<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
- --------------------------------------------------------------------------------
EMERGING MARKETS EQUITY PORTFOLIO
SEMI-ANNUAL REPORT
JUNE 30, 1998
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO
- --------------------------------------------------------------------------------
INVESTMENT OVERVIEW
COMPARISON OF NET ASSETS (AT JUNE 30, 1998)
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C>
Argentina 4.4%
Brazil 16.5%
Chile 0.6%
China 0.6%
Egypt 1.6%
Greece 1.9%
Hong Kong 1.4%
Hungary 2.7%
India 6.0%
Indonesia 0.9%
Israel 4.1%
Korea 3.5%
Malaysia 2.5%
Mexico 9.4%
Pakistan 1.6%
Philippines 1.4%
Poland 2.4%
Russia 4.7%
South Africa 7.4%
Taiwan 4.3%
Thailand 1.4%
Turkey 5.9%
Zimbabwe 0.6%
Other 14.2%
</TABLE>
PERFORMANCE COMPARED TO THE IFC GLOBAL TOTAL RETURN COMPOSITE INDEX(1)
- ------------------------------------
<TABLE>
<CAPTION>
TOTAL RETURNS(2)
----------------------------------------
AVERAGE ANNUAL
ONE SINCE
YTD YEAR INCEPTION(3)
---------- ---------- ----------------
<S> <C> <C> <C>
PORTFOLIO... -15.56% -30.99% -10.03%
INDEX..... -15.84% -38.58% -18.02%
</TABLE>
1. The IFC Global Total Return Composite Index is an unmanaged index of common
stocks and includes developing countries in Latin America, East and South
Asia, Europe, the Middle East and Africa (includes dividends).
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 October 1, 1996.
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
<TABLE>
<CAPTION>
TOP FIVE HOLDINGS
PERCENT OF
SECURITY COUNTRY NET ASSETS
- ------------------------------ ------------ -------------
<S> <C> <C>
Telebras Brazil 6.6%
Telmex, Class L ADR Mexico 3.2%
CRT Brazil 3.0%
Yapi Ve Kredi Bankasi A.S. Turkey 2.9%
FEMSA Mexico 2.3%
</TABLE>
<TABLE>
<CAPTION>
TOP FIVE SECTORS
VALUE PERCENT OF
INDUSTRY (000) NET ASSETS
- ------------------------ --------- -------------
<S> <C> <C>
Services $ 11,252 31.3%
Consumer Products 4,895 13.6%
Finance 4,865 13.5%
Energy 4,045 11.3%
Capital Equipment 2,304 6.4%
</TABLE>
THE COUNTRY SPECIFIC PERFORMANCE RESULTS PROVIDED IN THIS OVERVIEW ARE AS
MEASURED BY THE MORGAN STANLEY CAPITAL INTERNATIONAL (MSCI) EMERGING MARKETS
COUNTY OR REGIONAL INDICES AND 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.
The Emerging Markets Equity Portfolio seeks long-term capital appreciation by
investing primarily in common and preferred stocks, convertible securities,
rights and warrants to purchase common stocks, sponsored or unsponsored ADRs and
other equity securities of emerging market country issuers.
For the six months ended June 30, 1998, the Portfolio had a total return of
- -15.56% compared to -15.84% for the IFC Global Total Return Composite Index (the
"Index"). For the one year period ended June 30, 1998, the Portfolio had a total
return of -30.99% compared to -38.58% for the Index. For the period from October
1, 1996 (commencement of operations) through June 30, 1998, the Portfolio had a
total return of -10.03% compared with -18.02% for the Index.
The spectacular bust in Asia and the bear market in emerging countries have
heightened the importance of resolving the issues plaguing these markets. In our
view, investors are passing judgment that capitalism without democracy is
fundamentally flawed, and they are demanding politically open systems which
encourage the free flow of information of all kinds. This free flow of
information is ultimately the best natural "regulator" in the world. A free
press, full and frequent disclosure by corporations, government agencies and, in
particular, the banking system is vital for vibrant and effective economic
functioning.
It is our opinion that one of the most critical factors in the modernizing
equation for poor countries, particularly democracies, is the specter of mass
unemployment. Economic liberalization dramatically increases efficiency and is
fundamentally deflationary in its early stages. Japan, Asia and Russia are in
the throes of an inevitable adjustment, and Latin America, particularly Mexico,
is in the early stages of recovering from one. In truly impoverished countries,
unemployment is more than a statistic and a political inconvenience. Social
safety nets are crucial in countries with high illiteracy and low or no labor
mobility. Mass privatizations are critical, not only in increasing efficiency
and accountability in large parts of the economy, but also as an important
source of funding for social security and unemployment benefits.
1
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO
- --------------------------------------------------------------------------------
INVESTMENT OVERVIEW (CONT.)
At the micro economic level, a focus on shareholder values needs to replace the
idea of old style "Asian Values", i.e., corporations must be run in the interest
of the owners, and not directed by overweening politicians, ministries or run in
the "national interest". In today's world of low and declining tariffs, intense
global competition and readily available information, corporate survival will
increasingly depend on producing goods and services of better quality at lower
prices. The corporate largesse engendered by the corrupt nexus between politics
and big business must end. Increasingly, the ability to extract earnings from
assets that exceed their cost of capital will be key. Developing countries will
have to focus on nurturing and producing a professional cadre of businessmen who
can steer family-begun and run empires in a more competitive global landscape.
Education at the management and employee level will be critical, otherwise
technologically driven productivity jumps, primarily in the West, will erode one
of the important competitive edges of the Emerging Markets -- cheap and
plentiful labor.
To summarize, we believe there are several important lessons to be learned from
the Asian currency crisis:
- Consistency in fiscal, monetary and currency policy is crucial.
Inconsistency is brutally punished.
- Banking systems are the heart of an economy and must be carefully and
rigorously supervised.
- Bankruptcy laws are crucial cleansing solvents, and must be clearly stated
and enforced.
- Return on equity must exceed the cost of equity. Prices of both must be
clear; shareholder and property rights must be respected in the capital
markets and in the board room.
- Deregulating capital markets without deregulating domestic industry is a
disastrous combination.
During the second quarter, a second round of Asian contagion spread throughout
the emerging markets largely due to Japan's equity and currency malaise. The
Portfolio fell 20.2% versus a drop of 21.6% for the Index. The Portfolio's edge
over the Index was largely driven by strong stock selection, particularly in
Russia, Brazil, India, and Taiwan. Our underweight position in Malaysia was the
single most important contributor to outperformance on a country basis as the
market fell 46.1% during the second quarter. Also favorable was our overweight
exposure to Poland and Turkey which returned -2.7% and +9.5%, respectively. The
most notable negative was our underweight position in Greece which was up 17.8%
over the second quarter.
The recent turmoil in the emerging markets has led to steep declines in all the
Latin markets. The Latin region fell 20.0% during the second quarter led by
Venezuela (-40.2%), Brazil (-22.0%), and Chile (-21.7%). Peru was the best
performing Latin market, falling 4.7%. Declining commodity prices (particularly
oil and copper) and political noise given upcoming presidential elections
(Brazil and Venezuela) have negatively affected these markets.
During the second quarter, we increased our Argentine exposure by approximately
2%, to a market weight position. This increase was driven by signs of economic
strength and the government's commitment to reform. We trimmed 2% from our
Brazilian holdings, bringing us to a market-neutral position. While Brazil
offers attractive value and growth opportunities on a stock level, it suffers
from deteriorating macro variables, such as a widening fiscal deficit and a
vulnerable currency. In Argentina and Brazil, we are focusing on the telecom
sector given its strong operating earnings growth and privatization potential.
While remaining underweight, we increased 1% our Mexican exposure during the
month of April. Our underweight position is driven by a deterioration in the
macro environment (i.e., worsening trade account and expectations for higher
inflation and interest rates). We are focusing on the consumer-related
industries, such as beverages and retailers, given the continued strength of the
Mexican consumer.
The Asian markets plunged 33.2% during the second quarter, driven by declines in
Thailand (-52.6%), Indonesia (-52.5%), and Malaysia (-46.1%). The best
performing Asian market was Taiwan, which fell 23.1%. Asia's abysmal returns
were a result of renewed fears that Asia's currency markets would devalue again
based on currency instability in Japan and Russia. Also disconcerting for the
markets has been news of mounting bad bank loans, and rising interest rates,
inflation and unemployment within South East Asia. The most notable political
event took place in Indonesia, where President Suharto resigned on May 21 after
leading the country for 32 years. Vice President Habibie replaced him (to the
dismay of many student protesters) and has pledged new general elections next
year. We expect that Habibie will be in office on a transitional basis.
The equity markets of the Indian sub-continent plummeted, with India and
Pakistan falling 20.8% and 52.3% respectively. Both markets toppled in the
aftermath of nuclear tests, sparking renewed tension in the region and economic
sanctions from the U.S. and Japan. We had been focusing on these markets as they
offered good value and growth potential. Nevertheless, with the announcement of
a disappointing Indian budget on June 1, we have begun to trim our overweight
position there.
Europe, Middle East and Africa posted disparate returns. The laggards included
Russia (-53.1%) and South Africa (-26.6%). Turkey and Israel were the star
performers of this region, returning +9.5% and +5.8% respectively. Russia's
equity market was
2
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO
- --------------------------------------------------------------------------------
INVESTMENT OVERVIEW (CONT.)
decimated this past quarter given political changes, pressure on the currency,
and oil price declines. At the end of March, President Yeltsin dismantled his
cabinet in a successful effort to get rid of then Prime Minister Chernomyrdin.
Yeltsin assembled his new team headed by Prime Minister Kiriyenko, who had
previously been the Fuel and Energy Minister. In the short-term, sentiment
deteriorated as fears over currency instability forced the central bank to hike
interest rates by more than 100%. On a positive note, expectations of an IMF
package for the ailing economy have been realized and should be supportive of
the market and currency going forward.
South African equity and currency markets faced an arduous June, as returns
spiraled downward throughout the month. The equity market fell 23.3% in June,
including a 15.7% decline in the currency versus the dollar. A weak supply of
foreign currency reserves left the government unable to ward off increasing
pressure on the currency, as speculators sensed vulnerability. A lack of
consistency in implementing monetary policy led to a loss of confidence in the
central bank. The central bank continued to tinker with overnight repurchase
rates throughout the month, only to induce more pessimism over the short-term
future of the South African market. Ongoing structural problems in wages, which
remain high in real terms, weaker dollar commodity prices and low economic
growth conspired to create an overvalued Rand vis-a-vis Asian currencies,
further eroding the competitiveness of South African companies.
Over the course of the second quarter, we entered (+2%) the Greek market given
our expectation for improving macroeconomic numbers as Greece prepares to join
the European Union. We moved to an overweight stance on Hungary as a result of
improving economic growth and declining inflation. Though still overweight, we
trimmed 2% from our exposure to Russia as interest rates rose to astronomical
levels. Lastly, while maintaining our underweight position, we added 3% to South
Africa where we are focusing on the corporate restructuring story.
With most Asian markets down 75%-90% and others halved, we believe we are
somewhere close to an important economic and market trough. The speed and size
of the recovery in these countries will be a function of recognizing and
resolving the issues discussed in our general overview. In Asia, we are in the
midst of a Japan-Yen driven panic that has led to a second round of volatility
in Asia. Nonetheless, the early indications are that Korea and Thailand in
particular are starting to transform. Both these countries have new political
leadership which should pave a clearer path to readjustment. With the market
down 95% and Suharto ousted, it is easy, though glib to say that the worst is
over in Indonesia. The repair work to construct both a free market economy and a
functioning democracy is going to be long and painful. The ability of Russia and
China to adapt to economic recessions and the intense pressure to devalue are
important factors that have yet to play out.
The markets are in an unforgiving mood, having driven China/Hong Kong down 50%
and Russia down 70%. There may be worse economic, and perhaps political news
ahead, particularly if the Japanese mandarins don't take their heads out of the
sand. However, we believe that the death knell to socialism's last and true
champions has been struck and the evidence indicates that Darwinian adaptation
is underway. Stock buybacks in Japan, chaebol asset sales in Korea, bankruptcy
law formulation in Thailand and the passage of social security reform in Brazil
are perhaps the first drops of rain after the long drought.
Asset valuations are near bargain levels. Investor sentiment is the most
depressed that we have ever seen, and we are seeing the early signs of
restructuring across several markets. Yen stability and some decisive action by
Japan to end its crisis of confidence will most likely be the catalyst that
arrests the current free fall in sentiment and prices. We are aligning our
portfolios more towards countries and companies that are demonstrating
hard-headed adaptability to the new environment we envisage.
July 1998
3
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS
JUNE 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
VALUE
SHARES (000)
<C> <S> <C>
- -----------------------------------------------------------------------------------------------
COMMON STOCKS (85.1%)
ARGENTINA (4.4%)
1,100 Nortel ADR.................................................. $ 27
17,440 Telecom Argentina ADR....................................... 520
26,148 Telefonica Argentina ADR.................................... 848
5,860 YPF ADR..................................................... 176
-------
1,571
-------
BRAZIL (16.5%)
27,613,809 Banco Bradesco (Preferred).................................. 232
174,000 Brahma (Preferred).......................................... 108
21,301 Brahma (Preferred) ADR...................................... 266
17,927,393 CEMIG (Preferred)........................................... 558
3,880 CEMIG (Preferred) ADR....................................... 120
989,607 CRT (Preferred)............................................. 1,079
4,783 CVRD (Preferred)............................................ 95
3,023 CVRD ADR.................................................... 64
287,200 Coteminas................................................... 78
(e)2,700 Coteminas ADR............................................... 37
18,700 Electropaulo Metropolitana (Preferred)...................... 1
(a)18,700 Empresa Bandeirante de Energia (Preferred).................. --
(a)18,700 Empresa Metropolitana de Aguas e Energia (Preferred)........ --
18,700 Empresa Paulista de Transmissao de Energia Eletrica
(Preferred)............................................... --
110,000 Encorpar (Preferred)........................................ --
11,000 Lightpar.................................................... --
(a)2,311,000 Lojas Arapua (Preferred).................................... 2
(a)1,305 Lojas Arapua (Preferred) GDR................................ 1
1,050,000 Lojas Renner (Preferred).................................... 31
4,490 Pao de Acucar (Preferred) ADR............................... 102
1,027,000 Petrobras (Preferred)....................................... 191
(e)1,555 Petrobras (Preferred) ADR................................... 29
1,513,900 Telebras.................................................... 120
15,665 Telebras (Preferred) ADR.................................... 1,711
4,810,970 Telebras (Preferred)........................................ 523
4,836 Telecommunicacoes de Sao Paulos S.A. (Preferred)............ 1
(a)430,000 Telerj Celular S.A. (Preferred), Class B.................... 25
(a)3,158,836 Telesp Celular S.A. (Preferred), Class B.................... 262
10,185 Unibanco (Preferred) ADR.................................... 300
-------
5,936
-------
CHILE (0.6%)
3,235 CCU ADR..................................................... 68
3,140 Endesa ADR.................................................. 45
3,845 Enersis ADR................................................. 94
1,473 Santa Isabel ADR............................................ 16
-------
223
-------
CHINA (0.6%)
(a)5,275 Huaneng Power International, Inc. ADR....................... 71
36,000 Qingling Motors Co., Class H................................ 10
(a)8,650 Yanzhou Coal Mining Co. ADR................................. 84
425,000 Zhenhai Refining & Chemical Co., Ltd., Class H.............. 55
-------
220
-------
<CAPTION>
VALUE
SHARES (000)
<C> <S> <C>
- -----------------------------------------------------------------------------------------------
COLOMBIA (0.0%)
2,661 Banco de Colombia........................................... $ 5
-------
EGYPT (1.6%)
1,600 Al-Ahram Beverages Co. GDR.................................. 50
2,275 Commercial International Bank............................... 25
4,073 Commercial International Bank GDR (Registered).............. 44
4,600 Eastern Tobacco............................................. 83
400 Egypt Gas Co................................................ 38
1,200 Egyptian Financial & Industrial............................. 26
1,000 Helwan Cement............................................... 15
1,635 Industrial & Engineering.................................... 27
2,300 Madinet Nasr Housing & Development.......................... 110
350 North Cairo Flour Mills Co.................................. 6
600 Paints & Chemicals Industry................................. 17
5,600 Paints & Chemicals Industry GDR............................. 50
3,000 Suez Cement Co. GDR......................................... 54
1,200 Tourah Portland Cement Co................................... 21
-------
566
-------
GREECE (1.9%)
(a)7,340 Hellenic Petroleum S.A...................................... 60
18,065 Hellenic Telecommunication Organization S.A................. 464
600 National Bank of Greece S.A................................. 77
(a)1,930 STET Hellas Telecommunications S.A. ADR..................... 80
-------
681
-------
HONG KONG (1.4%)
43,000 CLP Holdings Ltd............................................ 196
71,000 China Resources Enterprise Ltd.............................. 73
1,000 Li & Fung Ltd............................................... 2
129,000 Ng Fung Hong Ltd............................................ 89
7,000 Shanghai Industrial Holdings Ltd............................ 17
88,000 South China Morning Post Holdings Ltd....................... 42
14,000 Sun Hung Kai Properties Ltd................................. 59
129,000 Zhejiang Expressway Co., Ltd., Class H...................... 22
-------
500
-------
HUNGARY (2.7%)
(a)1,447 Gedeon Richter Rt........................................... 116
780 Gedeon Richter Rt. GDR (Registered)......................... 64
(a)6,700 MOL Magyar Olaj-es Gazipari GDR............................. 181
11,230 MOL Magyar Olaj-es Gazipari Rt. GDR (Registered)............ 303
15,830 Matav Rt.................................................... 92
(a)3,190 Matav Rt. ADR............................................... 94
2,150 OTP Bank Rt................................................. 106
-------
956
-------
INDIA (6.0%)
13,800 Bajaj Auto Ltd.............................................. 186
54,000 Bharat Heavy Electricals Ltd................................ 313
(a)3,500 Bharat Petrolium Corp., Ltd................................. 29
26,500 Container Corp. of India Ltd................................ 286
14,529 Hero Honda Motors Ltd....................................... 300
5,000 Hindustan Petroleum Corp., Ltd.............................. 46
3,900 Housing Development Finance Corp............................ 275
6,500 ITC Ltd..................................................... 100
</TABLE>
The accompanying notes are an integral part of the financial statements.
4
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS (CONT.)
JUNE 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- -----------------------------------------------------------------------------------------------
<C> <S> <C>
</TABLE>
INDIA (CONT.)
<TABLE>
<C> <S> <C>
21,600 ITW Signode India Ltd....................................... $ 29
4,500 Infosys Technology Ltd...................................... 236
20,850 Larson & Toubro Ltd......................................... 113
(a,g)35,500 Morgan Stanley India Investment Fund, Inc................... 228
-------
2,141
-------
INDONESIA (0.9%)
76,616 Gudang Garam................................................ 45
(a)9,300 Gulf Indonesia Resources Ltd................................ 107
316,900 Indah Kiat Pulp & Paper Corp................................ 61
4,000 Indofood Sukses Makmur (Foreign)............................ --
21,000 PT Semen Fresik............................................. 12
222,000 Telekomunikasi Indonesia.................................... 63
3,715 Telekomunikasi Indonesia ADS................................ 22
-------
310
-------
ISRAEL (4.1%)
(a)89,200 Bank Hapoalim Ltd........................................... 270
(a)5,600 Dor Energy Corp............................................. 40
28,600 First International Bank of Israel Ltd., Class 5............ 224
4,670 Koor Industries Ltd......................................... 540
(a)3,859 Orbotech Ltd................................................ 140
48,950 Supersol Ltd................................................ 161
6,780 Supersol Ltd. ADR........................................... 112
-------
1,487
-------
KOREA (3.5%)
4,700 Hankuk Glass Industry Co., Ltd.............................. 51
(d)14,342 Pohang Iron & Steel Co., Ltd................................ 470
1,330 S1 Corp..................................................... 135
(a)16,352 Samsung Electronics Co...................................... 506
(a,e)370 Samsung Electronics Co. GDR................................. 5
(a)600 Samsung Electronics Co. GDR................................. 8
10 Samsung Fire & Marine Insurance............................. 2
(d)207 SK Telecom Co., Ltd......................................... 94
-------
1,271
-------
MALAYSIA (2.5%)
32,000 Carlsberg Brewery Malaysia Bhd.............................. 97
52,000 Genting Bhd................................................. 94
36,000 Golden Hope Plantations Bhd................................. 33
19,000 Kuala Lumpur Kepong Bhd..................................... 31
(a)25,000 Magnum Corp. Bhd............................................ 9
33,280 Malayan Banking Bhd......................................... 33
33,280 Malayan Banking 'A' Bhd..................................... 33
8,000 Malaysian International Shipping Corp. Bhd (Foreign)........ 12
8,000 Nestle (Malaysia) Bhd....................................... 36
58,000 Petronas Gas Bhd............................................ 108
68,000 R.J. Reynolds Bhd........................................... 94
8,200 Rothmans of Pall Mall (Malaysia) Bhd........................ 57
34,000 Technology Resources Industries Bhd......................... 23
84,000 Telekom Malaysia Bhd........................................ 142
73,000 Tenaga Nasional Bhd......................................... 88
-------
890
-------
<CAPTION>
VALUE
SHARES (000)
<C> <S> <C>
- -----------------------------------------------------------------------------------------------
MEXICO (9.4%)
(a)77,110 Banacci, Class B............................................ $ 150
(a)26,925 Bancomer, Class B........................................... 10
(e)3,810 Bancomer, Class B ADR....................................... 28
92,438 Cemex CPO................................................... 346
1,420 Cemex, Class B.............................................. 6
6,215 Cemex, Class B ADR.......................................... 55
(a)942 FEMSA ADR................................................... 30
25,242 FEMSA D..................................................... 786
75,906 Kimberly-Clark, Class A..................................... 268
4,400 TV Azteca ADR............................................... 48
(a)13,456 Televisa CPO GDR............................................ 506
24,236 Telmex, Class L ADR......................................... 1,165
-------
3,398
-------
PAKISTAN (1.6%)
136,000 Fauji Fertilizer Co., Ltd................................... 147
83,200 Hub Power Co................................................ 23
19,628 Pakistan State Oil Co., Ltd................................. 31
1,045,000 Pakistan Telecommunications Corp., Class A.................. 367
(a)104,535 Sui Northern Gas Pipelines Ltd.............................. 20
-------
588
-------
PHILIPPINES (1.4%)
333,120 Ayala Corp.................................................. 86
6,496 Ayala Land, Inc., Class B................................... 2
34,820 Manila Electric Co., Class B................................ 92
8,420 Philippine Long Distance Telephone Co....................... 192
500 Philippine Long Distance Telephone Co. ADR.................. 11
298,510 SM Prime Holdings, Inc...................................... 47
45,680 San Miguel Corp., Class B................................... 60
-------
490
-------
POLAND (2.4%)
(a)4,859 Agros Holding, Class C...................................... 71
99,373 BIG Bank Gdanski............................................ 133
2,000 BIG Bank Gdanski GDR........................................ 38
2,400 BRE Bank.................................................... 65
1,050 Bank Slaski................................................. 70
2,494 Bank of Handlowy W Warszawie................................ 47
(a)3,000 Debica...................................................... 60
(a)25,411 Elektrim.................................................... 310
(a)3,038 Exbud....................................................... 37
10,606 Polifarb Cieszyn-Wroclaw.................................... 28
-------
859
-------
RUSSIA (4.0%)
5,155 AO Tatneft ADR.............................................. 40
16,515 Lukoil Holding ADR.......................................... 549
27,099 Mosenergo ADR............................................... 135
(d)554 Mustcom..................................................... 191
(e)3,100 Pliva d.d. GDR.............................................. 50
33,410 Surgutneftegaz ADR.......................................... 134
2,560 Tatneft ADR................................................. 20
724,178 Unified Energy Systems...................................... 94
(a)4,966 Unified Energy Systems GDR.................................. 70
(a)3,331 Vimpel-Communications ADR................................... 149
-------
1,432
-------
</TABLE>
The accompanying notes are an integral part of the financial statements.
5
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS (CONT.)
JUNE 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- -----------------------------------------------------------------------------------------------
<C> <S> <C>
SOUTH AFRICA (7.4%)
18,299 Amalgamated Banks of South Africa........................... $ 114
1 Anglo American Corp. of South Africa Ltd.................... --
9,680 Barlow Rand Ltd............................................. 51
12,252 Bidvest Group Ltd........................................... 94
700 Coronation Holdings Ltd..................................... 11
900 Coronation Holdings Ltd. (New).............................. 14
58,000 Education Investment Corp. (The) Ltd........................ 105
22,840 Ellerine Holdings Ltd....................................... 125
15,645 Forbes Group Ltd............................................ 31
50,300 Illovo Sugar Ltd............................................ 63
13,791 Liberty Life Association of Africa Ltd...................... 269
16,550 Malbak Ltd.................................................. 11
(g)4,595 Morgan Stanley Africa Investment Fund, Inc.................. 54
119,580 NBS Boland Group Ltd........................................ 156
(a)345,300 New Africa Investments Ltd., Class N........................ 370
35,840 Orion Selections Ltd........................................ 45
23,890 Orion Selections Holdings Ltd............................... 40
21,700 Persetel Holdings Ltd....................................... 194
16,700 Primedia Ltd., N Shares..................................... 110
87,059 Protea Furnishers Ltd....................................... 62
20,300 Rembrandt Group Ltd......................................... 127
(a)29,400 Samgro Investment Holdings Ltd. (New)....................... 50
45,310 Sasol Ltd................................................... 263
10,360 South African Breweries Ltd................................. 214
102,400 Woolworths Holdings Ltd..................................... 76
-------
2,649
-------
TAIWAN (4.3%)
(a)27,750 Asustek Computer, Inc....................................... 227
(a)124,000 Chinatrust Commercial Bank.................................. 122
(a)82,974 Compal Electronics.......................................... 223
287,308 Far Eastern Textile Ltd..................................... 222
(a)42,000 Hon Hai Precision Industry.................................. 213
(a)43,000 Kuoyang Construction Industries............................. 68
32,000 President Chain Store Corp.................................. 102
(a)151,589 Siliconware Precision Industries Co......................... 220
(a)75,000 Taiwan Semiconductor Manufacturing Co....................... 155
-------
1,552
-------
THAILAND (1.4%)
15,500 Advanced Info Service PCL (Foreign)......................... 66
16,200 BEC World PCL (Foreign)..................................... 62
100,700 Bangkok Bank PCL (Foreign).................................. 124
14,700 Delta Electronics PCL (Foreign)............................. 84
5,000 Lanna Lignite PCL (Foreign)................................. 3
(a)15,200 PTT Exploration & Production PCL (Foreign).................. 115
11,100 Shinawatra Computer Co. PCL (Foreign)....................... 41
(a)600 Siam Cement PCL (Foreign)................................... --
(a,d)4,200 Thai Engine Manufacturing PCL (Foreign)..................... 2
-------
497
-------
TURKEY (5.9%)
801,600 Akbank T.A.S................................................ 26
(e)3,840 Akbank T.A.S. ADR........................................... 25
2,375,684 Arcelik..................................................... 112
855,000 Ege Biracilik............................................... 101
<CAPTION>
VALUE
SHARES (000)
<C> <S> <C>
- -----------------------------------------------------------------------------------------------
528,700 Erciyas Biracilik........................................... $ 80
(a)1,999,400 Eregli Demir Celik.......................................... 312
44,000 Migros Turk T.A.S........................................... 43
289,200 Petrol Ofisi A.S............................................ 74
652,000 Turk Sise ve Cam Fabrikalari A.S............................ 21
2,167,500 Turkiye Is Bankasi, Class C................................. 87
(a)1,733,000 Vestel Elektronik Sanayi Ve Ticaret A.S..................... 231
40,187,240 Yapi Ve Kredi Bankasi A.S................................... 1,026
-------
2,138
-------
VENEZUELA (0.0%)
16,340 Electricidad de Caracas..................................... 7
-------
ZIMBABWE (0.6%)
155,838 Delta Corp. Ltd............................................. 102
53,400 Meikles Africa Ltd.......................................... 65
230,000 Trans Zambesi Industries Ltd................................ 29
(e)100,300 Trans Zambesi Industries Ltd. ADR........................... 13
-------
209
-------
TOTAL COMMON STOCKS (COST $38,077)............................................ 30,576
-------
</TABLE>
<TABLE>
<CAPTION>
NO. OF
RIGHTS
<C> <S> <C>
- ---------------
RIGHTS (0.0%)
BRAZIL (0.0%)
25,746 CRT......................................................... --
10,817 CRT RFD..................................................... 12
(a,d)227 TELESP (Preferred), expiring 7/2/98......................... --
-------
12
-------
POLAND (0.0%)
(a)2,400 BRE Bank, expiring 7/11/98.................................. 1
-------
TURKEY (0.0%)
(a,d)501,000 Akbank T.A.S................................................ 13
(a,d)652,000 Turk Sise ve Cam Fabrikalari A.S............................ 5
-------
18
-------
TOTAL RIGHTS (COST $14)....................................................... 31
-------
</TABLE>
<TABLE>
<CAPTION>
NO. OF
WARRANTS
<C> <S> <C>
- ---------------
WARRANTS (0.0%)
THAILAND (0.0%)
(a)8,833 Siam Commercial Bank PCL, expiring 12/31/02 (COST $0)....... --
-------
</TABLE>
<TABLE>
<CAPTION>
FACE
AMOUNT
(000)
<C> <S> <C>
- ---------------
CONVERTIBLE NOTES (0.7%)
RUSSIA (0.7%)
$ (d)325 Svyaz Finance
17.00%, 8/11/99 (COST $325)............................... 260
-------
TOTAL FOREIGN SECURITIES (85.8%) (COST $38,416)............................... 30,867
-------
</TABLE>
The accompanying notes are an integral part of the financial statements.
6
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS (CONT.)
JUNE 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
<C> <S> <C>
- -----------------------------------------------------------------------------------------------
SHORT-TERM INVESTMENT (10.1%)
REPURCHASE AGREEMENT (10.1%)
$3,626 Chase Securities, Inc. 5.40%, dated 6/30/98 due 7/1/98, to
be repurchased at $3,627, collateralized by U.S. Treasury
Bonds, 11.25%, due 2/15/15, valued at $3,708 (COST
$3,626)................................................... $ 3,626
-------
FOREIGN CURRENCY (3.5%)
BRL 52 Brazilian Real.............................................. 45
COP 134 Colombian Peso.............................................. --
EGP 16 Egyptian Pound.............................................. 5
HKD 22 Hong Kong Dollar............................................ 3
HUF 100 Hungarian Forint............................................ --
INR 19,013 Indian Rupee................................................ 448
IDR 46,452 Indonesian Rupiah........................................... 3
KWN 2,433 Korea Won................................................... 2
MYR 126 Malaysian Ringgit........................................... 30
MXP 96 Mexican Peso................................................ 11
PKR 1,705 Pakistani Rupee............................................. 37
PHP 20 Philippines Peso............................................ 1
PLZ 58 Polish Zloty................................................ 17
ZAR 920 South African Rand.......................................... 155
TWD 17,017 Taiwan Dollar............................................... 495
VEB 150 Venezuelan Bolivar.......................................... --
-------
TOTAL FOREIGN CURRENCY (COST $1,265).......................................... 1,252
-------
TOTAL INVESTMENTS (99.4%) (COST $43,307)...................................... 35,745
-------
</TABLE>
<TABLE>
<S> <C> <C>
OTHER ASSETS (3.3%)
Receivable for Investments Sold................................... $ 341
Deferred Organization Costs....................................... 334
Net Unrealized Gain on Foreign Currency Exchange Contracts........ 172
Receivable for Portfolio Shares Sold.............................. 170
Dividends Receivable.............................................. 100
Receivable for Closed Foreign Currency Exchange Contracts......... 7
Due from Adviser.................................................. 2
Other............................................................. 68 1,194
-----------
LIABILITIES (-2.7%)
Payable for Investments Purchased................................. (399)
Unrealized Loss on Swap Agreement................................. (184)
Custodian Fees Payable............................................ (127)
Bank Overdraft.................................................... (84)
Payable for Portfolio Shares Redeemed............................. (78)
Professional Fees Payable......................................... (39)
Administrative Fees Payable....................................... (10)
Payable for Foreign Taxes......................................... (5)
Directors' Fees and Expenses Payable.............................. (1)
Other Liabilities................................................. (53) (980)
----------- -----------
NET ASSETS (100%)................................................................ $ 35,959
-----------
-----------
</TABLE>
<TABLE>
<CAPTION>
AMOUNT
(000)
<S> <C> <C>
- ------------------------------------------------------------------------------------
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 4,506,389 outstanding $0.001 par value shares (authorized
500,000,000 shares)................................................... $ 7.98
----------
----------
NET ASSETS CONSIST OF:
Paid in Capital......................................................... $ 47,235
Undistributed Net Investment Income..................................... 243
Accumulated Net Realized Loss........................................... (3,957 )
Unrealized Depreciation on Investments, Foreign Currency Translations
and Swaps (Net of foreign taxes of $3)................................ (7,562 )
----------
NET ASSETS.............................................................. $ 35,959
----------
----------
</TABLE>
- ---------------------------------------------------
FOREIGN CURRENCY EXCHANGE CONTRACT INFORMATION:
Under the terms of foreign currency exchange contracts open at June 30, 1998,
the Portfolio is obligated to deliver or is to receive foreign currency in
exchange for U.S. dollars as indicated below:
<TABLE>
<CAPTION>
NET
CURRENCY IN EXCHANGE UNREALIZED
TO DELIVER VALUE SETTLEMENT FOR VALUE GAIN (LOSS)
(000) (000) DATE (000) (000) (000)
- ------------ --------- ----------- ----------- --------- ---------------
<S> <C> <C> <C> <C> <C>
U.S.$ 49 $ 49 7/1/98 BRL 57 $ 49 $ --
U.S.$ 4 4 7/1/98 IDR 63,185 4 --
U.S.$ 4 4 7/2/98 IDR 53,173 4 --
PHP 16 -- 7/2/98 U.S.$ -- -- --
MYR 1,780 420 8/11/98 U.S.$ 473 473 53
ZAR 777 127 9/18/98 U.S.$ 140 140 13
ZAR 1,997 326 9/18/98 U.S.$ 360 360 34
ZAR 427 68 12/23/98 U.S.$ 73 73 5
ZAR 1,710 272 12/24/98 U.S.$ 290 290 18
ZAR 2,122 339 12/28/98 U.S.$ 363 363 24
ZAR 268 43 12/31/98 U.S.$ 44 44 1
KWN 253,134 183 1/4/99 U.S.$ 164 164 (19)
U.S.$ 15 15 6/21/99 ZAR 98 15 --
ZAR 2,556 392 6/21/99 U.S.$ 435 435 43
--------- --------- -----
$ 2,242 $ 2,414 $ 172
--------- --------- -----
--------- --------- -----
</TABLE>
The accompanying notes are an integral part of the financial statements.
7
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS (CONT.)
JUNE 30, 1998
(UNAUDITED)
- ---------------------------------------------------
SWAP AGREEMENT:
The Portfolio had the following Total Return Swap Agreement open at June 30,
1998:
<TABLE>
<CAPTION>
NOTIONAL UNREALIZED
AMOUNT (DEPRECIATION)
(000) DESCRIPTION (000)
- ----------- ------------------------------------------- ---------------
<S> <C> <C>
$ 350 Agreement with Goldman Sachs International $ (184)
terminating November 3, 1998 to pay 12
month USD-LIBOR minus 4.00% and to receive
the return of the Securities Exchange of
Thailand (SET) Index converted into U.S.
Dollars at the mid-market rate on October
30, 1998
</TABLE>
- ---------------
(a) -- Non-income producing security
(d) -- Security valued at fair value -- See note A-1 to financial statements.
(e) -- 144A Security -- certain conditions for public sale may exist.
(g) -- The Fund is advised by an affiliate.
ADR -- American Depositary Receipt
ADS -- American Depositary Shares
CPO -- Certificate of Participation
GDR -- Global Depository Receipt
LIBOR -- London Interbank Offer Rate
PCL -- Public Company Limited
RFD -- Ranked for Dividends
USD -- U.S. Dollar
- ----------------------------------------------------------------
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>
$ 42,042 $ 1,075 $ (8,624) $ (7,549)
</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 approximately $22,137,000 and $12,207,000,
respectively. There were no purchases and sales of long-term U.S. Government
securities for the six months ended June 30, 1998.
- ----------------------------------------------------------------
At June 30, 1998, the Portfolio owned shares of affiliated funds for which the
Portfolio earned dividend income of less than $1,000 and realized losses of
approximately $14,000.
- ----------------------------------------------------------------
SUMMARY OF FOREIGN SECURITIES BY INDUSTRY CLASSIFICATION
<TABLE>
<CAPTION>
% OF
VALUE NET
SECTOR DIVERSIFICATION (000) ASSETS
- ---------------------------------------- --------- ---------
<S> <C> <C>
Capital Equipment....................... $ 2,304 6.4%
Consumer Products....................... 4,895 13.6
Energy.................................. 4,045 11.3
Finance................................. 4,865 13.5
Materials............................... 2,206 6.1
Multi-Industry.......................... 1,300 3.6
Services................................ 11,252 31.3
--------- ---
Total Foreign Securities................ $ 30,867 85.8%
--------- ---
--------- ---
</TABLE>
The accompanying notes are an integral part of the financial statements.
8
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1998
(UNAUDITED)
(000)
<S> <C>
- -----------------------------------------------------------------------------------
INVESTMENT INCOME:
Dividends $ 413
Interest 188
Less: Foreign Taxes Withheld (16)
--------
Total Income 585
--------
EXPENSES:
Investment Advisory Fees 237
Less: Fees Waived (237)
--------
Net Investment Advisory Fees --
Custodian Fees 150
Shareholder Reports 70
Administrative Fees 56
Amortization of Organizational Costs 51
Professional Fees 25
Interest Expense 13
Foreign Tax Expense 10
Directors' Fees and Expenses 2
Other 1
Expenses Reimbursed by Adviser (22)
--------
Net Expenses 356
--------
Net Investment Income 229
--------
NET REALIZED LOSS ON:
Investments Sold (includes realized losses from affiliates
of $14,000) (2,630)
Foreign Currency Transactions (251)
Swap Agreements (151)
--------
Net Realized Loss (3,032)
--------
CHANGE IN UNREALIZED APPRECIATION/DEPRECIATION ON:
Investments (Net of foreign taxes of $3 on unrealized
depreciation) (3,935)
Foreign Currency Translations 292
Swap Agreements (83)
--------
Change in Unrealized Appreciation/Depreciation (3,726)
--------
Net Realized Loss and Change in Unrealized
Appreciation/Depreciation (6,758)
--------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $(6,529)
--------
--------
</TABLE>
- --------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1998 YEAR ENDED
(UNAUDITED) DECEMBER 31, 1997
(000) (000)
<S> <C> <C>
- -----------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS:
Net Investment Income $ 229 $ 106
Net Realized Gain (Loss) (3,032) 195
Change in Unrealized
Appreciation/Depreciation (3,726) (3,701)
-------- --------
Net Decrease in Net Assets Resulting
from Operations (6,529) (3,400)
-------- --------
DISTRIBUTIONS:
Net Investment Income -- (226)
Net Realized Gain -- (76)
In Excess of Net Realized Gain -- (924)
-------- --------
Total Distributions -- (1,226)
-------- --------
CAPITAL SHARE TRANSACTIONS (1):
Subscribed 16,852 39,684
Distributions Reinvested -- 1,223
Redeemed (8,462) (13,972)
-------- --------
Net Increase in Net Assets Resulting from
Capital Share Transactions 8,390 26,935
-------- --------
Total Increase in Net Assets 1,861 22,309
NET ASSETS:
Beginning of Period 34,098 11,789
-------- --------
End of Period (Including undistributed
net investment income of $243 and $14,
respectively) $35,959 $34,098
-------- --------
-------- --------
- -----------------------------------------------------------------------------------
(1) Capital Share Transactions:
Shares Subscribed 1,756 3,551
Shares Issued on Distributions
Reinvested -- 135
Shares Redeemed (860) (1,282)
-------- --------
Net Increase in Capital Shares
Outstanding 896 2,404
-------- --------
-------- --------
- -----------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
9
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
SIX MONTHS ENDED PERIOD FROM
JUNE 30, 1998 YEAR ENDED OCTOBER 1, 1996*
SELECTED PER SHARE DATA AND RATIOS (UNAUDITED) DECEMBER 31, 1997 TO DECEMBER 31, 1996
<S> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $ 9.45 $ 9.78 $ 10.00
------- ------- -------
INCOME FROM INVESTMENT OPERATIONS
Net Investment Income 0.05 0.04 0.01
Net Realized and Unrealized Loss (1.52) -- (0.21)
------- ------- -------
Total From Investment Operations (1.47) 0.04 (0.20)
------- ------- -------
DISTRIBUTIONS
Net Investment Income -- (0.07) (0.02)
Net Realized Gain -- (0.02) --
In Excess of Net Realized Gain -- (0.28) --
------- ------- -------
Total Distributions -- (0.37) (0.02)
------- ------- -------
NET ASSET VALUE, END OF PERIOD $ 7.98 $ 9.45 $ 9.78
------- ------- -------
------- ------- -------
TOTAL RETURN (15.56)% 0.52% (2.03)%
------- ------- -------
------- ------- -------
RATIOS AND SUPPLEMENTAL DATA:
Net Assets, End of Period (000's) $35,959 $34,098 $11,789
Ratio of Expenses to Average Net
Assets 1.87%** 1.80% 1.79%**
Ratio of Expenses to Average Net
Assets Excluding Interest Expense
and Foreign Tax Expense 1.75%** 1.75% 1.75%**
Ratio of Net Investment Income to
Average Net Assets 1.21%** 0.47% 0.32%**
Portfolio Turnover Rate 38% 87% 9%
- -------------------------------------------------------------------------------------------------------
Effect of Voluntary Expense
Limitation During the Period:
Per Share Benefit to Net Investment
Income $ 0.06 $ 0.17 $ 0.08
Ratios Before Expense Limitation:
Expenses to Average Net Assets 3.24%** 4.12% 6.17%**
Net Investment Loss to Average Net
Assets (0.15)%** (1.84)% (4.06)%**
</TABLE>
- --------------------------------------------------------------------------------
* Commencement of operations
** Annualized
The accompanying notes are an integral part of the financial statements.
10
<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 Equity
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.
11
<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 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
12
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
JUNE 30, 1998 (UNAUDITED)
- --------------------------------------------------------------------------------
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 options which are exercised or are closed are added to or
offset against the proceeds or amount paid on the transaction
13
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
JUNE 30, 1998 (UNAUDITED)
- --------------------------------------------------------------------------------
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.
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
the Portfolios of 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
Equity 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 Equity... 1.25% 1.20% 1.15%
</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 1.75%.
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 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
14
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
JUNE 30, 1998 (UNAUDITED)
- --------------------------------------------------------------------------------
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 $148,000 and had amounts
payable to MSTC at June 30, 1998 of approximately $123,000.
In addition, for the six months ended June 30, 1998, the Portfolio earned
interest income of approximately $1,000 and incurred interest expense on
balances with MSTC of approximately $24,000.
E. OTHER: During the six months ended June 30, 1998, the Portfolio paid
brokerage commissions to Morgan Stanley & Co., Incorporated, an affiliated
broker/dealer of approximately $5,000.
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.
15
<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.
16
