MORGAN STANLEY UNIVERSAL FUNDS INC, N-30D, 1999-03-02

MORGAN STANLEY UNIVERSAL FUNDS INC
N-30D, 1999-03-02

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MORGAN STANLEY UNIVERSAL FUNDS, INC.

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EMERGING MARKETS EQUITY PORTFOLIO

ANNUAL REPORT
DECEMBER 31, 1998
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO

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INVESTMENT OVERVIEW
COMPOSITION OF NET ASSETS (AT DECEMBER 31, 1998)

EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC

<TABLE>
<S> <C>
Argentina 1.8%
Brazil 7.0%
Chile 1.1%
China 1.2%
Egypt 1.3%
Greece 8.1%
Hungary 3.6%
India 8.2%
Indonesia 1.7%
Israel 6.0%
Korea 11.6%
Malaysia 1.7%
Mexico 10.4%
Pakistan 1.4%
Philippines 1.7%
Poland 3.1%
South Africa 5.2%
Taiwan 6.9%
Thailand 1.8%
Turkey 1.7%
Other 14.5%
</TABLE>

<TABLE>
<CAPTION>
TOP FIVE HOLDINGS
PERCENT OF
ISSUER COUNTRY NET ASSETS
- ----------------------------------- ------- ------------
<S> <C> <C>
Hellenic Telecommunication
Organization S.A. Greece 5.2%
Samsung Electronics Co. Korea 4.4%
Pohang Iron & Steel Co., Ltd. Korea 3.2%
Telmex ADR, Class L Mexico 2.6%
Formento Economico Mexicano, S.A.
de CV Mexico 2.4%
</TABLE>

<TABLE>
<CAPTION>
TOP FIVE SECTORS
PERCENT
OF
VALUE NET
INDUSTRY (000) ASSETS
- ----------------------------------- ------ ---------
<S> <C> <C>
Services $10,135 27.9%
Consumer Goods 6,035 16.6%
Capital Equipment 5,101 14.0%
Energy 3,722 10.2%
Finance 3,252 9.0%
</TABLE>

PERFORMANCE COMPARED TO THE IFC GLOBAL TOTAL RETURN COMPOSITE INDEX(1)
AND THE MSCI EMERGING MARKETS FREE INDEX(2)
- ------------------------------------

<TABLE>
<CAPTION>
TOTAL RETURNS(3)
----------------------------
AVERAGE ANNUAL
ONE SINCE
YEAR INCEPTION(4)
---------- ----------------
<S> <C> <C>
PORTFOLIO........ -24.34% -12.26%
IFC GLOBAL TOTAL
RETURN COMPOSITE
INDEX(1)......... -21.08% -16.77%
MSCI EMERGING
MARKETS FREE
INDEX(2)......... -25.34% -17.21%
</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. The Morgan Stanley Capital International (MSCI) Emerging Markets Free Index
is a market capitalization weighted equity index composed of companies that
are representative of the market structure of the following countries:
Argentina, Brazil, Chile, China Free, Colombia, Czech Republic, Greece,
Hungary, India, Indonesia, Israel, Jordan, Korea (at 50%), Malaysia, Mexico
Free, Pakistan, Peru, Philippines Free, Poland, Portugal, Russia, South
Africa, Sri Lanka, Taiwan (at 50%), Thailand, Turkey and Venezuela Free.
3. 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.
4. Commenced operations on October 1, 1996.
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
COMPARISON OF THE CHANGE IN VALUE OF A
$10,000 INVESTMENT

EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC

<TABLE>
<CAPTION>
EMERGING MARKETS IFC GLOBAL TOTAL RETURN MSCI EMERGING MARKETS
EQUITY PORTFOLIO COMPOSITE INDEX (1) FREE INDEX (2)
<S> <C> <C> <C>
10/1/96* $10,000 $10,000 $10,000
12/31/96 $9,797 $9,830 $9,905
12/31/97 $9,848 $8,413 $8,675
12/31/98 $7,451 $6,640 $5,672
</TABLE>

* Commencement of operations.
In accordance with SEC regulations, Portfolio performance shown assumes that all
recurring fees (including management fees) were deducted and all dividends and
distributions were reinvested.

CERTAIN INFORMATION APPEARING IN THIS INVESTMENT OVERVIEW IS UNAUDITED.
ACCORDINGLY, THE REPORT OF INDEPENDENT ACCOUNTANTS APPEARING ELSEWHERE IN THIS
REPORT DOES NOT EXTEND TO THIS INFORMATION. THE INFORMATION CONTAINED IN THIS
OVERVIEW REGARDING SPECIFIC SECURITIES IS FOR INFORMATIONAL PURPOSES ONLY AND
SHOULD NOT BE CONSTRUED AS A RECOMMENDATION TO PURCHASE OR SELL THE SECURITIES
MENTIONED. THE COUNTRY SPECIFIC PERFORMANCE RESULTS PROVIDED IN THIS OVERVIEW
ARE AS MEASURED BY THE IFC GLOBAL TOTAL RETURN COMPOSITE INDEX AND THE MSCI
EMERGING MARKETS FREE INDEX 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 year ended December 31, 1998, the Portfolio had a total return of
- -24.34% compared to -21.08% for the IFC Global Total Return Composite Index (the
"Index") and -25.34% for the Morgan Stanley Capital International (MSCI)
Emerging Markets Free Index. For the period since inception on October 1, 1996
through December 31, 1998, the Portfolio had an average annual total return of
- -12.26% compared with -16.77% for the Index and -17.21% for the MSCI Emerging

1
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MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO

- --------------------------------------------------------------------------------
INVESTMENT OVERVIEW (CONT.)

Markets Free Index. Beginning with this report, the Portfolio's performance will
be compared to the MSCI Emerging Markets Free Index as it is more closely
aligned with our investment strategy for the Portfolio.
The financial crises of 1998 have left a legacy of lessons for the emerging
markets as well as for the broader global financial markets. Making sense of all
that took place last year is not an easy task. Nevertheless, in the following
few pages we will attempt to review the critical events that took place in 1998
for the emerging markets, and tender some tentative observations about what we
expect in the year ahead.
While it is true that the currency devaluations of Asia--the visible starting
point of the malaise that still reverberates in the global economy today--took
place in 1997, it was not until 1998 that the full fury of the events unleashed
by those depreciating currencies was felt. Numerous events--both at the global
and at the emerging market level--took place which shook many investors'
understanding of and faith in financial markets, and a recap of a few of the
more momentous ones might be helpful:
GLOBAL
1) The Japanese yen, following the collapse of that country's economy,
collapsed into the mid to high 140's (to the U.S. dollar) seemingly on its
way to the 160's before staging a startling and largely unexplained rally to
approximately the 115 level. As we write, the yen is now at 109.
2) Both the European and U.S. stock markets collapsed from healthy double digit
gains early in the year, dipped into negative territory by the end of the
summer, only to almost completely climb back to their earlier highs by the
end of the year.
3) The Federal Reserve Bank engineered a controversial rescue of a highly
leveraged hedge fund which, remarkably, threatened the health of the world's
financial markets.
4) No fewer than 37 central banks--in an almost unprecedented show of
coordination--executed more than 75 monetary policy easings in the latter
half of 1998 to avert a total meltdown in financial markets.
5) Commodity prices continued their lurching downward spiral as Asian demand
shortfalls further aggravated supply/demand imbalances; oil was particularly
hard hit, as OPEC continued to undergo a secular decline in influence and
the oil industry cartel slowly continued to disintegrate.
EMERGING
1) The Russian currency, economy, and debt markets collapsed as that country
unilaterally announced a de facto debt moratorium and currency devaluation,
singlehandedly triggering a worldwide credit contraction and financial
market panic.
2) Malaysia announced currency controls in a single act of defiance against
market forces that, due to its possible emulation by other governments, cast
a chill throughout emerging markets.
3) Indonesia descended into social and political chaos as riots and mayhem
engulfed that country in the aftermath of its economic crisis, leading to an
eventual departure of longstanding leader Suharto.
4) Brazil stared into the abyss of possible economic destruction in the
aftermath of the Russian meltdown, nearly averting a currency collapse with
the help of Messrs. Greenspan and Rubin.
5) Venezuela, in the throes of a steep recession exacerbated by historically
low oil prices, elected a populist, ex-military/failed coup leader as
President.

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MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO

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INVESTMENT OVERVIEW (CONT.)

6) Broader Asian markets staged a remarkable early-year recovery, collapsed
again and touched new lows, then staged an even more powerful recovery late
in the year led by currency strengthening throughout the region.
As a whole, 1998 was a volatile year that we would prefer not to repeat.
Importantly, though, the year contained significant bright spots. The chief
positives came from the phenomenal stabilization and recovery of Asian financial
markets toward the latter part of the year, and the continued fiscal discipline
exhibited by the peripheral European markets striving to converge with western
Europe, most notably Greece.
The Asian crisis has been written about and discussed ad infinitum. Here, we
would like simply to point out that the faith placed by Asian citizens in their
host country's financial systems and government policies has been nothing short
of astounding. This faith, together with high domestic savings rates, played a
single-handed role in allowing most battered Asian countries to simultaneously
benefit from lower interest rates and stronger currencies. Early in the year
this confluence of events would scarcely have been imaginable. Simply put, as
foreign capital fled, and most banking systems seized up (and were in many cases
taken over by the government) investors continued to both restrain their
consumption and continue depositing their savings in local currency-denominated
assets in domestic financial institutions. And, as collapsing domestic
consumption and investment triggered a dramatic decline in imports, Asian
countries were able to build up reserve levels through massive current account
surpluses. The resulting recapitalization of the economy and excess supply of
money relative to demand resulted in a historic drop in interest rates in most
of the beleaguered countries--the primary two examples are South Korea and
Thailand. This achievement has, in our view, singularly restored health to the
capital markets in Asia--much more so than forward-looking reforms or foreign
investment flows, both of which have been largely disappointing.
Equally impressive is the secular change being witnessed in eastern Europe
(Hungary, Poland, and the Czech Republic) and especially Greece. To briefly
oversimplify, the power of the euro is exerting a tremendous pull on these
countries to get their respective fiscal houses in order; they must do so to be
accepted into the eurozone when it is their turn. In Greece's case, the
"convergence" story is immediate, and the remarkable performance of that
country's equity market last year is explained by the equally remarkable
performance of the Greek government to control spending and keep a lid on
inflation (the two most important criteria for EMU acceptance). In the eastern
European markets EMU acceptance is further away, but nevertheless those
countries' respective governments (and, equally importantly, electorates) are
already conducting both fiscal and monetary policy in strict accordance with
their goals of being accepted into the EMU as soon as possible. The relative
resilience of their equity markets last year reflects that underlying
determination.
As a final comment about positive developments witnessed in 1998, we should note
an important secular trend at the micro, or sector, level. That is, an important
positive secular development continued to take place in the technology field,
and both Taiwan and India have continued to exploit this trend (and, to some
extent, Korea). Taiwan has developed into a PC-component manufacturing
powerhouse, and as the trend toward lower cost PC's continues so does the global
outsourcing trend, which directly benefits that sector. As a result, the
"electronics" sector in Taiwan posted solid absolute returns in 1998 while the
broader Taiwanese market ended the year in negative territory. A similar
phenomenon has taken place in India, yet in this case it is in the software
services sector. As programming talent in the U.S. gets more expensive, Indian
companies are increasingly capturing a larger piece of the global software
services expenditure pie due to their cost advantages and abundant supply of
high quality programming talent.
THE PORTFOLIO IN 1998
Country allocation contributed positively to performance in the fourth quarter.
Specifically, our overweight positions in Korea and Thailand contributed solidly
to performance in the fourth quarter and throughout the year. Our overweight in
Hungary was also positive as that market solidly

3
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MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO

- --------------------------------------------------------------------------------
INVESTMENT OVERVIEW (CONT.)

outpaced the Index in the fourth quarter. Also positive were our underweights in
Argentina, Chile, Peru and Venezuela. Strong stock selection in Brazil, Mexico
and Taiwan also contributed significantly to total return.
Underperformance relative to the Index was largely driven by our overweight
positions in Turkey (+3.9%), Poland (+6.3%) and Pakistan (-8.8%) coupled with
our underweight exposure to Greece (+33.3%). Underperformance relative to the
Index was also partly driven by disappointing stock returns in some of our Asian
positions. Our Korean and Thai holdings underperformed their country benchmarks,
and while the overweights in these markets had a positive impact on return,
stock selection in these markets was poor.
OUTLOOK FOR 1999
Given all that has happened to the world and to our asset class in the past few
years, any predictions need to be put forth with a large degree of
circumspection. Let us begin with a broad review of what we think are some of
the important lessons and themes for 1999 coming out of the experience of 1998:
1) Liquidity will be abundant in Europe and the U.S. owing to the generous
monetary easings mentioned earlier and the modest global growth we foresee
for 1999.
2) This developed market liquidity will have great difficulty finding its way
back to the "vulnerable" emerging markets; that is, the reduction in global
financial risk appetites witnessed last year will, in our view, persist for
some time to come.
3) Commodity prices may stop falling, but it will take a marked recovery in
global aggregate demand to lead to a sustained and meaningful recovery in
broad commodity prices; we think this is, at best, a medium to long-term
event.
4) As a result of #2 above, fiscally profligate emerging market governments
will be met with grave skepticism and not likely given the "benefit of the
doubt" by financial markets.
5) The Asian financial market recovery will continue into 1999, and we should
begin to see the beginning of an economic stabilization if not full-scale
recovery.
6) In short, the separation between the "haves" and the "have nots" witnessed
in 1998 will persist, and perhaps even widen in 1999; this process in the
emerging markets universe is not unlike what has taken place in the U.S.
stock market between the mega-cap nifty fifty stocks (the haves) and the
small cap or industrial commodity stocks (the have nots).
As a result of the above views, we have chosen to tilt the Portfolio toward high
quality markets and sectors with solid fundamental underpinnings, especially
those with endogenously generated underpinnings less vulnerable to exogenous
shocks. The broader regional strategy, therefore, is to overweight peripheral
Europe and Asia, and to underweight Latin America and South Africa. The
overweight in peripheral Europe owes to a continuation of the forces at work
cited above. We are confident Greece will be accepted into EMU, and therefore
that interest rates will converge with those in western Europe. Eastern Europe
we like simply for the strong fiscal discipline they have evidenced, and are
looking for a related fall in interest rates throughout the year. The one
concern we are monitoring is the widening current account deficits in both
Poland and Hungary. Israel is a market that we like not because of the macro
picture but because of a group of Israeli technology companies that offer unique
bottom-up secular earnings growth unmatched in most of our emerging market
universe.
Asia is a region that is tough to get one's arms around; valuations are hard to
ferret out, and earnings outlooks hard to predict. Nevertheless, we are quite
optimistic that the Korean market represents enormous opportunity both for
continued interest rate declines and for enormous earnings growth owing to the
highly leveraged nature of that country's corporate sector. We do not have
dramatic country bets anywhere else in Asia but have a dramatic overweight in
the Taiwanese

4
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MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO

- --------------------------------------------------------------------------------
INVESTMENT OVERVIEW (CONT.)

electronics sector, for reasons mentioned above. India is a market whose macro
outlook is dubious at best but whose market offers up a wide range of attractive
bottom-up stories, especially in the aforementioned software services sector.
On the underweight side, Latin America is our biggest bet. We are very concerned
about the macro picture in Brazil. After a visit to the country in November we
fleetingly held a more constructive stance, but events since then have
transpired to make us more negative on the market. While not explicitly calling
for a market collapse, we think odds are high that something breaks in that
country's policy mix this year, most likely in the first half. The combination
of an overvalued exchange rate, gargantuan fiscal deficit, and stubbornly high
current account deficit is an unruly mix that will not likely be tolerated by
financial markets. We would be more underweight the market were it not for our
extremely constructive stance on the secular earnings growth outlook for the
telecommunications sector; within our underweight in Brazil we have a dramatic
overweight in that sector. Elsewhere in the region, we are dramatically
underweight Chile (vulnerable to weak copper price, anemic corporate earnings
growth, and large current account deficit) and solidly underweight Argentina
(solid macro but equities are not cheap and the market is vulnerable to Brazil
collapse). Further, we are underweight in Venezuela (overvalued currency,
terrible macro owing to low oil price) and Peru (commodity price-based economy)
and market weight Mexico. As a final note, we are underweight South Africa in
large part due to that country's currency vulnerability to exogenous shocks
(e.g. Brazil), and to the fact that corporate earnings growth, on a secular
basis, should be lackluster.
General risks to our bets would be 1) a return to risk-loving behavior by global
financial markets which would lead to the "vulnerable" emerging markets gaining
access to capital more easily than we expect, and 2) a meaningful near-term
increase in the price of commodities owing to a successful reflation effort by
the developed markets' central banks, which would dramatically improve the
current account positions and economic activities of both Latin America and
South Africa. We think either of these scenarios are low-probability ones, but
nevertheless are on vigilant watch for early warning signals of either scenario
proving us wrong. The tenuous Brazil outlook--and with it the prospect for a
weaker than expected U.S. economy--as well as the prospect for Japanese economic
activity surprising on the downside (owing to the strong currency and backup in
interest rates) give us some comfort that global aggregate demand will not be
buoyant enough to sharply reverse the trend in commodity prices.
CONCLUSION
Undoubtedly, emerging markets investors have had a difficult few years. Having
said that, we are glimpsing signs that this multi-year bear market may finally
be working its way through. Now that the Brazil shoe has dropped (see below), we
think that may likely be the bottom for our asset class-- barring a meltdown in
the U.S. equity market of course. We believe that most of the risks in the asset
class have either dissipated or have been fully discounted. Further, we believe
that our Portfolio is positioned to take advantage of opportunities arising from
changes in these markets. Not only are our stocks cheap, they are terrific
companies. We are strong believers that sometime in the medium-term, if not the
near term, this asset class, and our Portfolio with it, will be well on its way
to steadily posting the superior returns for which it earned its "emerging"
label.
BRAZIL UPDATE
After a long struggle, the Brazilian government finally bowed to market
pressures and altered its exchange rate regime in mid-January. While details
about specific policy strategy are sketchy, the facts we know are as follows:
1) The currency, the real, was initially allowed to move to the weak side of
its wide trading band, causing an immediate effective devaluation of roughly
10%.
2) Central bank president Gustavo Franco, widely associated with a staunch
defense of the real, has resigned; he will be succeeded by his deputy
Francisco Lopes.

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MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO

- --------------------------------------------------------------------------------
INVESTMENT OVERVIEW (CONT.)

3) The currency has subsequently been allowed to float and has found a level of
approximately 1.55. The market reaction to this event has been positive.
Our thoughts about the implications of this move for Brazil are necessarily
tentative at this stage. The currency move per se is not a bad thing; to the
extent it removes rigidities and price distortions from the economy it can be
argued that, longer-term, it will have been helpful. Further, given that high
interest rates have prevailed in Brazil for some time, leverage in the economy
and financial system is actually quite low. Therefore, the follow-on
reverberations witnessed after the Asian devaluations owing to excessive
leverage should not be repeated in Brazil. Having said that, it is too early to
tell what inflationary impact the devaluation may have; there is a possibility,
though we think it low, that inflation spirals out of control. Further, fiscal
imbalances are not solved by the devaluation, and these remain as a major item
to be tackled by the Cardoso administration. On the flip side, a spike in
inflation may temporarily ease some of these fiscal pressures. Overall, we will
have to wait and see how subsequent policy strategy and implementation is
handled, and this will greatly determine whether Brazil is better or worse off
post-devaluation.
Taking a step back, though, asset values in the equity market had already
factored in a good portion of the macro vulnerabilities. Our favorite sector,
the telecommunications sector, trades at unfathomably cheap levels. In fact it
is the attractiveness of this sector which has prevented us from being more
underweight. Given that these assets can be bought today 15-20% more cheaply, we
will be aggressively looking for signs of financial market stabilization to add
to our positions. For the time being, we will monitor developments.
January 1999

6
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MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO

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STATEMENT OF NET ASSETS
DECEMBER 31, 1998
<TABLE>
<CAPTION>
VALUE
SHARES (000)
<C> <S> <C>
- -----------------------------------------------------------------------------------------------

COMMON STOCKS (88.1%)
ARGENTINA (1.8%)
15,488 Telecom Argentina ADR....................................... $ 426
3,720 Telefonica Argentina ADR.................................... 104
3,894 YPF ADR..................................................... 109
-------
639
-------
BRAZIL (7.0%)
121,600 Brahma (Preferred).......................................... 53
8,741 Brahma (Preferred) ADR...................................... 83
17,869,136 CEMIG (Preferred)........................................... 340
5,538 CEMIG (Preferred) ADR....................................... 105
8,870 CIA Vale do Rio Doce (Preferred), Class A................... 114
(d)287,200 Coteminas................................................... 31
(e)2,700 Coteminas ADR............................................... 13
1,549,074 CRT (Preferred), Class A.................................... 558
3,273 CVRD ADR.................................................... 42
4,872,936 Embratel Participacoes S.A. (Preferred)..................... 67
(a)2,311,000 Lojas Arapua (Preferred).................................... 1
(a,e)1,305 Lojas Arapua GDR............................................ --
3,220 Pao de Acucar ADR........................................... 50
2,553 Petrobras (Preferred)....................................... --
(e)1,530 Petrobras ADR............................................... 17
(a)1,050,000 Renner Participacoes S.A.................................... 1
(a)13,202,936 Tele Celular Sul Participacoes S.A. (Preferred)............. 22
(a)450 Tele Celular Sul Participacoes S.A. ADR..................... 8
(a)11,372,936 Tele Centro Sul Participacoes S.A. (Preferred).............. 99
(a)555 Tele Centro Sul Participacoes S.A. ADR...................... 23
(a)17,315,936 Tele Leste Celular Participacoes S.A. (Preferred)........... 10
(a)10,252,936 Tele Nordeste Celular Participacoes S.A. (Preferred)........ 9
(a)375 Tele Nordeste Celular Participacoes S.A. ADR................ 7
(a)4,072,936 Tele Norte Celular Participacoes S.A. (Preferred)........... 2
(a)4,072,936 Tele Norte Leste Participacoes S.A. (Preferred)............. 51
(a)13,378,936 Tele Sudeste Celular Participacoes S.A. (Preferred)......... 56
(a)144 Tele Sudeste Celular Participacoes S.A. ADR................. 3
(a)4,072,936 Telebras (Preferred)........................................ --
(a)3,067 Telebras (Preferred) ADR.................................... 223
(a)18,410,936 Telemig Celular Participacoes S.A. (Preferred).............. 20
(a)470 Telemig Celular Participacoes S.A. ADR...................... 10
(a)518,000 Telerj Celular S.A. (Preferred) Class B..................... 12
(a)7,736,936 Telesp Celular Participacoes S.A. (Preferred)............... 57
(a)72 Telesp Celular Participacoes S.A. ADR....................... 1
(a)4,419,836 Telesp Celular S.A. (Preferred) Class B..................... 194
(a)1,835,936 Telesp Participacos S.A. (Preferred)........................ 42
12,655 Unibanco (Preferred) GDR.................................... 183
2,005 USIMINAS ADR................................................ 5
12,300 USIMINAS (Preferred)........................................ 27
-------
2,539
-------
CHILE (1.1%)
4,771 CCU S.A. ADR................................................ 92
6,047 Endesa ADR.................................................. 69

<CAPTION>
VALUE
SHARES (000)
<C> <S> <C>
- -----------------------------------------------------------------------------------------------
8,745 Enersis ADR................................................. $ 225
1,473 Santa Isabel ADR............................................ 10
-------
396
-------
CHINA (1.2%)
(a)9,275 Huaneng Power International, Inc. ADR....................... 134
9,633 Yanzhou Coal Mining Co. ADR................................. 73
541,000 Zhejiang Expressway Co., Ltd., Class H...................... 110
759,000 Zhenhai Refining & Chemical Co., Ltd., Class H.............. 116
-------
433
-------
COLOMBIA (0.0%)
2,661 Bancolumbia S.A.(Preferred)................................. 4
-------
CROATIA (0.2%)
3,100 Pliva d.d. GDR.............................................. 51
(e)510 Pliva d.d. GDR (Registered)................................. 8
-------
59
-------
CZECH REPUBLIC (0.4%)
(a)6,872 SPT Telecom a.s............................................. 105
(a)2,360 SPT Telecom a.s. GDR........................................ 35
-------
140
-------
EGYPT (1.3%)
(a)1,500 Al-Ahram Beverages Co. GDR.................................. 43
(a)2,316 Al-Ahram Beverages Co., Class S GDR......................... 67
3,600 Eastern Tobacco............................................. 83
925 Egypt Gas Co................................................ 69
1,303 Egyptian Financial & Industrial............................. 21
1,635 Industrial & Engineering.................................... 23
1,800 Madinet Nasr Housing & Development.......................... 54
8,960 Paints & Chemicals Industry GDR............................. 54
4,000 Suez Cement Co. GDR......................................... 55
-------
469
-------
GREECE (8.1%)
869 Alpha Credit Bank........................................... 91
4,760 Attica Enterprises S.A...................................... 43
3,300 Hellenic Bottling Co. S.A................................... 102
45,378 Hellenic Telecommunication Organization S.A................. 1,208
(a)50,485 Hellenic Telecommunication Organization S.A. ADR............ 669
610 Heracles General Cement Co. S.A............................. 16
(a)1,520 Ionian Bank S.A............................................. 81
2,459 National Bank of Greece S.A................................. 553
(a)2,110 Panafon Hellenic Telecom S.A. GDR........................... 55
(a)2,370 STET Hellas Telecommunications S.A. ADR..................... 77
600 Titan Cement Co. S.A........................................ 46
-------
2,941
-------
HONG KONG (0.4%)
90,000 China Telecom Ltd. (Hong Kong).............................. 156
-------
HUNGARY (3.6%)
28,485 Matav Rt.................................................... 162
(a)9,596 Matav Rt. ADR............................................... 286
4,730 MOL Magyar Olaj-es Gazipari Rt.............................. 129
(a)6,700 MOL Magyar Olaj-es Gazipari Rt. GDR......................... 185
</TABLE>

The accompanying notes are an integral part of the financial statements.

7
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO

HUNGARY (CONT.)
<TABLE>
<C> <S> <C>
14,090 MOL Magyar Olaj-es Gazipari Rt. GDR (Registered)............ $ 389
3,330 Otp Bank Rt................................................. 167
-------
1,318
-------
INDIA (8.2%)
6,500 Bajaj Auto Ltd.............................................. 80
73,000 Bharat Heavy Electricals Ltd................................ 451
(d)26,500 Container Corp. of India Ltd................................ 149
2,000 Gujarat Ambuja Cements Ltd.................................. 12
25,884 Hero Honda Motors, Ltd...................................... 331
8,500 Hindustan Lever Ltd......................................... 333
5,000 Hindustan Petroleum Corp., Ltd.............................. 28
2,520 Housing Development Finance Corp............................ 129
500 Infosys Technologies Ltd.................................... 35
5,100 Infosys Technology Ltd...................................... 355
19,500 ITC Ltd..................................................... 344
16,000 Larson & Toubro Ltd......................................... 61
12,000 Mahanagar Telephone Nigam Ltd............................... 52
(a,g)35,500 Morgan Stanley India Investment Fund, Inc................... 240
10,000 Satyam Computer Services Ltd................................ 171
17,000 State Bank of India......................................... 63
(a)15,000 Tata Engineering & Locomotive Co. Ltd....................... 58
6,500 Zee Telefilms Ltd........................................... 98
-------
2,990
-------
INDONESIA (1.7%)
174,616 Gudang Garam................................................ 255
(a)7,700 Gulf Indonesia Resources Ltd................................ 50
419,400 Indah Kiat Pulp & Paper Corp................................ 114
498,500 Telekomunikasi Indonesia.................................... 168
3,715 Telekomunikasi Indonesia ADR................................ 24
-------
611
-------
ISRAEL (6.0%)
65,000 Bank Hapoalim Ltd........................................... 118
(a)27,731 Bezeq Israeli Telecommunication Corp. Ltd................... 87
(a)4,920 Comverse Technology, Inc.................................... 349
(a)5,600 Dor Energy Ltd. GDR......................................... 16
9,317 ECI Telecommunications Ltd.................................. 332
1 Elbit Systems Ltd........................................... --
2,686 Elron Electronic Industries Ltd............................. 43
6,878 First International Bank of Israel Ltd., Class 5............ 34
(a)615 Gilat Satellite Networks Ltd................................ 34
4,176 Koor Industries Ltd......................................... 365
2,215 Koor Industries Ltd. ADR.................................... 39
(a)596 NICE-Systems Ltd............................................ 13
(a)4,080 NICE-Systems Ltd. ADR....................................... 88
(a)5,849 Orbotech Ltd................................................ 277
(a)1,060 Orckit Communications Ltd................................... 17
3,757 Supersol Ltd................................................ 9
15,310 Supersol Ltd. ADR........................................... 188
4,159 Tadiran Telecommunications Ltd.............................. 79
2,400 Teva Pharmaceutical Industries Ltd. ADR..................... 98
-------
2,186
-------
<CAPTION>
VALUE
SHARES (000)
<C> <S> <C>
- -----------------------------------------------------------------------------------------------
KOREA (11.6%)
5,810 Hankuk Glass Industry Co., Ltd.............................. $ 121
31,720 Korea Electric Power Corp................................... 786
(d)18,432 Pohang Iron & Steel Co., Ltd................................ 1,164
1,383 S1 Corp..................................................... 259
23,488 Samsung Electronics Co...................................... 1,575
1,063 Samsung Electronics Co. GDR................................. 39
(d)367 SK Telecom Co., Ltd......................................... 277
-------
4,221
-------
MALAYSIA (1.7%)
(d)25,000 Genting Bhd................................................. 38
(d)42,000 Kuala Lumpur Kepong Bhd..................................... 50
(d)15,000 Nestle (Malaysia) Bhd....................................... 42
(d)48,000 Petronas Gas Bhd............................................ 76
(d)20,200 Rothmans of Pall Mall (Malaysia) Bhd........................ 83
(d)7,000 Technology Resources Industries Bhd......................... 3
(d)117,000 Telekom Malaysia Bhd........................................ 216
(d)78,000 Tenaga Nasional Bhd......................................... 112
-------
620
-------
MEXICO (10.4%)
25,135 Alfa, S.A. de C.V., Class A................................. 71
(a)98,888 Banacci, Class B............................................ 130
58,655 Bancomer, Class B........................................... 13
59,508 Cemex CPO................................................... 128
12,255 Cemex CPO ADR............................................... 52
9,900 Cemex, Class B.............................................. 24
20,499 Cemex, Class B ADR.......................................... 100
(a)66,116 Cifra S.A., Class C......................................... 81
16,940 Cifra S.A., Class V......................................... 20
5,000 Cifra S.A., Class V ADR..................................... 61
1,893 Desc S.A. de C.V., Class C ADR.............................. 36
11,880 Fomento Economico Mexicano, S.A. de C.V. ADR................ 316
207,092 Fomento Exonomico Mexicano, S.A. de C.V. UBD................ 562
28,104 Grupo Carso S.A. de C.V., Class A1.......................... 95
(e)9,575 Grupo Financiero Bancomer ADS............................... 41
(a)29,792 Grupo Televisa S.A. GDR..................................... 736
105,737 Kimberly-Clark Corp., Class A............................... 336
19,250 Telmex ADR, Class L......................................... 937
3,423 Tubos de Acero de Mexico S.A. ADR........................... 22
4,400 TV Azteca ADR............................................... 29
-------
3,790
-------
PAKISTAN (1.4%)
(d)136,000 Fauji Fertilizer Co., Ltd................................... 113
(d)175,200 Hub Power Co................................................ 41
(d)19,628 Pakistan State Oil Co., Ltd................................. 28
(a,d)3,018 Pakistan Telecommunications Corp. GDR....................... 104
(d)541,700 Pakistan Telecommunications Corp., Class A.................. 187
(a,d)104,535 Sui Northern Gas Pipelines Ltd.............................. 17
-------
490
-------
PHILIPPINES (1.7%)
52,290 Manila Electric Co., Class B................................ 168
5,290 Philippine Long Distance Telephone Co....................... 136
400 Philippine Long Distance Telephone Co. ADR.................. 10
</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 NET ASSETS (CONT.)
DECEMBER 31, 1998
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- -----------------------------------------------------------------------------------------------
<C> <S> <C>
90,630 San Miguel Corp., Class B................................... $ 175
576,510 SM Prime Holdings, Inc...................................... 110
-------
599
-------
POLAND (3.1%)
(a)2,570 Bank Bandlowy w Warszawie GDR (Registered).................. 32
1,627 Bank of Handlowy W Warszawie................................ 20
1,323 Bank Slaski................................................. 68
99,373 BIG Bank Gdanski............................................ 89
3,160 BIG Bank Gdanski GDR........................................ 43
2,474 BRE S.A..................................................... 57
2 Debica...................................................... --
21,342 Elektrim.................................................... 231
(a)1,509 Exbud S.A................................................... 13
(a)5,098 Exbud S.A. GDR.............................................. 44
75 Polifarb-Cieszyn S.A........................................ --
881 Powszechny Bank Kredytowy S.A............................... 19
6,260 Prokom Software GDR......................................... 118
(a)70,780 Telekomunikacja Polska S.A. GDR............................. 361
3,432 Wielkopolski Bank Kredytowy S.A............................. 22
-------
1,117
-------
RUSSIA (0.8%)
3,690 Lukoil Holding ADR.......................................... 59
(a,d)554,047 Mustcom..................................................... 63
(a)4,000 Rostelecom ADR.............................................. 17
24,980 Surgutneftegaz ADR.......................................... 84
1,600 Unified Energy Systems ADR.................................. 5
(a)10,460 Unified Energy Systems GDR.................................. 34
(a)3,670 Vimpel-Communications ADR................................... 48
-------
310
-------
SINGAPORE (0.2%)
55,000 Want Want Holdings Ltd...................................... 66
-------
SOUTH AFRICA (5.2%)
41,378 ABSA Group Ltd.............................................. 196
414,148 B.O.E. Corp. Ltd., Class N.................................. 235
38,018 Bidvest Group Ltd........................................... 276
56,500 BOE Ltd..................................................... 36
11,657 Comparex Holdings Ltd....................................... 94
58,580 Education Investment Corp. (The) Ltd........................ 68
30,340 Ellerine Holdings Ltd....................................... 65
92,200 FirstRand Ltd............................................... 100
6,991 Liberty Life Association of Africa Ltd...................... 96
(g)4,595 Morgan Stanley Africa Investment Fund, Inc.................. 39
5,980 Nedcor Ltd.................................................. 102
(a)168,200 New Africa Investments Ltd., Class N........................ 103
16,700 Primedia Ltd., N Shares..................................... 37
27,470 Rembrandt Group Ltd......................................... 168
30,770 Sasol Ltd................................................... 116
7,230 South African Breweries Ltd................................. 122
78,600 Woolworths Holdings Ltd..................................... 39
-------
1,892
-------
<CAPTION>
VALUE
SHARES (000)
<C> <S> <C>
- -----------------------------------------------------------------------------------------------
TAIWAN (6.9%)
(a)14,000 Arima Computer Corp......................................... $ 73
(a)27,816 Asustek Computer, Inc....................................... 260
(a)62,974 Compal Electronics, Inc..................................... 205
(a)26,000 Compeq Manufacturing Co., Ltd............................... 170
84,000 Far Eastern Textile Ltd..................................... 69
(a)106,800 Hon Hai Precision Industry.................................. 590
51,496 President Chain Store Corp.................................. 162
(a)153,589 Siliconware Precision Industries Co......................... 272
(a)196,000 Taiwan Semiconductor Manufacturing Co....................... 432
(a)18,220 Taiwan Semiconductor Manufacturing Co. Ltd. ADR............. 258
-------
2,491
-------
THAILAND (1.8%)
43,600 Advanced Info Service PCL (Foreign)......................... 259
(d)20,600 BEC World PCL (Foreign)..................................... 113
14,700 Delta Electronics PCL (Foreign)............................. 78
(a)15,200 PTT Exploration & Production PCL (Foreign).................. 107
(a)15,100 Shinawatra Computer Co. PCL (Foreign)....................... 52
(a)25,800 Siam Cement PCL (Foreign)................................... 57
-------
666
-------
TURKEY (1.7%)
(e)2,940 Akbank T.A.S. ADR........................................... 12
1,264,000 Ege Biracilik............................................... 98
528,700 Erciyas Biracilik........................................... 35
41,000 Migros Turk T.A.S........................................... 41
289,938 Petrol Ofisi A.S............................................ 39
(a)1,811,693 Vestel Elektronik Sanayi Ve Ticaret A.S..................... 149
21,828,743 Yapi Ve Kredi Bankasi A.S................................... 253
-------
627
-------
VENEZUELA (0.4%)
7,424 CANTV, Class D ADR.......................................... 132
-------
ZIMBABWE (0.2%)
155,838 Delta Corp. Ltd............................................. 34
53,400 Meikles Africa Ltd.......................................... 30
230,000 Trans Zambesi Industries Ltd................................ 10
(e)100,300 Trans Zambesi Industries Ltd. ADR........................... 5
-------
79
-------
TOTAL COMMON STOCKS (COST $36,949)............................................ 31,981
-------
</TABLE>

<TABLE>
<CAPTION>
NO. OF
RIGHTS
<C> <S> <C>
- ---------------

RIGHTS (0.0%)
BRAZIL (0.0%)
(a)10,817 CRT......................................................... 4
-------
SOUTH AFRICA (0.0%)
(a)16,700 Primedia Ltd................................................ --
-------
TAIWAN (0.0%)
(a,d)151 Compal Electronics, Inc..................................... --
-------
TOTAL RIGHTS (COST $14)....................................................... 4
-------
</TABLE>

The accompanying notes are an integral part of the financial statements.

9
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO

- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS (CONT.)
DECEMBER 31, 1998

<TABLE>
<CAPTION>
NO. OF VALUE
WARRANTS (000)
<C> <S> <C>
- -----------------------------------------------------------------------------------------------

WARRANTS (0.0%)
THAILAND (0.0%)
(a,d)8,833 Siam Commercial Bank PCL, expiring 12/31/02 (COST $0)....... $ --
-------
</TABLE>

<TABLE>
<CAPTION>
FACE
AMOUNT
(000)
<C> <S> <C>
- ---------------

CONVERTIBLE NOTES (0.1%)
RUSSIA (0.1%)
$ (d)325,393 Svyaz Finance
17.00%, 8/11/99 (COST $325)............................... 51
-------
TOTAL FOREIGN SECURITIES (88.2%) (COST $37,288)............................... 32,036
-------
SHORT-TERM INVESTMENT (8.5%)
REPURCHASE AGREEMENT (8.5%)
3,090 Chase Securities, Inc. 4.45%, dated 12/31/98, due 1/4/99, to
be repurchased at $3,092, collateralized by U.S. Treasury
Bonds, 10.375%, due 11/15/12, valued at $3,122 (COST
$3,090)................................................... 3,090
-------
FOREIGN CURRENCY (3.8%)
BRL 117 Brazilian Real.............................................. 97
COP 66 Colombian Peso.............................................. --
EGP 78 Egyptian Pound.............................................. 23
GRD 19,142 Greek Drachma............................................... 68
HUF 6 Hungarian Forint............................................ --
INR 9,786 Indian Rupee................................................ 230
ISS 240 Israeli Shekel.............................................. 58
KRW 262 Korean Won.................................................. --
MYR (d)341 Malaysia Ringgit............................................ 63
MXP 9 Mexican Peso................................................ 1
PKR (d)2,274 Pakistani Rupee............................................. 41
PHP 96 Philippines Peso............................................ 3
PLZ 144 Polish Zloty................................................ 41
ZAR 1,086 South African Rand.......................................... 184
TWD 18,190 Taiwan Dollar............................................... 565
-------
TOTAL FOREIGN CURRENCY (COST $1,395).......................................... 1,374
-------
TOTAL INVESTMENTS (100.5%) (COST $41,773)..................................... 36,500
-------
</TABLE>

<TABLE>
<CAPTION>
VALUE
(000)
<S> <C> <C>
- -----------------------------------------------------------------------------------------------
OTHER ASSETS (2.7%)
Cash.............................................................. $ 108
Receivable for Portfolio Shares Sold.............................. 375
Deferred Organization Costs....................................... 282
Receivable for Investments Sold................................... 140
Dividends Receivable.............................................. 38
Interest Receivable............................................... 22
Unrealized Gain on Swap Agreements................................ 10
Other Assets...................................................... 13 988
----------- -----------
LIABILITIES (-3.2%)
Payable for Investments Purchased................................. (903)
Unrealized Loss on Foreign Currency Exchange Contracts............ (103)
Professional Fees Payable......................................... (47)
Custodian Fees Payable............................................ (45)
Investment Advisory Fees Payable.................................. (29)
Payable for Foreign Taxes......................................... (13)
Administrative Fees Payable....................................... (8)
Payable for Portfolio Shares Redeemed............................. (7)
Other Liabilities................................................. (20) (1,175)
----------- -----------
NET ASSETS (100%)................................................................ $ 36,313
-----------
-----------
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 5,106,190 outstanding $0.001 par value shares (authorized
500,000,000 shares)............................................................ $ 7.11
-----------
-----------
NET ASSETS CONSIST OF:
Paid in Capital.................................................................. $ 51,390
Overdistributed Net Investment Income............................................ (101)
Accumulated Net Realized Loss.................................................... (9,606)
Unrealized Depreciation on Investments, Foreign Currency Translations and Swaps
(Net of foreign taxes of $3)................................................... (5,370)
-----------
NET ASSETS....................................................................... $ 36,313
-----------
-----------
</TABLE>

- ---------------------------------------------------

(a) -- Non-income producing security
(d) -- Securities (totaling $2,958 or 8.1% of net assets at December 31,
1998) were 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 Participations
GDR -- Global Depositary Receipt
LIBOR -- London Interbank Offer Rate
PCL -- Public Company Limited

The accompanying notes are an integral part of the financial statements.

10
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO

- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS (CONT.)
DECEMBER 31, 1998

FOREIGN CURRENCY EXCHANGE INFORMATION:

Under the terms of foreign currency contracts open at December 31, 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.$ 210 $ 210 1/4/99 KRW 253,134 $ 211 $ 1
KRW 253,134 210 1/4/99 U.S.$ 164 164 (46)
U.S.$ 31 31 1/5/99 GRD 8,823 31 --
KRW 269,040 224 1/5/99 U.S.$ 177 177 (47)
KRW 50,325 42 1/6/99 U.S.$ 33 33 (9)
KRW 229,520 191 1/7/99 U.S.$ 151 151 (40)
U.S.$ 360 360 2/11/99 MYR 1,624 299 (61)
MYR 1,624 299 2/11/99 U.S.$ 360 360 61
U.S.$ 397 397 6/21/99 ZAR 2,556 412 15
ZAR 2,556 412 6/21/99 U.S.$ 435 435 23
--------- --------- -----
$ 2,376 $ 2,273 $ (103)
--------- --------- -----
--------- --------- -----
</TABLE>

- ---------------------------------------------------

SWAP AGREEMENT:

The Portfolio had the following Total Return Swap Agreement open at December 31,
1998:

<TABLE>
<CAPTION>
NOTIONAL UNREALIZED
AMOUNT APPRECIATION
(000) DESCRIPTION (000)
- ----------- ------------------------------------------- ---------------
<S> <C> <C>
$ 313 Agreement with Goldman Sachs International $ 10
terminating March 8, 1999 to pay 3 month
USD-LIBOR plus 2.00% and to receive the
return of the Securities Exchange of
Thailand (SET) Index converted into U.S.
Dollars at the mid-market rate on March 4,
1999.
</TABLE>

- ----------------------------------------------------------------

At December 31, 1998, cost and unrealized appreciation (depreciation) for U.S.
Federal income tax purposes of the investments (excluding foreign currency) of
the Portfolio were:

<TABLE>
<CAPTION>
NET
COST APPRECIATION (DEPRECIATION) (DEPRECIATION)
(000) (000) (000) (000)
- --------- ------------- --------------- ---------------
<S> <C> <C> <C>
$ 41,739 $ 2,439 $ (9,052) $ (6,613)
</TABLE>

- ----------------------------------------------------------------

For the year ended December 31, 1998, purchases and sales of investment
securities for the Portfolio, other than long-term U.S. Government securities
and short-term investments, were approximately $45,688,000 and $30,900,000
respectively. There were no purchases and sales of U.S. Government securities
for the year ended December 31, 1998.

- ----------------------------------------------------------------

For the year ended December 31, 1998, the Portfolio owned shares of affiliated
funds for which the Portfolio earned dividend income and realized losses on
sales of these shares of approximately $3,900 and $14,000, respectively.

- ----------------------------------------------------------------

At December 31, 1998, the Portfolio had available capital loss carryforwards of
approximately $6,888,000 to offset future net capital gains, to the extent
provided by regulations, through December 31, 2006. To the extent that capital
loss carryforwards are used to offset future net capital gains realized during
the carryforward period as provided by U.S. Federal income tax regulations, no
capital gains tax liability will be incurred by the Portfolio for gains realized
and not distributed. To the extent that capital gains are so offset, such gains
will not be distributed to shareholders.

Net capital and net currency losses incurred after October 31 and within the
taxable year are deemed to arise on the first business day of the Portfolio's
next taxable year. For the period from November 1, 1998 to December 31, 1998 the
Portfolio incurred and elected to defer until January 1, 1999 for U.S. Federal
income tax purposes, net capital losses and net currency losses of $1,366,000
and $72,000, respectively.

- ----------------------------------------------------------------

SUMMARY OF FOREIGN SECURITIES BY INDUSTRY CLASSIFICATION
(UNAUDITED)

<TABLE>
<CAPTION>
% OF
VALUE NET
SECTOR DIVERSIFICATION (000) ASSETS
- ---------------------------------------- --------- ---------
<S> <C> <C>
Capital Equipment....................... $ 5,101 14.0%
Consumer Goods.......................... 6,035 16.6
Energy.................................. 3,722 10.2
Finance................................. 3,252 9.0
Materials............................... 2,415 6.7
Multi-Industry.......................... 1,376 3.8
Services................................ 10,135 27.9
--------- ---
Total Foreign Securities................ $ 32,036 88.2%
--------- ---
--------- ---
</TABLE>

The accompanying notes are an integral part of the financial statements.

11
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO

- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1998
(000)
<S> <C>
- -----------------------------------------------------------------------------

INVESTMENT INCOME:
Dividends $ 700
Interest 332
Less: Foreign Taxes Withheld (34)
---------------
Total Income 998
---------------
EXPENSES:
Investment Advisory Fees 447
Less: Fees Waived (447)
---------------
Net Investment Advisory Fees --
Custodian Fees 293
Shareholder Reports 127
Administrative Fees 105
Amortization of Organizational Costs 102
Professional Fees 78
Interest Expense 26
Foreign Tax Expense 21
Directors' Fees and Expenses 2
Other 32
Expenses Reimbursed by Adviser (87)
---------------
Net Expenses 699
---------------
Net Investment Income 299
---------------
NET REALIZED LOSS ON:
Investments Sold (includes realized losses on sales of
affiliated funds of $14,000) (8,617)
Foreign Currency Transactions (216)
Swap Agreements (148)
---------------
Net Realized Loss (8,981)
---------------
CHANGE IN UNREALIZED APPRECIATION/DEPRECIATION ON:
Investments (Net of foreign taxes of $3 on unrealized
appreciation) (1,639)
Foreign Currency Translations (6)
Swap Agreements 111
---------------
Change in Unrealized Appreciation/Depreciation (1,534)
---------------
Net Realized Loss and Change in Unrealized
Appreciation/Depreciation (10,515)
---------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $ (10,216)
---------------
---------------
</TABLE>

- --------------------------------------------------------------------------------

STATEMENT OF CHANGES IN NET ASSETS

<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1997
(000) (000)
<S> <C> <C>
- --------------------------------------------------------------------------------

INCREASE (DECREASE) IN NET ASSETS
OPERATIONS:
Net Investment Income $ 299 $ 106
Net Realized Gain (Loss) (8,981) 195
Change in Unrealized
Appreciation/Depreciation (1,534) (3,701)
---------- ----------
Net Decrease in Net Assets
Resulting from Operations (10,216) (3,400)
---------- ----------
DISTRIBUTIONS:
Net Investment Income (198) (226)
Net Realized Gain -- (76)
In Excess of Net Realized Gain -- (924)
---------- ----------
Total Distributions (198) (1,226)
---------- ----------
CAPITAL SHARE TRANSACTIONS (1):
Subscribed 29,230 39,684
Distributions Reinvested 197 1,223
Redeemed (16,798) (13,972)
---------- ----------
Net Increase in Net Assets Resulting
from Capital Share Transactions 12,629 26,935
---------- ----------
Total Increase in Net Assets 2,215 22,309
NET ASSETS:
Beginning of Period 34,098 11,789
---------- ----------
End of Period (Including
(overdistributed) undistributed
net investment income of $(101)
and $14, respectively) $ 36,313 $ 34,098
---------- ----------
---------- ----------
- --------------------------------------------------------------------------------
(1) Capital Share Transactions:
Shares Subscribed 3,556 3,551
Shares Issued on Distributions
Reinvested 28 135
Shares Redeemed (2,088) (1,282)
---------- ----------
Net Increase in Capital Shares
Outstanding 1,496 2,404
---------- ----------
---------- ----------
- --------------------------------------------------------------------------------
</TABLE>

The accompanying notes are an integral part of the financial statements.

12
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
EMERGING MARKETS EQUITY PORTFOLIO

- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS

<TABLE>
<CAPTION>
PERIOD FROM
YEAR ENDED YEAR ENDED OCTOBER 1, 1996*
SELECTED PER SHARE DATA AND RATIOS DECEMBER 31, 1998 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 0.06 0.04 0.01
Net Realized and Unrealized Loss (2.36) -- (0.21)
------- ------- -------
Total From Investment Operations (2.30) 0.04 (0.20)
------- ------- -------
DISTRIBUTIONS
Net Investment Income (0.04) (0.07) (0.02)
Net Realized Gain -- (0.02) --
In Excess of Net Realized Gain -- (0.28) --
------- ------- -------
Total Distributions (0.04) (0.37) (0.02)
------- ------- -------
NET ASSET VALUE, END OF PERIOD $ 7.11 $ 9.45 $ 9.78
------- ------- -------
------- ------- -------
TOTAL RETURN (24.34)% 0.52% (2.03)%
------- ------- -------
------- ------- -------
RATIOS AND SUPPLEMENTAL DATA:
Net Assets, End of Period (000's) $36,313 $34,098 $11,789
Ratio of Expenses to Average Net
Assets 1.95% 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 0.83% 0.47% 0.32%**
Portfolio Turnover Rate 100% 87% 9%
- -------------------------------------------------------------------------------------------------------
Effect of Voluntary Expense
Limitation During the Period:
Per Share Benefit to Net Investment
Income $ 0.11 $ 0.17 $ 0.08
Ratios Before Expense Limitation:
Expenses to Average Net Assets 3.45% 4.12% 6.17%**
Net Investment Loss to Average Net
Assets (0.66)% (1.84)% (4.06)%**
</TABLE>

- --------------------------------------------------------------------------------

* Commencement of operations
** Annualized

The accompanying notes are an integral part of the financial statements.

13
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998

- --------------------------------------------------------------------------------

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. Effective January 6, 1999, the Fund's name changed to the Morgan
Stanley Dean Witter Universal Funds, Inc. As of December 31, 1998, the Fund was
comprised of eleven separate active portfolios (individually referred to as a
"Portfolio", collectively as the "Portfolios"). An additional Portfolio, the
Money Market Portfolio, commenced operations on January 5, 1999.

The accompanying financial statements relate to the Emerging Markets Equity
Portfolio. Please refer to the Portfolio's Investment Overview for the
Portfolio's investment objectives.

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. 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.

A Portfolio 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 transactions in 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.

14
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
DECEMBER 31, 1998

- --------------------------------------------------------------------------------
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.

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.

The investment techniques of the Fund described in the following notes (5-12)
are applicable to certain, but not all, of the Portfolios of the Fund.

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 Portfolio as unrealized gain or loss. The Portfolio records
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: Certain
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 up to 120 days after the date of the
transaction. Additionally, a 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 a 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. A 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. A
Portfolio's investment in Participations typically results in the Portfolio
having a contractual relationship with only the Lender and not with the
borrower. A 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. A 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 a 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

15
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
DECEMBER 31, 1998

- --------------------------------------------------------------------------------
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. 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 purchased securities cannot exceed the total
amount invested.

9. 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 a Portfolio may not be able to enter into a closing
transaction because of an illiquid secondary market.

10. 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 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.

11. 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

16
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
DECEMBER 31, 1998

- --------------------------------------------------------------------------------
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 the portfolio securities
or other financial instruments. A 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.

12. 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 Dean Witter Investment 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 unamortized organizational costs in the same
proportion as the number of shares redeemed bears to the initial shares held at
time of redemption.

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 that
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 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 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 Dean Witter Investment Management Inc. ("MSDW
Investment Management"), a wholly-owned subsidiary of Morgan Stanley Dean Witter
& Co., provides the 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
$500 MILLION $1 BILLION $1 BILLION
- --------------- --------------- -------------
<S> <C> <C>
1.25% 1.20% 1.15%
</TABLE>

MSDW Investment Management 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: MSDW Investment Management (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

17
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
DECEMBER 31, 1998

- --------------------------------------------------------------------------------
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. CUSTODIAN: The Chase Manhattan Bank and its affiliates serve as custodian for
the Fund. The Fund's assets held outside the United States have been held by
Morgan Stanley Trust Company ("MSTC"), which was an affiliate of the Adviser
prior to October 1, 1998. On October 1, 1998, MSTC was acquired by the Chase
Manhattan Bank. Custody fees are payable monthly based on assets held in
custody, investment purchase and sales activity, and account maintenance fee,
plus reimbursement for certain out-of-pocket expenses. Through September 30,
1998, the Fund paid MSTC fees of approximately $193,000.

E. OTHER: During the year ended December 31, 1998, the Portfolio paid brokerage
commissions to Morgan Stanley & Co., Incorporated, an affiliated broker/dealer,
of approximately $9,000.

At December 31, 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.

18
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
REPORT OF INDEPENDENT ACCOUNTANTS

- --------------------------------------------------------------------------------

To the Board of Directors and Shareholders of
Morgan Stanley Dean Witter Universal Funds, Inc.
(formerly, Morgan Stanley Universal Funds, Inc.) --
Emerging Markets Equity Portfolio

In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Morgan Stanley Dean Witter Universal Funds, Inc. -- Emerging Markets Equity
Portfolio (hereafter referred to as the "Fund") at December 31, 1998, the
results of its operations for the year then ended, the changes in its net assets
for each of the two years in the period then ended and the financial highlights
for each of the two years in the period then ended and for the period October 1,
1996 (commencement of operations) through December 31, 1996, in conformity with
generally accepted accounting principles. These financial statements and
financial highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits, which included confirmation of investments at December 31, 1998 by
correspondence with the custodian and brokers, provide a reasonable basis for
the opinion expressed above.

PricewaterhouseCoopers LLP
1177 Avenue of the Americas
New York, New York 10036
February 8, 1999

19
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.

- --------------------------------------------------------------------------------

DIRECTORS

Barton M. Biggs
CHAIRMAN OF THE BOARD
Chairman and Director, Morgan Stanley Dean Witter Investment
Management Inc. and Morgan Stanley Dean Witter Investment
Management Limited; Managing Director,
Morgan Stanley & Co. Incorporated

Michael F. Klein
DIRECTOR AND PRESIDENT
Principal, Morgan Stanley Dean Witter Investment 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 Dean Witter Investment 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

CUSTODIAN

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

Belinda A. Brady

ASSISTANT TREASURER

Karl O. Hartmann

ASSISTANT SECRETARY

LEGAL COUNSEL

Morgan, Lewis & Bockius LLP
1701 Market Street
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.