<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
- --------------------------------------------------------------------------------
EMERGING MARKETS DEBT PORTFOLIO
SEMI-ANNUAL REPORT
JUNE 30, 1998
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS DEBT PORTFOLIO
- --------------------------------------------------------------------------------
INVESTMENT OVERVIEW
COMPOSITION OF NET ASSETS (AT JUNE 30, 1998)
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C>
%
Argentina 16.0
Brazil 21.7
Bulgaria 1.3
Colombia 1.0
Ecuador 0.3
Ivory Coast 0.3
Korea 1.6
Mexico 15.5
Peru 1.1
Russia 27.4
Turkey 5.5
Venezuela 3.0
Other 5.3
</TABLE>
PERFORMANCE COMPARED TO THE J.P. MORGAN EMERGING MARKETS BOND PLUS INDEX(1)
- ------------------------------------
<TABLE>
<CAPTION>
TOTAL RETURNS(2)
-----------------------------------------
AVERAGE ANNUAL
ONE SINCE
YTD YEAR INCEPTION(3)
---------- ---------- -----------------
<S> <C> <C> <C>
PORTFOLIO... -3.83% -3.10% -2.99%
INDEX..... -1.08% 1.39% 0.69%
</TABLE>
1. The J.P. Morgan Emerging Markets Bond Plus Index is a total return index
tracking the traded U.S.$ currency denominated instruments in the emerging
markets. The Index is composed of Brady Bonds, benchmark Eurobonds, loans and
Argentine domestic debt.
2. Total returns for the Portfolio reflect expenses waived and reimbursed, if
applicable, by the Adviser. Without such waiver and reimbursement, total
returns would be lower.
3. Commenced operations on June 16, 1997.
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
<TABLE>
<CAPTION>
TOP FIVE HOLDINGS
PERCENT OF
SECURITY COUNTRY NET ASSETS
- ---------------------------------- --------- ---------------
<S> <C> <C>
United Mexican States,
Global Bond, 11.50%, 5/15/26 Mexico 8.4%
Federative Republic of Brazil,
C Bond, 8.00%, 4/15/14 Brazil 7.7%
Russian Principal Loans, 3.313%,
12/15/20 Russia 7.4%
Federative Republic of Brazil,
Series EI-L, 6.625%, 4/15/06 Brazil 6.9%
Republic of Argentina, 6.625%,
3/31/05 Argentina 5.9%
</TABLE>
<TABLE>
<CAPTION>
TOP FIVE COUNTRIES
VALUE PERCENT OF
COUNTRY (000) NET ASSETS
- ------------------------- --------- -------------
<S> <C> <C>
Russia $ 8,347 27.4%
Brazil 6,627 21.7%
Argentina 4,894 16.0%
Mexico 4,739 15.5%
Turkey 1,695 5.5%
</TABLE>
THE PERFORMANCE RESULTS PROVIDED ARE FOR INFORMATIONAL PURPOSES ONLY AND SHOULD
NOT BE CONSTRUED AS A GUARANTEE OF THE PORTFOLIO'S FUTURE PERFORMANCE. PAST
PERFORMANCE SHOWN IS NOT PREDICTIVE OF FUTURE PERFORMANCE. INVESTMENT RETURN AND
PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY
BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. PLEASE SEE THE PROSPECTUS FOR A
DESCRIPTION OF CERTAIN RISK CONSIDERATIONS ASSOCIATED WITH INTERNATIONAL
INVESTING. YIELDS WILL FLUCTUATE AS MARKET CONDITIONS CHANGE.
The Emerging Markets Debt Portfolio seeks high total return by investing
primarily in fixed income securities of government and government related
issuers located in emerging market countries.
For the six months ended June 30, 1998, the Portfolio had a total return of
- -3.83% compared to -1.08% for the J.P. Morgan Emerging Markets Bond Plus Index
(the "Index"). For the one year period ended June 30, 1998, the Portfolio had a
total return of -3.10% compared to 1.39% for the Index. From inception on June
16, 1997 to June 30, 1998, the Portfolio had an average annual total return of
- -2.99% compared to 0.69% for the Index. As of June 30, 1998, the Portfolio had
an SEC 30-day yield of 13.80%.
The underperformance for the year-to-date can be attributed to an overweight in
Russia and Indonesian corporates. Throughout the second quarter events in Asia
dictated the tone of the market.
The second quarter started off uneventfully as financial markets globally
drifted sideways throughout the month of April. Relative stability in Asia and
Indonesia in particular allowed emerging market debt to rally despite political
uncertainty in Russia, Ecuador and Venezuela. This period of relative calm was
short lived as continued weakness in Asia and the forced resignation of former
President Suharto in Indonesia caused investors to reassess the risk premiums
required for all emerging market assets. Russia in particular came under
pressure. We decreased the Portfolio's exposure to Indonesia as the post-Suharto
political environment remained fragile with no "quick
1
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS DEBT PORTFOLIO
- --------------------------------------------------------------------------------
INVESTMENT OVERVIEW (CONT.)
fix" in sight. Believing that the market had overly penalized Russian debt, we
shifted to an overweight position in late May after Russian assets experienced a
significant sell-off, returning -9.90% for the month.
The months of May and June saw the return of the kind of nervousness, investor
skepticism, and volatility in the emerging markets that we experienced during
the large sell off in 1994 and more recently in the Asian induced sell off
during the fourth quarter of 1997. The reasons for this round of volatility are
less obvious than past episodes, as there have not been the classic signs of a
decrease in global liquidity nor has this sell off been precipitated by
political/social instability in any major country. Interest rates continue to
stay low globally, there have not been large flows out of emerging market debt
mutual funds, global inflation remains quite well contained, and broadly
speaking, most emerging countries continue to pursue virtuous economic policies.
However, the ill health of the Japanese economy and of major Japanese banks has
caused investors to adjust risk premiums higher and has caused liquidity for
most emerging countries to evaporate. Investors fear that Japan's inability to
fix its economy will continue to weaken the yen and might eventually cause a
devaluation in China. This would increase the risk of another round of currency
devaluation in Asia and might further depress commodity prices, a large source
of earnings for many emerging countries. The good news is that markets have
considerably discounted such a negative scenario. While Asia continues to cast a
dark shadow over the emerging markets, any evidence of a turn around or
stabilization in Asia should allow prices on emerging market debt to recover
substantially.
In June, Russian debt underperformed the other emerging market bonds by a wide
margin again, with the Russian subcomponent of the JP Morgan Emerging Markets
Bond Plus Index returning -13.85% for the month. The dramatic sell off in
Russian assets reflects investor's concerns about short term liquidity rather
than longer term solvency issues. Russia relies heavily on foreign debt and
foreign investors in its local markets to fund its budget deficit which has been
aggravated this year by poor tax collection resulting from low oil prices. As
global liquidity has become scarce, Russia has come under particular scrutiny as
it relies on the markets for constant funding. We believe that the new
administration in Moscow has developed a credible program to thwart off a full
blown economic crisis and will survive its current predicament. The Russians are
working closely with the International Monetary Fund and should come to terms,
in the next two months, for additional aid and an expanded program to bolster
international reserves. The current government is the most reform-minded since
the collapse of communism and it is in western government's interest to see them
succeed. We will continue to overweight Mexico as we remain confident about the
soundness of Mexico's macroeconomics fundamentals. The Mexican economy is
expected to register growth of 5% this year and unlike 1995, growth is more
balanced now as it is being driven by both the export sector and the
non-tradables sector. We continue to underweight Venezuela due to the country's
declining fiscal and political condition.
July 1998
2
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS DEBT PORTFOLIO
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS
JUNE 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
<C> <S> <C>
- ----------------------------------------------------------------------------
DEBT INSTRUMENTS (91.1%)
ARGENTINA (16.0%)
CORPORATE (5.2%)
U.S.$ (e)450 Acindar Industria, (Floating Rate), 11.555%,
11/12/98....................................... $ 454
ARP (e)200 CIA International Telecommunications, 10.375%,
8/1/04......................................... 165
(e)770 CIA International Telecommunications, 10.375%,
8/1/04......................................... 635
U.S.$ (e)350 Supercanal Holdings S.A., 11.50%, 5/15/05........ 337
-------
1,591
-------
SOVEREIGN (10.8%)
1,300 Republic of Argentina, Global Bond, Series BGL5,
11.375%, 1/30/17............................... 1,385
120 Republic of Argentina Global Bond, 9.75%,
9/19/27........................................ 111
2,043 Republic of Argentina, (Floating Rate), (Bearer),
6.625%, 3/31/05................................ 1,807
-------
3,303
-------
4,894
-------
BRAZIL (21.7%)
CORPORATE (1.0%)
(e)350 Globo Communicacoes e Participacoes, 10.625%,
12/5/08........................................ 312
-------
SOVEREIGN (20.7%)
(v)116 Federative Republic of Brazil, C Bond, (Floating
Rate), (Registered), PIK, 8.00%, 4/15/04....... 85
(v)3,202 Federative Republic of Brazil, C Bond, 8.00%,
4/15/14........................................ 2,360
(v)2,571 Federative Republic of Brazil, Series EI-L,
(Floating Rate), 6.625%, 4/15/06............... 2,117
1,950 Federative Republic of Brazil, Global Bond,
9.375%, 4/7/08................................. 1,753
-------
6,315
-------
6,627
-------
BULGARIA (1.3%)
SOVEREIGN (1.3%)
(n,v)75 Republic of Bulgaria Front Loaded Interest
Reduction Bond, Series A, 2.25%, 7/28/12....... 46
(v)500 Republic of Bulgaria Interest Arrears PDI Bond,
(Floating Rate), 6.563%, 7/28/11............... 358
-------
404
-------
COLOMBIA (1.0%)
SOVEREIGN (1.0%)
330 Republic of Colombia, 7.625%, 2/15/07............ 298
-------
ECUADOR (0.3%)
CORPORATE (0.3%)
100 Conecel, 14.00%, 5/1/02.......................... 100
-------
IVORY COAST (0.3%)
SOVEREIGN (0.3%)
FRF (v)1,800 Republic of Ivory Coast, Front Loaded Interest
Reduction Bond, (Floating Rate), Series FRF,
2.00%, 3/29/18................................. 90
-------
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
<C> <S> <C>
- ----------------------------------------------------------------------------
KOREA (1.6%)
SOVEREIGN (1.6%)
U.S.$ 550 Korea Development Bank, Global Bond, 7.125%,
9/17/01........................................ $ 486
-------
MEXICO (15.5%)
SOVEREIGN (15.5%)
(v)500 United Mexican States Discount Bond, Series B,
(Floating Rate), 6.477%, 12/31/19.............. 449
1,450 United Mexican States, Global Bond, 9.875%,
1/15/07........................................ 1,509
200 United Mexican States, Global Bond, 11.375%,
9/15/16........................................ 223
2,250 United Mexican States, Global Bond, 11.50%,
5/15/26........................................ 2,558
-------
4,739
-------
PERU (1.1%)
SOVEREIGN (1.1%)
(n,v)600 Republic of Peru Front Loaded Interest Reduction
Bond, 3.25%, 3/7/17............................ 335
-------
RUSSIA (27.4%)
CORPORATE (1.3%)
500 UnExim International Finance BV, (Floating Rate),
8.625%, 1/24/00................................ 381
-------
SOVEREIGN (26.1%)
(v)4,770 Russian Principal Loans, (Floating Rate), 3.313%,
12/15/20....................................... 2,266
(e)220 Ministry of Finance Russia, GDR, 3.00%,
5/14/03........................................ 127
600 Ministry of Finance Russia Debentures, Series
III, 14.00%, 5/19/99........................... 508
400 Ministry of Finance Russia Debentures, Series IV,
3.00%, 5/14/03................................. 231
820 Ministry of Finance Russia, 10.00%, 6/26/07...... 620
(e)740 Ministry of Finance Russia 11.75%, 6/10/03....... 655
(e)1,200 Ministry of Finance Russia, 11.75%, 6/10/03...... 1,062
1,550 Ministry of Finance Russia, 11.75%, 6/10/03...... 1,372
(e)1,070 Ministry of Finance Russia 12.75%, 6/24/28....... 956
201 Russian Interest Arrears Note, (Floating Rate),
6.625%, 12/15/15............................... 112
102 Russian Interest Arrears Note, Series 19YR,
(Floating Rate), 6.625%, 12/15/15.............. 57
-------
7,966
-------
8,347
-------
TURKEY (1.9%)
SOVEREIGN (1.9%)
(e)650 Pera Financial Services Co., 9.375%, 10/15/02.... 580
-------
VENEZUELA (3.0%)
SOVEREIGN (3.0%)
(v)1,131 Republic of Venezuela Debt Conversion Bond,
Series DL, (Floating Rate), 6.625%, 12/18/07... 926
-------
TOTAL FOREIGN DEBT INSTRUMENTS (COST $30,177)...................... 27,826
-------
</TABLE>
The accompanying notes are an integral part of the financial statements.
3
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS DEBT PORTFOLIO
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS (CONT.)
JUNE 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- ----------------------------------------------------------------------------
<C> <S> <C>
COMMON STOCK (0.0%)
UNITED KINGDOM (0.0%)
(a)309 Nextel Communications, Inc., Class A (COST $8)... $ 8
-------
</TABLE>
<TABLE>
<CAPTION>
NO. OF
WARRANTS
<C> <S> <C>
- ---------------
WARRANT (0.0%)
NIGERIA (0.0%)
(a)250 Central Bank of Nigeria, expiring 11/15/20 (COST
$0)............................................ --
-------
</TABLE>
<TABLE>
<CAPTION>
FACE
AMOUNT
(000)
<C> <S> <C>
- ---------------
SHORT-TERM INVESTMENTS (8.7%)
TURKEY (3.6%)
TREASURY BILLS (3.6%)
TRL 180,350,000 75.00%, 8/19/98.................................. 616
149,350,000 75.28%, 9/2/98................................... 499
-------
1,115
-------
UNITED STATES (5.1%)
REPURCHASE AGREEMENT (5.1%)
U.S.$ 1,545 Chase Securities, Inc. 5.40%, dated 6/30/98, due
7/1/98, to be repurchased at $1,545,
collateralized by U.S. Treasury Bonds, 8.875%,
due 2/15/19, valued at $1,587.................. 1,545
-------
TOTAL SHORT-TERM INVESTMENTS (COST $2,771)......................... 2,660
-------
FOREIGN CURRENCY (0.4%)
FRF 654 French Franc (COST $109)......................... 108
-------
</TABLE>
<TABLE>
<S> <C> <C>
TOTAL INVESTMENTS (100.2%) (COST $33,065).................. 30,602
--------
OTHER ASSETS (6.6%)
Cash........................................... $ 1,013
Interest Receivable............................ 583
Receivable for Investments Sold................ 373
Due from Adviser............................... 40
Receivable for Portfolio Shares Sold........... 15 2,024
--------
LIABILITIES (-6.8%)
Payable for Investments Purchased.............. (1,970)
Professional Fees Payable...................... (40)
Payable for Portfolio Shares Redeemed.......... (24)
Custodian Fees Payable......................... (21)
Administrative Fees Payable.................... (6)
Payable for Closed Foreign Currency Exchange
Contracts..................................... (3)
Directors' Fees and Expenses Payable........... (1)
Payable for Foreign Taxes...................... (1)
Other Liabilities.............................. (31) (2,097)
-------- --------
NET ASSETS (100%).......................................... $30,529
--------
--------
<CAPTION>
AMOUNT
(000)
- ----------------------------------------------------------------------
<S> <C> <C>
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 3,283,612 outstanding $0.001 par value shares
(authorized 500,000,000 shares).......................... $ 9.30
--------
--------
NET ASSETS CONSIST OF:
Paid in Capital............................................ $32,599
Undistributed Net Investment Income........................ 1,433
Accumulated Net Realized Loss.............................. (1,038)
Unrealized Depreciation on Investments and Foreign Currency
Translations............................................. (2,465)
--------
NET ASSETS................................................. $30,529
--------
--------
</TABLE>
- ---------------
(a) -- Non-income producing security
(e) -- 144A Security -- certain conditions for public sale may exist.
(n) -- Step Bond -- coupon rate increases in increments to maturity. Rate
disclosed is as of June 30, 1998. Maturity date disclosed is the
ultimate maturity date.
(v) -- Security is a Brady Bond, created through the debt restructuring
exchange of commercial bank loans to foreign entitites for new fixed
income obligations. These bonds may be collateralized and are actively
traded on the over-the-counter secondary market.
ARP -- Argentine Peso
FRF -- French Franc
GDR -- Global Depositary Receipt
PDI -- Past Due Interest
PIK -- Payment-in-Kind. Income may be paid in additional securities or cash
at the discretion of the issuer.
TRL -- Turkish Lira
Floating Rate Security -- Interest rate changes on these instruments are based
upon a designated base rate. The rates shown are those in effect at
June 30, 1998.
- ---------------
At June 30,1998, cost and unrealized appreciation (depreciation) for U.S.
Federal income tax purposes of the investments of the Portfolio were:
<TABLE>
<CAPTION>
NET
COST APPRECIATION (DEPRECIATION) (DEPRECIATION)
(000) (000) (000) (000)
- --------- ----------------- --------------- ---------------
<S> <C> <C> <C>
$ 32,956 $ 12 $ (2,474) $ (2,462)
</TABLE>
- ----------------------------------------------------------------
For the six months ended June 30, 1998, purchases and sales of investment
securities for the Portfolio other than long-term U.S. Government securities and
short-term investments were $74,081,000 and $67,857,000, respectively. There
were no purchases and sales of long-term U.S. Government securities during the
six months ended June 30, 1998.
- ----------------------------------------------------------------
The accompanying notes are an integral part of the financial statements.
4
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS DEBT PORTFOLIO
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1998
(UNAUDITED)
(000)
<S> <C>
- ---------------------------------------------------------------------------
INVESTMENT INCOME:
Interest $ 1,638
-------
EXPENSES:
Investment Advisory Fees 116
Less: Fees Waived (106)
-------
Net Investment Advisory Fees 10
Shareholder Reports 88
Administrative Fees 39
Professional Fees 31
Custodian Fees 19
Interest Expense 5
Directors' Fees and Expenses 1
Other 12
-------
Net Expenses 205
-------
Net Investment Income 1,433
-------
NET REALIZED GAIN (LOSS) ON:
Investments Sold (799)
Foreign Currency Transactions 7
Securities Sold Short 2
Written Options 8
-------
Net Realized Loss (782)
-------
CHANGE IN UNREALIZED APPRECIATION/DEPRECIATION ON:
Investments (1,992)
Foreign Currency Translations (1)
-------
Change in Unrealized Appreciation/Depreciation (1,993)
-------
Net Realized Loss and Change in Unrealized
Appreciation/Depreciation (2,775)
-------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $(1,342)
-------
-------
</TABLE>
- --------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
SIX MONTHS PERIOD FROM
ENDED JUNE 16, 1997*
JUNE 30, 1998 TO
(UNAUDITED) DECEMBER 31, 1997
(000) (000)
<S> <C> <C>
- --------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS:
Net Investment Income $ 1,433 $ 719
Net Realized Gain/Loss (782) 20
Change in Unrealized
Appreciation/Depreciation (1,993) (472)
--------------- --------
Net Increase/Decrease in Net Assets
Resulting from Operations (1,342) 267
--------------- --------
DISTRIBUTIONS:
Net Investment Income -- (694)
Net Realized Gain -- (46)
In Excess of Net Realized Gain -- (255)
--------------- --------
Total Distributions -- (995)
--------------- --------
CAPITAL SHARE TRANSACTIONS (1):
Subscribed 23,653 41,254
Distributions Reinvested -- 731
Redeemed (18,160) (14,879)
--------------- --------
Net Increase in Net Assets Resulting
from Capital Share Transactions 5,493 27,106
--------------- --------
Total Increase in Net Assets 4,151 26,378
NET ASSETS:
Beginning of Period 26,378 --
--------------- --------
End of Period (Including
undistributed net investment
income of $1,433 and $0,
respectively) $ 30,529 $ 26,378
--------------- --------
--------------- --------
- --------------------------------------------------------------------------
(1) Capital Share Transactions:
Shares Subscribed 2,392 4,155
Shares Issued on Distributions
Reinvested -- 79
Shares Redeemed (1,835) (1,507)
--------------- --------
Net Increase in Capital Shares
Outstanding 557 2,727
--------------- --------
--------------- --------
- --------------------------------------------------------------------------
</TABLE>
* Commencement of operations
The accompanying notes are an integral part of the financial statements.
5
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS DEBT PORTFOLIO
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
PERIOD FROM
SIX MONTHS JUNE 16,
ENDED 1997*
JUNE 30, 1998 TO DECEMBER 31,
SELECTED PER SHARE DATA AND RATIOS (UNAUDITED) 1997
<S> <C> <C>
- ------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $ 9.67 $ 10.00
------- -------
INCOME FROM INVESTMENT OPERATIONS
Net Investment Income 0.44 0.28
Net Realized and Unrealized
Gain(Loss) (0.81) (0.22)
------- -------
Total From Investment Operations (0.37) 0.06
------- -------
DISTRIBUTIONS
Net Investment Income -- (0.27)
Net Realized Gain -- (0.02)
In Excess of Net Realized Gain -- (0.10)
------- -------
Total Distributions -- (0.39)
------- -------
NET ASSET VALUE, END OF PERIOD $ 9.30 $ 9.67
------- -------
------- -------
TOTAL RETURN (3.83)% 0.76%
------- -------
------- -------
RATIOS AND SUPPLEMENTAL DATA:
Net Assets, End of Period (000's) $30,529 $26,378
Ratio of Expenses to Average Net
Assets 1.41%** 1.35%**
Ratio of Expenses to Average Net
Assets Excluding Interest Expense 1.30%** 1.30%**
Ratio of Net Investment Income to
Average Net Assets 9.85%** 8.10%**
Portfolio Turnover Rate 266% 173%
- ------------------------------------------------------------------------------
Effect of Voluntary Expense
Limitation During the Period:
Per Share Benefit to Net Investment
Income $ 0.03 $ 0.02
Ratios Before Expense Limitation:
Expenses to Average Net Assets 2.14%** 2.06%**
Net Investment Income to Average
Net Assets 9.12%** 7.39%**
</TABLE>
- --------------------------------------------------------------------------------
* Commencement of operations
** Annualized
The accompanying notes are an integral part of the financial statements.
6
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998 (UNAUDITED)
- --------------------------------------------------------------------------------
Morgan Stanley Universal Funds, Inc. (the "Fund") is registered under the
Investment Company Act of 1940, as amended, as an open-end management investment
company. As of June 30, 1998, the Fund was comprised of eleven separate active
portfolios (individually referred to as a "Portfolio", collectively as the
"Portfolios").
The accompanying financial statements cover only the Emerging Markets Debt
Portfolio.
The Fund is intended to be the funding vehicle for variable annuity contracts
and variable life insurance policies to be offered by the separate accounts of
certain life insurance companies.
A. ACCOUNTING POLICIES: The following significant accounting policies are in
conformity with generally accepted accounting principles for investment
companies. Such policies are consistently followed by the Fund in the
preparation of the financial statements. Generally accepted accounting
principles may require management to make estimates and assumptions that affect
the reported amounts and disclosures in the financial statements. Actual results
may differ from those estimates.
1. SECURITY VALUATION: Equity securities listed on a U.S. exchange and equity
securities traded on NASDAQ are valued at the latest quoted sales price on the
valuation date. Securities listed on a foreign exchange are valued at their
closing price. Unlisted securities and listed securities not traded on the
valuation date, for which market quotations are readily available, are valued at
the average of the mean between the current bid and asked prices obtained from
reputable brokers. Bonds and other fixed income securities may be valued
according to the broadest and most representative market. In addition, bonds and
other fixed income securities may be valued on the basis of prices provided by a
pricing service which are based primarily on institutional size trading in
similar groups of securities. The prices provided by a pricing service are
determined without regard to bid or last sale prices, but take into account
institutional size trading in similar groups of securities and any developments
related to the specific securities. Debt securities purchased with remaining
maturities of 60 days or less are valued at amortized cost, if it approximates
market value. All other securities and assets for which market values are not
readily available, including restricted securities, are valued at fair value as
determined in good faith by the Board of Directors, although the actual
calculations may be done by others.
2. INCOME TAXES: It is each Portfolio's intention to qualify as a regulated
investment company and distribute all of its taxable and tax-exempt income.
Accordingly, no provision for Federal income taxes is required in the financial
statements.
Certain Portfolios may be subject to taxes imposed by countries in which they
invest. Such taxes are generally based on income and/or capital gains earned or
repatriated. Taxes are accrued and applied to net investment income, net
realized gains and net unrealized appreciation as these amounts are earned.
Taxes may also be based on the movement of foreign currency and are accrued
based on the value of investments denominated in such currency.
3. REPURCHASE AGREEMENTS: The Portfolios of the Fund may enter into repurchase
agreements under which the Portfolio lends excess cash and takes possession of
securities with an agreement that the counterparty will repurchase such
securities. In connection with transactions in repurchase agreements, a bank as
custodian for the Fund takes possession of the underlying securities which are
held as collateral, with a market value at least equal to the amount of the
repurchase transaction, including principal and accrued interest. To the extent
that any repurchase transaction exceeds one business day, the value of the
collateral is marked-to-market on a daily basis to determine the adequacy of the
collateral. In the event of default on the obligation to repurchase, the Fund
has the right to liquidate the collateral and apply the proceeds in satisfaction
of the obligation. In the event of default or bankruptcy by the counterparty to
the agreement, realization and/or retention of the collateral or proceeds may be
subject to legal proceedings.
4. FOREIGN CURRENCY TRANSLATION AND FOREIGN INVESTMENTS: The books and records
of the Fund are maintained in U.S. dollars. Foreign currency amounts are
translated into U.S. dollars at the mean of the bid and asked prices of such
currencies against U.S. dollars last quoted by a major bank as follows:
- investments, other assets and liabilities at the prevailing rates of
exchange on the valuation date;
- investment transactions and investment income at the prevailing rates of
exchange on the dates of such transactions.
Although the net assets of the Fund are presented at the foreign exchange rates
and market values at the close of the period, the Fund does not isolate that
portion of the results of operations arising as a result of changes in the
foreign exchange rates from the fluctuations arising from changes in the market
prices of the securities held at period end. Similarly, the Fund does not
isolate the effect of changes in foreign exchange rates from the fluctuations
arising from changes in the market prices of securities sold during the period.
Accordingly, realized and unrealized foreign currency gains (losses) are
included in the reported net realized and unrealized gains (losses) on
investment transactions and balances. However, pursuant to U.S. Federal income
tax regulations, gains and losses from certain foreign currency transactions and
the foreign currency portion of gains and losses realized on sales and
maturities of foreign denominated debt securities are treated as ordinary income
for U.S. Federal income tax purposes.
7
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
JUNE 30, 1998 (UNAUDITED)
- --------------------------------------------------------------------------------
Net realized gains (losses) on foreign currency transactions represent net
foreign exchange gains (losses) from foreign currency exchange contracts,
disposition of foreign currencies, currency gains or losses realized between the
trade and settlement dates on securities transactions, and the difference
between the amount of investment income and foreign withholding taxes recorded
on the Fund's books and the U.S. dollar equivalent amounts actually received or
paid. Net unrealized currency gains (losses) from valuing foreign currency
denominated assets and liabilities at period end exchange rates are reflected as
a component of unrealized appreciation (depreciation) on the Statement of Net
Assets. The change in net unrealized currency gains (losses) for the period is
reflected on the Statement of Operations.
Foreign security and currency transactions may involve certain considerations
and risks not typically associated with those of U.S. dollar denominated
transactions as a result of, among other factors, the possibility of lower
levels of governmental supervision and regulation of foreign securities markets
and the possibility of political or economic instability.
Prior governmental approval for foreign investments may be required under
certain circumstances in some countries, and the extent of foreign investments
in domestic companies may be subject to limitation in other countries. Foreign
ownership limitations also may be imposed by the charters of individual
companies to prevent, among other concerns, violation of foreign investment
limitations. As a result, an additional class of shares (identified as "Foreign"
in the Statement of Net Assets) may be created and offered for investment. The
"local" and "foreign" shares' market values may differ. In the absence of
trading of the foreign shares in such markets, the Fund values the foreign
shares at the closing exchange price of the local shares. Such securities are
identified as fair valued in the Statement of Net Assets.
5. FOREIGN CURRENCY EXCHANGE CONTRACTS: Certain Portfolios may enter into
foreign currency exchange contracts generally to attempt to protect securities
and related receivables and payables against changes in future foreign currency
exchange rates and, in certain situations, to gain exposure to foreign
currencies. A foreign currency exchange contract is an agreement between two
parties to buy or sell currency at a set price on a future date. The market
value of the contract will fluctuate with changes in currency exchange rates.
The contract is marked-to-market daily and the change in market value is
recorded by the Portfolios as unrealized gain or loss. The Portfolios record
realized gains or losses when the contract is closed equal to the difference
between the value of the contract at the time it was opened and the value at the
time it was closed. Risk may arise upon entering into these contracts from the
potential inability of counterparties to meet the terms of their contracts and
is generally limited to the amount of the unrealized gain on the contracts, if
any, at the date of default. Risks may also arise from unanticipated movements
in the value of a foreign currency relative to the U.S. dollar.
6. FORWARD COMMITMENTS AND WHEN-ISSUED/DELAYED DELIVERY SECURITIES: The
Portfolios may make forward commitments to purchase or sell securities. Payment
and delivery for securities which have been purchased or sold on a forward
commitment basis can take place a month or more (not to exceed 120 days) after
the date of the transaction. Additionally, the Portfolio may purchase securities
on a when-issued or delayed delivery basis. Securities purchased on a
when-issued or delayed delivery basis are purchased for delivery beyond the
normal settlement date at a stated price and yield, and no income accrues to the
Portfolio on such securities prior to delivery. When the Portfolio enters into a
purchase transaction on a when-issued or delayed delivery basis, it establishes
either a segregated account in which it maintains liquid assets in an amount at
least equal in value to the Portfolio's commitments to purchase such securities
or designates such assets as segregated on the custodian's records for the
Portfolio's regular custody account. Purchasing securities on a forward
commitment or when-issued or delayed-delivery basis may involve a risk that the
market price at the time of delivery may be lower than the agreed upon purchase
price, in which case there could be an unrealized loss at the time of delivery.
7. LOAN AGREEMENTS: Certain Portfolios may invest in fixed and floating rate
loans ("Loans") arranged through private negotiations between an issuer of
sovereign debt obligations and one or more financial institutions ("Lenders")
deemed to be creditworthy by the investment adviser. The Portfolio's investments
in Loans may be in the form of participations in Loans ("Participations") or
assignments of all or a portion of Loans ("Assignments") from third parties. The
Portfolio's investment in Participations typically results in the Portfolio
having a contractual relationship with only the Lender and not with the
borrower. The Portfolio has the right to receive payments of principal, interest
and any fees to which it is entitled only upon receipt by the Lender of the
payments from the borrower. The Portfolio generally has no right to enforce
compliance by the borrower with the terms of the loan agreement. As a result,
the Portfolio may be subject to the credit risk of both the borrower and the
Lender that is selling the Participation. When the Portfolio purchases
Assignments from Lenders, it typically acquires direct rights against the
borrower on the Loan. 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.
8. ORGANIZATIONAL COSTS: The organizational costs of the Fund are being
amortized on a straight line basis over a period of five years beginning with
the commencement of operations. Morgan Stanley Asset Management Inc. has
8
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
JUNE 30, 1998 (UNAUDITED)
- --------------------------------------------------------------------------------
agreed that in the event any of its initial shares which comprised the Fund at
inception are redeemed, the proceeds on redemption will be reduced by the
pro-rata portion of any unamortized organizational costs in the same proportion
as the number of shares redeemed bears to the initial shares held at time of
redemption.
9. SHORT SALES: Certain Portfolios may sell securities short. A short sale is a
transaction in which the Portfolio sells securities it may or may not own, but
has borrowed, in anticipation of a decline in the market price of the
securities. The Portfolio is obligated to replace the borrowed securities at the
market price at the time of replacement. The Portfolio may have to pay a premium
to borrow the securities as well as pay any dividends or interest payable on the
securities until they are replaced. The Portfolio's obligation to replace the
securities borrowed in connection with a short sale will generally be secured by
collateral deposited with the broker that consists of cash, U.S. government
securities or other liquid, high grade debt obligations. In addition, the
Portfolio will either designate on the custodian records in its regular custody
account or place in a segregated account with its Custodian an amount of cash,
U.S. government securities or other liquid high grade debt obligations equal to
the difference, if any, between (1) the market value of the securities sold and
(2) any cash, U.S. government securities or other liquid high grade debt
obligations deposited as collateral with the broker in connection with the short
sale. Short sales by the Portfolio involve certain risks and special
considerations. Possible losses from short sales differ from losses that could
be incurred from a purchase of a security, because losses from short sales may
be unlimited, whereas losses from purchases cannot exceed the total amount
invested.
10. FUTURES: Certain Portfolios may purchase and sell futures contracts. Futures
contracts provide for the sale by one party and purchase by another party of a
specified amount of a specified security, index, instrument or basket of
instruments. Futures contracts (secured by cash or government securities
deposited with brokers or custodians as "initial margin") are valued based upon
their quoted daily settlement prices; changes in initial settlement value
(represented by cash paid to or received from brokers as "variation margin") are
accounted for as unrealized appreciation (depreciation). When futures contracts
are closed, the difference between the opening value at the date of purchase and
the value at closing is recorded as realized gains or losses in the Statement of
Operations.
Certain Portfolios may use futures contracts in order to manage exposure to the
stock and bond markets, to hedge against unfavorable changes in the value of
securities or to remain fully invested and to reduce transaction costs. Futures
contracts involve market risk in excess of the amounts recognized in the
Statement of Net Assets. Risks arise from the possible movements in security
values underlying these instruments. The change in value of futures contracts
primarily corresponds with the value of their underlying instruments, which may
not correlate with the change in value of the hedged investments. In addition,
there is the risk that the Portfolios may not be able to enter into a closing
transaction because of an illiquid secondary market.
11. SWAP AGREEMENTS: The Portfolios may enter into swap agreements to exchange
one return or cash flow for another return or cash flow in order to hedge
against unfavorable changes in the value of securities or to remain fully
invested and to reduce transaction costs. The following summarizes swaps which
may be entered into by the Portfolios.
INTEREST RATE SWAPS: Interest rate swaps involve the exchange of commitments to
pay and receive interest based on a notional principal amount. Net periodic
interest payments to be received or paid are accrued daily and are recorded in
the Statement of Operations as an adjustment to interest income. Interest rate
swaps are marked-to-market daily based upon quotations from market makers and
the change, if any, is recorded as unrealized appreciation or depreciation in
the Statement of Operations.
TOTAL RETURN SWAPS: Total return swaps involve commitments to pay interest in
exchange for a market-linked return based on a notional amount. To the extent
the total return of the security, instrument or basket of instruments underlying
the transaction exceeds or falls short of the offsetting interest obligation,
the Portfolio will receive a payment from or make a payment to the counterparty,
respectively. Total return swaps are marked-to-market daily based upon
quotations from market makers and the change, if any, is recorded as unrealized
gains or losses in the Statement of Operations. Periodic payments received or
made at the end of each measurement period, but prior to termination, are
recorded as realized gains or losses in the Statement of Operations. Realized
gains or losses on maturity or termination of interest rate and total return
swaps are presented in the Statement of Operations.
Because there is no organized market for these swap agreements, the value of
open swaps reported in the Statement of Net Assets may differ from that which
would be realized in the event the Portfolio terminated its position in the
agreement. Risks may arise upon entering into these agreements from the
potential inability of the counterparties to meet the terms of the agreements
and are generally limited to the amount of net interest payments to be received
and/or favorable movements in the value of the underlying security, instrument
or basket of instruments, if any, at the date of default.
12. PURCHASED AND WRITTEN OPTIONS: Certain Portfolios may write covered call and
put options on portfolio securities and other financial instruments. Premiums
are received and are recorded as liabilities. The liabilities are subsequently
adjusted to reflect the current value of the options written. Premiums received
from writing options which expire are treated as realized gains. Premiums
received from writing
9
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
JUNE 30, 1998 (UNAUDITED)
- --------------------------------------------------------------------------------
options which are exercised or are closed are added to or offset against the
proceeds or amount paid on the transaction to determine the net realized gain or
loss. By writing a covered call option, a Portfolio, in exchange for the
premium, foregoes the opportunity for capital appreciation above the exercise
price should the market price of the underlying security increase. By writing a
covered put option, a Portfolio, in exchange for the premium, accepts the risk
of a decline in the market value of the underlying security below the exercise
price.
Certain Portfolios may purchase call and put options on portfolio securities or
other financial instruments. The Portfolio may purchase call options to protect
against an increase in the price of the security or financial instrument it
anticipates purchasing. Each Portfolio may purchase put options on securities
which it holds or other financial instruments to protect against a decline in
the value of the security or financial instrument or to close out covered
written put positions. Risks may arise from an imperfect correlation between the
change in market value of the securities held by the Portfolio and the prices of
options relating to the securities purchased or sold by the Portfolio and from
the possible lack of a liquid secondary market for an option. The maximum
exposure to loss for any purchased option is limited to the premium initially
paid for the option.
During the six months ended June 30, 1998, the Portfolio wrote covered call
options as follows:
COVERED CALL OPTIONS:
<TABLE>
<CAPTION>
FACE AMOUNT PREMIUM
EMERGING MARKETS DEBT PORTFOLIO (000) (000)
- --------------------------------------- ------------- -----------
<S> <C> <C>
Options outstanding at December 31,
1997................................. $ -- $ --
Options written during the period...... 1,184 10
Options expired during the period...... (550) (6)
Options exercised during the period.... (634) (4)
------ -----------
Options outstanding at June 30, 1998... $ -- $ --
------ -----------
</TABLE>
13. OTHER: Security transactions are accounted for on the date the securities
are purchased or sold. Realized gains and losses on the sale of investment
securities are determined on the specific identified cost basis. Dividend income
is recorded on the ex-dividend date (except for certain foreign dividends which
may be recorded as soon as the Fund is informed of such dividends) net of
applicable withholding taxes where recovery of such taxes is not reasonably
assured. Interest income is recognized on the accrual basis except where
collection is in doubt. Discounts and premiums on securities purchased (other
than mortgage-backed securities) are amortized according to the effective yield
method over their respective lives. Most expenses of the Fund can be directly
attributed to a particular Portfolio. Expenses which cannot be directly
attributed are apportioned among the Portfolios based upon relative net assets.
Distributions from the Portfolios are recorded on the ex-distribution date.
The amount and character of income and capital gain distributions to be paid by
Portfolios of the Fund are determined in accordance with Federal income tax
regulations which may differ from generally accepted accounting principles.
These differences are primarily due to differing book and tax treatments for the
character and timing of the recognition of gains or losses on securities and
foreign currency exchange contracts, the timing of the deductibility of certain
foreign taxes and dividends received from real estate investment trusts.
Permanent book and tax basis differences relating to shareholder distributions
may result in reclassifications among undistributed net investment income
(loss), accumulated net realized gain (loss) and paid in capital.
Permanent book and tax differences, if any, are not included in ending
undistributed (distributions in excess of) net investment income/accumulated net
investment loss for the purpose of calculating net investment income (loss) per
share in the Financial Highlights.
Settlement and registration of foreign securities transactions may be subject to
significant risks not normally associated with investments in the United States.
In certain markets, including Russia, ownership of shares is defined according
to entries in the issuer's share register. In Russia, there currently exists no
central registration system and the share registrars may not be subject to
effective state supervision. It is possible that a Portfolio holding these
securities could lose its share registration through fraud, negligence or even
mere oversight. In addition, shares being delivered for sales and cash being
paid for purchases may be delivered before the exchange is complete. This may
subject a Portfolio to further risk of loss in the event of a failure to
complete the transaction by the counterparty.
B. ADVISER: Morgan Stanley Asset Management Inc. ("MSAM"), a wholly-owned
subsidiary of Morgan Stanley Dean Witter & Co., provides the Emerging Markets
Debt Portfolio with investment advisory services for a fee, paid quarterly, at
the annual rate based on average daily net assets as follows:
<TABLE>
<CAPTION>
FROM MORE
FIRST $500 MILLION TO THAN
PORTFOLIO $500 MILLION $1 BILLION $1 BILLION
- -------------------------- --------------- --------------- -------------
<S> <C> <C> <C>
Emerging Markets Debt..... 0.80% 0.75% 0.70%
</TABLE>
MSAM has agreed to reduce fees payable to it and to reimburse the Portfolio, if
necessary, to the extent that the annual operating expenses, as defined,
expressed as a percentage of average daily net assets, exceed the maximum ratio
of 1.30%.
C. ADMINISTRATOR: MSAM (the "Administrator") also provides the Portfolio with
administrative services pursuant to an administrative agreement for a monthly
fee which on an annual basis equals 0.25% of the average daily net assets of the
Portfolio, plus reimbursement of out-of-pocket expenses. Under an agreement
between the Administrator and Chase Global Funds Services Company ("CGFSC"), a
corporate
10
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
JUNE 30, 1998 (UNAUDITED)
- --------------------------------------------------------------------------------
affiliate of The Chase Manhattan Bank ("Chase"), CGFSC provides certain
administrative services to the Fund. For such services, the Administrator pays
CGFSC a portion of the fee the Administrator receives from the Fund. Certain
employees of CGFSC are officers of the Fund. In addition, the Fund incurs local
administration fees in connection with doing business in certain emerging market
countries.
D. CUSTODIANS: Morgan Stanley Trust Company ("MSTC"), a wholly-owned subsidiary
of Morgan Stanley Dean Witter & Co., acts as custodian for the Fund's assets
held outside the United States in accordance with a custodian agreement. Chase
serves as custodian for the Fund's U.S. assets in accordance with a separate
custodian agreement. Custodian fees are computed and payable monthly based on
assets held, investment purchases and sales activity, an account maintenance
fee, plus reimbursement for certain out-of-pocket expenses. For the six months
ended June 30, 1998, the Portfolio incurred custody fees with MSTC of
approximately $16,000 and had amounts payable to MSTC at June 30, 1998 of
approximately $16,000.
In addition, for the six months ended June 30, 1998, the Portfolio earned
interest income of approximately $3,000 and incurred interest expense on
balances with MSTC of approximately $2,000.
E. OTHER: At June 30, 1998, the net assets of certain Portfolios were
substantially comprised of foreign denominated securities and currency. Changes
in currency exchange rates will affect the U.S. dollar value of and investment
income from such securities.
From time to time, a Portfolio may have shareholders that hold a significant
portion of the Portfolio's outstanding shares. Investment activities of these
shareholders could have a material impact on those Portfolios.
11
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
- --------------------------------------------------------------------------------
DIRECTORS
Barton M. Biggs
CHAIRMAN OF THE BOARD
Chairman and Director, Morgan Stanley Asset Management Inc.
and Morgan Stanley Asset Management Limited;
Managing Director, Morgan Stanley & Co. Incorporated
Michael F. Klein
DIRECTOR AND PRESIDENT
Principal, Morgan Stanley Asset Management Inc. and
Morgan Stanley & Co. Incorporated
John D. Barrett II
Chairman and Director,
Barrett Associates, Inc.
Gerard E. Jones
Partner, Richards & O'Neil LLP
Andrew McNally IV
River Road Partners
Samuel T. Reeves
Chairman of the Board and CEO,
Pinacle L.L.C.
Fergus Reid
Chairman and Chief Executive Officer,
LumeLite Plastics Corporation
Frederick O. Robertshaw
Of Counsel, Copple, Chamberlin & Boehm, P.C.
INVESTMENT ADVISERS AND ADMINISTRATORS
Morgan Stanley Asset Management Inc.
1221 Avenue of the Americas
New York, New York 10020
Miller Anderson & Sherrerd, LLP
One Tower Bridge
West Conshohocken, PA 19428-2899
DISTRIBUTOR
Morgan Stanley & Co. Incorporated
1221 Avenue of the Americas
New York, NY 10020
CUSTODIANS
Morgan Stanley Trust Company
One Pierrepont Plaza
Brooklyn, New York 11210
The Chase Manhattan Bank
3 Chase MetroTech Center
Brooklyn, NY 11245
OFFICERS
Stefanie V. Chang
VICE PRESIDENT
James A. Gallo
VICE PRESIDENT
Harold J. Schaaff, Jr.
VICE PRESIDENT
Joseph P. Stadler
VICE PRESIDENT
Lorraine Truten
VICE PRESIDENT
Valerie Y. Lewis
SECRETARY
Joanna M. Haigney
TREASURER
Rene J. Feuerman
ASSISTANT TREASURER
Karl O. Hartmann
ASSISTANT SECRETARY
LEGAL COUNSEL
Morgan, Lewis & Bockius LLP
2000 One Logan Square
Philadelphia, Pennsylvania 19103
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP
1177 Avenue of the Americas
New York, New York 10036
- --------------------------------------------------------------------------------
THIS REPORT IS AUTHORIZED FOR DISTRIBUTION ONLY WHEN PRECEDED OR ACCOMPANIED BY
THE PROSPECTUS OF THE MORGAN STANLEY UNIVERSAL FUNDS, INC. WHICH DESCRIBES IN
DETAIL EACH INVESTMENT PORTFOLIO'S INVESTMENT POLICIES, FEES AND EXPENSES.
PLEASE READ THE PROSPECTUS CAREFULLY BEFORE YOU INVEST OR SEND MONEY.
12
