MSAM to be of investment grade quality.
Due to the possibility that prepayments on home mortgages will alter cash flow
on MBSs, it is not possible to determine in advance the actual final maturity
date or average life. Faster prepayment will shorten the average life and
slower prepayments will lengthen it. However, it is possible to determine what
the range of that movement could be and to calculate the effect that it will
have on the price of the security. In selecting these securities, MSAM will
look for those securities that offer a higher yield to compensate for any
variation in average maturity.
There are two methods of trading MBSs. A specified pool transaction is a trade
in which the pool number of the security to be delivered on the settlement date
is known at the time the trade is made. This is in contrast with the typical
MBS transaction, called a TBA (to be announced) transaction, in which the type
of MBS to be delivered is specified at the time of trade but the actual pool
numbers of the securities that will be delivered are not known at the time of
the trade. The pool numbers of the pools to be delivered at settlement will be
announced shortly before settlement takes place. The terms of the TBA trade may
be made more specific if desired. Generally, agency pass-through MBSs are
traded on a TBA basis.
CMOs. CMOs are debt securities that are issued by a thrift or other financial
institution and are collateralized as follows. The bondholder has a first
priority perfected security interest in collateral, usually consisting of
agency mortgage pass-through securities, although other assets, including U.S.
Treasuries (including Zero Coupons), Agencies, Cash Equivalents, whole loans
and Corporate Bonds, may qualify. The amount of collateral must be continuously
maintained at levels from 115% to 150% of the principal amount of the bonds
issued, depending on the specific issue structure and collateral type. See
"CMOs" above.
MUNICIPALS. Municipal securities ("Municipals") are debt obligations issued by
local, state and regional governments that provide interest income that is
exempt from federal income taxes. Municipals include both municipal bonds
(those securities with maturities of five years or more) and municipal notes
(those with maturities of less than five years). Municipal bonds are issued for
a wide variety of reasons: to construct public facilities, such as airports,
highways, bridges, schools, hospitals, mass transportation, streets, water and
sewer works; to obtain funds for operating expenses; to refund outstanding
municipal obligations; and to loan funds to various public institutions and
facilities. Certain industrial development bonds are also considered municipal
bonds if their interest is exempt from federal income tax. Industrial
development bonds are issued by or on behalf of public authorities to obtain
funds for various privately-operated manufacturing facilities, housing, sports
arenas, convention centers, airports, mass transportation systems and water,
gas or sewer works. Industrial development bonds are ordinarily dependent on
the credit quality of a private user, not the public issuer.
NON-DIVERSIFIED STATUS. The Portfolio is a non-diversified portfolio under the
1940 Act, which means that the Portfolio is not limited by the 1940 Act in the
proportion of its assets that may be invested in the obligations of a single
issuer. Thus, the Portfolio may invest a greater proportion of its assets in
the securities of a small number of issuers and, as a result, will be subject
to greater risk with respect to its portfolio securities. However, the
Portfolio intends to comply with diversification requirements imposed by the
Internal Revenue Code of 1986, as amended (the
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"Code"), for qualification as regulated investment company. See "Investment
Limitations" and "Taxes" in the SAI.
NON-PUBLICLY TRADED SECURITIES, PRIVATE PLACEMENTS AND RESTRICTED
SECURITIES. The Portfolio may invest in securities that are neither listed on a
stock exchange nor traded over-the-counter, including privately placed
securities. Such unlisted securities may involve a higher degree of business
and financial risk that can result in substantial losses. As a result of the
absence of a public trading market for these securities, they may be less
liquid than publicly traded securities. Although these securities may be resold
in privately negotiated transactions, the prices realized from these sales
could be less than those originally paid by the Portfolio or less than what may
be considered the fair value of such securities. Furthermore, companies whose
securities are not publicly traded may not be subject to the disclosure and
other investor protection requirements which might be applicable if their
securities were publicly traded. If such securities are required to be
registered under the securities laws of one or more jurisdictions before being
resold, the Portfolio may be required to bear the expenses of registration.
As a general matter, the Portfolio may not invest more than 15% of its net
assets in illiquid securities, including securities for which there is no
readily available secondary market and securities that are restricted from sale
to the public without registration ("Restricted Securities") under the
Securities Act of 1933, as amended (the "1933 Act") and are deemed to be
illiquid. Restricted Securities that can be offered and sold to qualified
institutional buyers under Rule 144A under the 1933 Act ("144A Securities") may
be deemed to be liquid under guidelines adopted by the Fund's Board of
Directors. The Portfolio may invest up to 25% of its total assets in 144A
Securities that are deemed to be liquid.
The Fund's Board of Directors has delegated to MSAM, subject to the supervision
of the Board of Directors, the daily function of determining and monitoring the
liquidity of Rule 144A Securities. Rule 144A Securities may become illiquid if
qualified institutional buyers are not interested in acquiring the securities.
Investors should note that investment of 5% of the Portfolio's total assets in
Restricted Securities may be considered a speculative activity and may involve
greater risk and expense to the Portfolio.
PREFERRED STOCKS. Preferred Stocks are non-voting securities which evidence
ownership in a corporation and which pay a fixed or variable stream of
dividends.
RIGHTS. Rights represent a preemptive right of stockholders to purchase
additional shares of a stock at the time of a new issuance, before the stock is
offered to the general public, allowing the stockholder to retain the same
ownership percentage after the new stock offering.
REPURCHASE AGREEMENTS. Repurchase Agreements are transactions in which the
Portfolio purchases a security and simultaneously commits to resell that
security to the seller (a bank, broker or dealer) at a mutually agreed upon
date and price. The term of these agreements is usually from overnight to one
week, and never exceeds one year. Repurchase Agreements may be viewed as a
fully collateralized loan of money by the Portfolio to the seller. The resale
price reflects the purchase price plus an agreed upon market rate of interest
which is unrelated to the coupon rate or date of maturity of the purchased
security.
In these transactions, the securities received by the Portfolio have a market
value at least equal to the purchase price (including accrued interest) of the
Repurchase Agreement as collateral, and this value is maintained during the
term of the agreement. These securities are held by the Portfolio's custodian
or an approved third party for the benefit of the Portfolio until repurchased.
Repurchase Agreements permit the Portfolio to keep all its assets invested
while retaining overnight flexibility in pursuit of investments of a longer
term nature. If the seller defaults and the collateral value declines, the
Portfolio might incur a loss. If bankruptcy proceedings are commenced with
respect to the seller, the Portfolio's realization upon the collateral may be
delayed or limited.
Pursuant to an order expected to be issued by the SEC, all of the Fund's
Portfolios, including the sixteen Portfolios of the Fund not described in this
Prospectus, may pool their daily uninvested cash balances in order to invest in
Repurchase Agreements on a joint basis. By entering into Repurchase Agreements
on a joint basis, it is expected that the Portfolios will incur lower
transaction costs and potentially obtain higher rates of interest on such
Repurchase Agreements. Each Portfolio's participation in the income from
jointly purchased Repurchase Agreements will be based on that Portfolio's
percentage share in the total Repurchase Agreement. The Portfolio's ability to
invest in Repurchase Agreements on a joint basis will be contingent upon
issuance of the order by the SEC described above.
REVERSE REPURCHASE AGREEMENTS. The Portfolio may enter into Reverse Repurchase
Agreements with brokers, dealers, domestic and foreign banks or other financial
institutions. In a Reverse Repurchase Agreement, the Portfolio sells a security
and agrees to repurchase it at a mutually agreed upon date and price,
reflecting the interest rate effective for the term of the agreement. It may
also be viewed as the borrowing of money by the Portfolio. The Portfolio's
investment of the proceeds of a Reverse Repurchase Agreement is the speculative
factor known as leverage. The Portfolio may enter into a Reverse Repurchase
Agreement only if the interest income from investment of the proceeds is
greater than the interest expense of the transaction and the proceeds are
invested for a period no longer than the term of the agreement. The Portfolio
will maintain with the custodian a separate account with a segregated portfolio
of unencumbered liquid assets in an amount at least equal to its purchase
obligations under these agreements. If interest rates rise during a Reverse
Repurchase
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Agreement, it may adversely affect the Portfolio's ability to maintain a stable
NAV.
RUSSIAN SECURITIES. The registration, clearing and settlement of securities
transactions involving Russian issuers are subject to significant risks not
normally associated with securities transactions in the United States and other
more developed markets. Ownership of Equity Securities in Russian companies is
evidenced by entries in a company's share register (except where shares are
held through depositories that meet the requirements of the 1940 Act) and the
issuance of extracts from the register or, in certain limited cases, by formal
share certificates. However, Russian share registers are frequently unreliable
and the Portfolio could possibly lose its registration through oversight,
negligence or fraud. Moreover, Russia lacks a centralized registry to record
securities transactions and registrars located throughout Russia or the
companies themselves maintain share registers. Registrars are under no
obligation to provide extracts to potential purchasers in a timely manner or at
all and are not necessarily subject to effective state supervision. In
addition, while registrars are liable under law for losses resulting from their
errors, it may be difficult for the Portfolio to enforce any rights it may have
against the registrar or issuer of the securities in the event of loss of share
registration. Although Russian companies with more than 1,000 shareholders are
required by law to employ an independent registrar in practice, such companies
have not always followed this law. Because of this lack of independence of
registrars, management of a Russian company may be able to exert considerable
influence over who can purchase and sell the company's shares by illegally
instructing the registrar to refuse to record transactions on the share
register. Furthermore, these practices may prevent the Portfolio from investing
in the securities of certain Russian companies deemed suitable by MSAM and
could cause a delay in the sale of Russian Securities by the Portfolio if the
company deems a purchaser unsuitable, which may expose the Portfolio to
potential loss on its investment.
In light of the risks described above, the Board of Directors of the Fund has
approved certain procedures concerning the Fund's investments in Russian
Securities. Among these procedures is a requirement that the Portfolio will not
invest in the Equity Securities of a Russian company unless that issuer's
registrar has entered into a contract with the Fund's sub-custodian containing
certain protective conditions, including, among other things, the sub-
custodian's right to conduct regular share confirmations on behalf of the
Portfolio. This requirement will likely have the effect of precluding
investments in certain Russian companies that the Portfolio would otherwise
make.
SMBSS. Stripped Mortgage-Backed Securities ("SMBSs") are Derivatives in the
form of multi-class mortgage securities. SMBSs may be issued by agencies or
instrumentalities of the U.S. Government and private originators of, or
investors in, mortgage loans, including savings and loan associations, mortgage
banks, commercial banks, investment banks and special purpose entities of the
foregoing.
SMBSs are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. One type of SMBS will have one class receiving some of the interest and
most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In some cases,
one class will receive all of the interest ("IO class"), while the other class
will receive all of the principal ("principal-only" or "PO class"). The yield
to maturity on IO classes and PO classes is extremely sensitive to the rate of
principal payments (including prepayments) on the related underlying mortgage
assets, and a rapid rate of principal payments may have a material adverse
effect on the portfolio yield to maturity. If the underlying mortgage assets
experience greater than anticipated prepayments of principal, the Portfolio may
fail to fully recoup its initial investment in these securities, even if the
security is in one of the highest rating categories.
Although SMBSs are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these securities
were only recently developed. As a result, established trading markets have not
yet developed and, accordingly, certain of these securities may be deemed
illiquid and subject to the Portfolio's limitations on investment in illiquid
securities.
TEMPORARY INVESTMENTS. During periods in which MSAM believes changes in
economic, financial or political conditions make it advisable, the Portfolio
may reduce its holdings for temporary defensive purposes and may invest in
certain short-term (less than twelve months to maturity) and medium-term (not
greater than five years to maturity) debt securities or may hold cash. The
short-term and medium-term debt obligations in which the Portfolio may invest
consist of (a) obligations of the U.S. or foreign country governments, their
respective agencies or instrumentalities; (b) bank deposits and bank
obligations (including certificates of deposit, time deposits and bankers'
acceptances) of U.S. or foreign country banks denominated in any currency; (c)
Floaters and other instruments denominated in any currency issued by
international development agencies; (d) finance company and corporate
commercial paper and other short-term corporate debt obligations of U.S. and
foreign country corporations meeting the Portfolio's credit quality standards;
and (e) Repurchase Agreements with banks and broker-dealers with respect to
such securities. For temporary defensive purposes, the Portfolio intends to
invest only in short-term and medium-term debt obligations that MSAM believes
to be of high quality, i.e., subject to relatively low risk of loss of interest
or principal (there is currently no rating system for foreign debt
obligations).
U.S. GOVERNMENTS. U.S. Governments are Fixed Income Securities that are backed
by the full faith and credit of the
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U.S. Government as to the payment of both principal and interest. U.S.
Governments may include securities issued by the U.S. Treasury and securities
issued by federal agencies and U.S. Government sponsored instrumentalities. For
further information on these securities, see "Description of U.S. Government
Securities" in the SAI.
WARRANTS. Warrants are instruments giving holders the right, but not the
obligation, to buy shares of a company at a given price during a specified
period.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. When-Issued and Delayed Delivery
Securities are securities purchased with payment and delivery taking place in
the future in order to secure what is considered to be an advantageous yield or
price at the time of the transaction. Delivery of and payment for these
securities may take as long as a month or more after the date of the purchase
commitment, but will take place no more than 120 days after the trade date. The
payment obligation and the interest rates that will be received are each fixed
at the time the Portfolio enters into the commitment and no interest accrues to
the Portfolio until settlement. Thus, it is possible that the market value at
the time of settlement could be higher or lower than the purchase price if the
general level of interest rates has changed. The Portfolio will maintain with
the custodian a separate account with a segregated portfolio of high-grade debt
securities or cash in an amount at least equal to these commitments. The
Portfolio will not enter into When-Issued or Delayed Delivery Securities
commitments exceeding, in the aggregate, 15% of the Portfolio's total assets
other than the obligations created by these commitments.
ZERO COUPONS, PAY-IN-KIND SECURITIES OR DEFERRED PAYMENT SECURITIES. Zero
Coupons are Fixed Income Securities that do not make regular interest payments.
Instead, Zero Coupons are sold at substantial discounts from their face value.
The difference between a Zero Coupon's issue or purchase price and its face
value represents the imputed interest an investor will earn if the obligation
is held until maturity. Zero Coupons may offer investors the opportunity to
earn higher yields than those available on ordinary interest-paying obligations
of similar credit quality and maturity. However, Zero Coupon prices may also
exhibit greater price volatility than ordinary Fixed Income Securities because
of the manner in which their principal and interest are returned to the
investor. Pay-In-Kind Securities are securities that have interest payable by
delivery of additional securities. Upon maturity, the holder is entitled to
receive the aggregate par value of the securities. Deferred Payment Securities
are securities that remain Zero Coupons until a predetermined date, at which
time the stated coupon rate becomes effective and interest becomes payable at
regular intervals. Zero Coupon, Pay-In-Kind and Deferred Payment Securities may
be subject to greater fluctuation in value and lesser liquidity in the event of
adverse market conditions than comparably rated securities paying cash interest
at regular interest payment periods.
FUNDAMENTAL INVESTMENT LIMITS
- -----------------------------
The investment objective of the Portfolio discussed under "Portfolio Summary"
above is a fundamental policy, that is, a policy subject to change only by
shareholder approval. All policies stated throughout this Prospectus, other
than those identified as fundamental, can be changed without shareholder
approval. For additional fundamental and nonfundamental investment limits, see
"Investment Limitations" in the SAI.
INTERNAL REVENUE SERVICE (IRS) LIMITATIONS. In addition to the above, the
Portfolio also follows certain limitations imposed by the IRS on separate
accounts of insurance companies relating to the tax-deferred status of variable
annuity contracts and variable life insurance policies. For additional
information, see "Investment Limitations" in the SAI.
MANAGEMENT OF THE FUND
- ----------------------
The Fund is governed by a Board of Directors which is responsible for the
management of the business and affairs of the Fund as provided in the laws of
the State of Maryland and the Fund's Articles of Incorporation and By-Laws. The
Board of Directors of the Fund has undertaken to monitor the Fund for the
existence of any material irreconcilable conflict among the interests of
variable annuity contract owners, variable life insurance policy owners and
qualified plans that invest in the Fund due to differences in tax treatment and
other considerations, and shall report any such conflict to the boards of the
respective life insurance companies that use the Fund as an investment vehicle
for their respective variable annuity contracts and variable life insurance
policies and to qualified plans. The Boards of Directors of those life
insurance companies and the fiduciaries of certain qualified plans and MSAM
have agreed or will agree to be responsible for reporting any potential or
existing conflicts to the Directors of the Fund. If a material irreconcilable
conflict exists that affects those life insurance companies, they will be
required, at their own cost, to remedy such conflict up to and including
establishing a new registered management investment company and segregating the
assets underlying the variable annuity contracts and the variable life
insurance policies. Qualified plans which acquire more than 10% of the assets
of the Fund will be required to report any potential or existing conflicts to
the Directors of the Fund, and if a material irreconcilable conflict exists, to
remedy such conflict, up to and including redeeming shares of the Portfolio
held by the qualified plans. The majority of the Fund's Directors are not
affiliated with MSAM, any of its affiliates, any of the other companies that
provide services to the Fund or any of their affiliates. The officers of the
Fund conduct and supervise its daily business operations.
THE FUND MAY HOLD SPECIAL MEETINGS. The Fund will not hold annual shareholder
meetings, but may call special meetings when required by law, when requested by
a
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sufficient number of shareholders or for other reasons. An insurance company
issuing a variable annuity contract or variable life insurance policy that
participates in the Portfolio will vote shares held in its separate account as
required by law and interpretations thereof, as may be amended or changed from
time to time. In accordance with current law and interpretations thereof, a
participating insurance company is required to request voting instructions from
contract or policy owners and must vote shares in the separate account in
proportion to the voting instructions received. For a further discussion,
please refer to your insurance company's separate account prospectus.
INVESTMENT MANAGEMENT
INVESTMENT ADVISER. MSAM serves as the adviser for the Portfolio. It provides
investment advice and portfolio management services, pursuant to an Investment
Advisory Agreement and, subject to the supervision of the Fund's Board of
Directors, makes the Portfolio's day-to-day investment decisions, arranges for
the execution of portfolio transactions and generally manages the Portfolio's
investments. MSAM, with principal offices at 1221 Avenue of the Americas, New
York, New York 10020, conducts a worldwide investment management business,
providing a
broad range of portfolio management services to customers in the United States
and abroad. MSAM is a subsidiary of Morgan Stanley, Dean Witter, Discover & Co.
("MSDWD"), which is a publicly owned financial services corporation listed on
the New York and Pacific stock exchanges. MSAM, a registered investment adviser
under the Investment Advisers Act of 1940, as amended, serves as investment
adviser to numerous open-end and closed-end investment companies. As of May 31,
1997, MSAM, together with its affiliated asset management companies, had
approximately $303 billion in assets under management and fiduciary care. See
"Management of the Fund" in the SAI.
PORTFOLIO MANAGER. The following individual has primary responsibility for
managing the Portfolio.
EMERGING MARKETS DEBT PORTFOLIO -- Paul Ghaffari. Paul Ghaffari is a Managing
Director of Morgan Stanley. He joined MSAM in June 1993 as a Vice President and
Portfolio Manager for the Morgan Stanley Emerging Markets Debt Fund Inc. (a
closed-end investment company). Prior to joining MSAM, Mr. Ghaffari was a Vice
President in the Fixed Income Division of the Emerging Markets Sales and
Trading Department at Morgan Stanley. He holds a B.A. in International
Relations from Pomona College and an M.S. in Foreign Service from Georgetown
University. Mr. Ghaffari has had primary responsibility for managing the
Portfolio's assets since inception.
OTHER SERVICES
DISTRIBUTOR. Under its Distribution Agreement with the Fund, Morgan Stanley &
Co. Incorporated ("Morgan Stanley"), a subsidiary of MSDWD, serves as the
exclusive distributor of the Fund and sells shares of the Portfolio upon the
terms and at the current offering price described in this Prospectus. Morgan
Stanley is not obligated to sell any certain number of shares of the Portfolio.
Morgan Stanley, as principal underwriter, or the insurance companies whose
variable products are funded by the Fund, will bear all of the Fund's marketing
expenses. This includes the cost of reproducing prospectuses, statements of
additional information or any other Fund documents (such as semiannual reports)
used as sales materials.
ADMINISTRATOR. MSAM also provides the Portfolio with administrative services
pursuant to an Administration Agreement. The services provided under the
Administration Agreement are subject to the supervision of the officers and the
Board of Directors of the Fund, and include day-to-day administration of
matters related to the corporate existence of the Fund, maintenance of its
records, preparation of reports, supervision of the Fund's arrangements with
its custodian, and assistance in the preparation of the Fund's registration
statements under federal and state laws. The Administration Agreement also
provides that the Administrator through its agents will provide the Fund with
dividend disbursing and transfer agent services. For its services under the
Administration Agreement, the Fund pays MSAM a monthly fee which on an annual
basis equals 0.25% of the average daily net assets of the Portfolio.
MSAM has entered into a Sub-Administration Agreement with Chase Global Funds
Services Company ("Chase Global"), a corporate affiliate of The Chase Manhattan
Bank ("Chase"), pursuant to which Chase Global has agreed to provide certain
administrative services to the Fund. MSAM supervises and monitors such
administrative services provided by Chase Global. The services provided under
the Administration Agreement and the Sub-Administration Agreement are also
subject to the supervision of the Board of Directors of the Fund. The Board of
Directors of the Fund has approved the provision of services described above
pursuant to the Administration Agreement and the Sub-Administration Agreement
as being in the best interests of the Fund. Chase Global's business address is
73 Tremont Street, Boston, Massachusetts 02108-3913. For additional information
regarding the Administration Agreement or the Sub-Administration Agreement, see
"Management of the Fund" in the SAI.
Certain administrative and recordkeeping services that would otherwise be
performed by MSAM or its service providers, may be performed by insurance
companies that purchase shares of the Portfolio. MSAM may make payments to
these insurance companies to defray the cost of providing these services.
Chase Global calculates the NAV and dividends, maintains the general accounting
records and administers the securities lending program for the Portfolio.
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CUSTODIANS. Chase serves as the custodian of domestic securities and cash of
the Portfolio. Chase is not an affiliate of either MSAM or Morgan Stanley.
Morgan Stanley Trust Company, Brooklyn, New York ("MSTC"), an affiliate of MSAM
and Morgan Stanley, acts as the Fund's custodian for foreign assets held
outside the United States and employs sub-custodians approved by the Board of
Directors of the Fund in accordance with regulations of the SEC for the purpose
of providing custodial services for such assets. MSTC may also hold certain
domestic assets for the Fund. For more information on the custodians, see
"General Information--Custody Arrangements" in the SAI.
DIVIDEND DISBURSING AND TRANSFER AGENT. Chase Global acts as dividend
disbursing and transfer agent for the Fund.
INDEPENDENT ACCOUNTANTS. Price Waterhouse LLP serves as independent accountants
for the Fund and audits the annual financial statements of the Portfolio.
LEGAL COUNSEL. Morgan, Lewis & Bockius LLP serves as legal counsel to the Fund.
BREAKDOWN OF EXPENSES
The Portfolio pays fees and other costs related to its daily operations.
Expenses paid out of the Portfolio's assets are reflected in its share price.
The Portfolio pays a management fee to MSAM for managing its investments and
business affairs. MSAM pays fees to affiliates who provide assistance with
these services. The Portfolio also pays other expenses, which are explained
below. MSAM may, from time to time, reduce its fees or reimburse the Portfolio
for expenses above a specified limit. These fee reductions or expense
reimbursements, which may be terminated at any time without notice, can
decrease the Portfolio's expenses and boost its performance.
MANAGEMENT FEE
The Adviser is entitled to receive from the Portfolio a management fee, payable
quarterly, at an annual rate as a percentage of average daily net assets as
follows: 0.80% of the first $500 million, 0.75% of the next $500 million, and
0.70% of net assets in excess of $1 billion.
However, MSAM has agreed to a reduction in its management fees and to reimburse
the Portfolio, if necessary, if such fees would cause the total annual
operating expenses of the Portfolio to exceed 1.30% of average daily net
assets. This fee reduction is voluntary and may be terminated by MSAM at any
time without notice.
OTHER EXPENSES
In addition to investment advisory and certain administrative expenses charged
by the administrator of the Portfolio, the Portfolio pays all expenses not
assumed by MSAM. Such expenses include or could include investment-related
expenses, such as brokers' commissions, transfer taxes and fees related to the
purchase, sale, or loan of securities; fees and expenses for Directors not
affiliated with MSAM; fees and expenses of its independent accountants and
legal counsel; costs of Director and shareholder meetings; SEC fees; expenses
of preparing and filing registration statements; the cost of providing proxy
statements, prospectuses and statements of additional information to existing
variable annuity contract and variable life insurance policy owners; expenses
of preparing and printing the annual and semiannual shareholder reports to
variable annuity contract and variable life insurance policy owners; bank
transaction charges and certain custodians' fees and expenses; federal, state
or local income or other taxes; costs of maintaining the Portfolio's corporate
existence; membership fees for the Investment Company Institute and similar
organizations; fidelity bond and Directors' liability insurance premiums; and
any extraordinary expenses such as indemnification payments or damages awarded
in litigation or settlements made. All these expenses that are incurred by the
Portfolio will be passed on to the shareholders through a daily charge made to
the assets held in the Portfolio, which will be reflected in the share price.
PORTFOLIO TRANSACTIONS
The Investment Advisory Agreement authorizes MSAM to select the brokers or
dealers that will execute the purchases and sales of investment securities for
the Portfolio and directs MSAM to use its best efforts to obtain the best
available price and most favorable execution with respect to all transactions
for the Portfolio. The Fund has authorized MSAM to pay higher commissions in
recognition of brokerage services which, in the opinion of MSAM, are necessary
for the achievement of better execution, provided MSAM believes this to be in
the best interest of the Fund.
Since shares of the Portfolio are not marketed through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of shares which may be made through such firms.
In purchasing and selling securities for the Portfolio, it is the Fund's policy
to obtain quality execution at the most favorable prices through responsible
broker-dealers. In selecting broker-dealers to execute the securities
transactions for the Portfolio, consideration will be given to such factors as
the price of the security, the rate of the commission, the size and difficulty
of the order, the reliability, integrity, financial condition, general
execution and operational capabilities of competing broker-dealers, and the
brokerage and research services which they provide to the Fund. Some securities
for investment by the Portfolio may also be appropriate for other clients
served by MSAM. If the purchase or sale of securities consistent with the
investment policies of the Portfolio and one or more of these other clients
served by MSAM is considered at or about the same time, transactions in such
securities will be allocated
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<PAGE>
among the Portfolio and such other clients in a manner deemed fair and
reasonable by MSAM. Although there is no specified formula for allocating such
transactions, the various allocation methods used by MSAM, and the results of
such allocations, are subject to periodic review by the Fund's Board of
Directors.
Subject to the overriding objective of obtaining the best possible execution of
orders, MSAM may allocate a portion of the Portfolio's brokerage transactions
to Morgan Stanley or broker affiliates of Morgan Stanley. In order for Morgan
Stanley or its affiliates to effect any portfolio transactions for the Fund,
the commissions, fees or other remuneration received by Morgan Stanley or such
affiliates must be reasonable and fair compared to the commissions, fees or
other remuneration paid to other brokers in connection with comparable
transactions involving similar securities being purchased or sold on a
securities exchange during a comparable period of time. Furthermore, the Board
of Directors of the Fund, including a majority of those Directors who are not
"interested persons," as defined in the 1940 Act, have adopted procedures which
are reasonably designed to provide that any commissions, fees or other
remuneration paid to Morgan Stanley or such affiliates are consistent with the
foregoing standard.
Portfolio securities will not be purchased from or through, or sold to or
through, MSAM or Morgan Stanley or any "affiliated persons," as defined in the
1940 Act of Morgan Stanley when such entities are acting as principals, except
to the extent permitted by law.
PORTFOLIO TURNOVER
Under certain market conditions, the Portfolio may experience high portfolio
turnover as a result of its investment strategies. For example, the purchase or
sale of securities by the Portfolio in anticipation of a rise or decline in
interest rates or to take advantage of yield disparities among different issues
of Fixed Income Securities could result in high portfolio turnover. As a result
of its investment strategies, the Portfolio's annual portfolio turnover rate is
expected to be as high as 200%. A higher portfolio turnover rate for the
Portfolio can result in corresponding increases in expenses such as brokerage
commissions and transaction costs. Although the Portfolio will not invest for
short-term trading purposes, investment securities may be sold from time to
time without regard to the length of time they have been held and the Portfolio
will not consider portfolio turnover rate a limiting factor in making
investment decisions consistent with its respective objectives and policies.
PERFORMANCE OF THE PORTFOLIO
The Portfolio's total return may be quoted in advertising if accompanied by
performance of your insurance company's separate account. Performance is based
on historical results and is not intended to indicate future performance. For
additional performance information, contact your insurance company for a free
annual report.
TOTAL RETURN. Total return is the change in value of an investment in the
Portfolio over a given period, assuming reinvestment of any dividends and
capital gains. A cumulative total return reflects actual performance over a
stated period of time. An average annual total return is a hypothetical rate of
return that, if achieved annually, would have produced the same cumulative
total return if performance had been constant over the entire period. Average
annual total returns smooth out variations in performance; they are not the
same as actual year-by-year results.
Average annual total returns covering periods of less than one year assume that
performance will remain constant for the rest of the year.
YIELD. Yield refers to the income generated by an investment in the Portfolio
over a given period of time, expressed as an annual percentage rate. When a
yield assumes that income is reinvested, it is called an effective yield.
Total return and yield quoted for the Portfolio includes the Portfolio's
expenses, but may not include charges and expenses attributable to any
particular insurance product. Since shares of the Portfolio may be purchased
only through variable annuity contracts and variable life insurance policies
and by tax qualified investors, such as qualified pension and retirement plans,
you should carefully review the prospectus of the insurance product you have
chosen for information on relevant charges and expenses. Excluding these
charges from quotations of the Portfolio's performance has the effect of
increasing the performance quoted. You should bear in mind the effect of these
charges when comparing the Portfolio's performance to that of other mutual
funds.
PERFORMANCE OF MSAM
MSAM manages a portfolio of Morgan Stanley Institutional Fund, Inc. ("MSIF")
which served as the model for the Portfolio of the Fund. The portfolio of MSIF
has substantially the same investment objectives and policies as the Portfolio
of the Fund. In addition, MSAM intends the Portfolio of the Fund and the
corresponding portfolio of MSIF to be managed by the same personnel and to
continue to have closely similar investment strategies, techniques, and
characteristics.
Past investment performance of the MSIF portfolio, as shown in the table below,
may be relevant to your consideration of the Portfolio. The investment
performance of the MSIF portfolio is not necessarily indicative of future
performance of the Portfolio. Also, the operating expenses of the Portfolio
will be different from, and may be higher than, the operating expenses of the
corresponding MSIF portfolio. The investment performance of the MSIF portfolio
is
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<PAGE>
provided merely to indicate the experience of MSAM in managing a similar
portfolio.
<TABLE>
<CAPTION>
TOTAL
RETURN ONE YEAR AVERAGE ANNUAL
FIVE MONTHS TOTAL RETURN TOTAL RETURN
ENDED AS OF SINCE
FUND NAME* 5/31/97 12/31/96 INCEPTION
- ------------------- ----------- ------------ --------------
<S> <C> <C> <C>
MSIF:
Emerging Markets Debt** 12.87% 50.52% 18.94%
</TABLE>
- -------
*(Class A Shares)
**Inception Date 2/1/94
ACCOUNT POLICIES
- ----------------
DISTRIBUTIONS AND TAXES
The Fund intends the Portfolio to qualify as a separate entity under the
Internal Revenue Code of 1986, as amended (the "Code"), and to qualify as a
"regulated investment company" under Subchapter M of the Code. As a regulated
investment company under the Code, net income and net realized gains of the
Portfolio will be distributed to shareholders at least once a year.
As stated on the cover of this Prospectus, shares of the Portfolio will be
purchased by life insurance companies for their separate accounts under
variable annuity contracts and variable life insurance policies and by other
entities under qualified pension and retirement plans. Under the provisions of
the Code currently in effect, net income and realized capital gains are not
currently taxable when left to accumulate within a variable annuity contract or
variable life insurance policy or under a qualified pension or retirement plan.
For information on federal income taxation of a life insurance company with
respect to its receipt of distributions from the Fund and federal income
taxation of owners of variable annuity contracts or variable life insurance
policies, refer to the life insurance company's variable annuity contract or
variable life insurance policy prospectus.
TRANSACTION DETAILS
The Portfolio is open for business each day the New York Stock Exchange
("NYSE") is open. The Portfolio's NAV is determined as of the close of business
of the NYSE (normally 4:00 p.m. Eastern Time) on each day that the NYSE is open
for business. The NYSE is currently scheduled to be closed on New Year's Day,
Martin Luther King, Jr.'s Birthday, Washington's Birthday, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day,
and on the preceding Friday or subsequent Monday when any of these holidays
falls on a Saturday or Sunday, respectively.
The Portfolio's NAV is the value of a single share. The NAV is computed by
adding the value of the Portfolio's investments, cash and other assets,
subtracting its liabilities, and then dividing the result by the number of
shares outstanding.
The Portfolio's investments are valued primarily on the basis of market
quotations. Foreign securities are valued on the basis of quotations from the
primary market in which they are traded, and are translated from the local
currency into U.S. dollars using current exchange rates. If quotations are not
readily available or if the values have been materially affected by events
occurring after the closing of a foreign market, assets are valued by a method
that the Fund's Board of Directors believes accurately reflects fair value.
The Portfolio's offering price (price to buy one share) and redemption price
(price to sell one share) are its NAV.
The Portfolio reserves the right to suspend the offering of shares for a period
of time. The Portfolio also reserves the right to reject any specific order.
Purchase orders may be refused if, in MSAM's opinion, they would disrupt
management of the Portfolio.
INVESTMENTS AND REDEMPTIONS. Investments and redemptions are made by insurance
companies for their variable annuity contracts and variable life insurance
policies and by tax qualified investors, such as qualified pension and
retirement plans.
Each participating insurance company receives orders from its variable annuity
contract and variable life insurance policy owners to purchase or redeem shares
of the Portfolio each business day. That night, all orders received by that
insurance company on that business day are aggregated, and the insurance
company places a net purchase or redemption order for shares of the Portfolio
the morning of the next business day. These orders are normally executed at the
NAV that was computed at the close of the previous business day in order to
provide a match between the variable contract and policy owners' orders to the
insurance companies and the insurance companies' orders to the Portfolio. In
some cases, an insurance company's orders for Portfolio shares may be executed
at the NAV next computed after the order is actually transmitted to the
Portfolio.
Redemption proceeds will normally be wired to the insurance company on the next
business day after receipt of the redemption instructions by the Portfolio but
in no event later than seven days following receipt of instructions. The
Portfolio may suspend redemptions or postpone payment dates on days when the
NYSE is closed (other than weekends or holidays), when trading on the NYSE is
restricted, or as permitted by the SEC.
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