<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
- --------------------------------------------------------------------------------
U.S. REAL ESTATE PORTFOLIO
ANNUAL REPORT
DECEMBER 31, 1998
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
U.S. REAL ESTATE PORTFOLIO
- --------------------------------------------------------------------------------
INVESTMENT OVERVIEW
COMPOSITION OF NET ASSETS (DECEMBER 31, 1998)
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C>
Diversified 10.1%
Health Care 0.2%
Lodging/Resorts 2.4%
Office/Industrial 24.3%
Residential 32.6%
Retail 17.6%
Self Storage 5.2%
Other 7.6%
</TABLE>
PERFORMANCE COMPARED TO THE NATIONAL ASSOCIATION OF REAL ESTATE INVESTMENT
TRUSTS (NAREIT) EQUITY INDEX(1)
- ------------------------------------
<TABLE>
<CAPTION>
TOTAL RETURNS(2)
-----------------------------
AVERAGE ANNUAL
ONE SINCE
YEAR INCEPTION(3)
---------- -----------------
<S> <C> <C>
PORTFOLIO.......... -10.86% 2.79%
INDEX.............. -17.50% -0.92%
</TABLE>
1. The NAREIT Equity Index is an unmanaged market weighted index of tax
qualified REITs listed on the New York Stock Exchange, American Stock
Exchange and the NASDAQ National Market Systems (including 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 March 3, 1997.
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
<TABLE>
<CAPTION>
TOP FIVE HOLDINGS
PERCENT OF
SECURITY INDUSTRY NET ASSETS
- -------------------------------- --------------- ---------------
<S> <C> <C>
Chateau Properties, Inc. REIT Residential 5.9%
Arden Realty Group, Inc. Office/Industrial 5.0%
Taubman Centers, Inc. REIT Retail 4.4%
Brookfield Properties Corp. Office/Industrial 4.1%
Equity Residential Properties
Trust REIT Residential 4.1%
</TABLE>
<TABLE>
<CAPTION>
TOP FIVE SECTORS
VALUE PERCENT OF
INDUSTRY (000) NET ASSETS
- ------------------------------------- --------- -------------
<S> <C> <C>
Residential $ 4,935 32.6%
Office/Industrial 3,680 24.3%
Retail 2,672 17.6%
Diversified 1,531 10.1%
Self Storage 780 5.2%
</TABLE>
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 PERFORMANCE RESULTS PROVIDED ARE FOR INFORMATIONAL PURPOSES ONLY
AND SHOULD NOT BE CONSTRUED AS A GUARANTEE OF THE PORTFOLIO'S FUTURE
PERFORMANCE. PAST PERFORMANCE SHOWN IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S
SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST.
COMPARISON OF THE CHANGE IN VALUE OF A
$10,000 INVESTMENT
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
U.S. REAL NATIONAL ASSOCIATION OF REAL ESTATE
ESTATE
PORTFOLIO INVESTMENT TRUSTS (NARRIT) EQUITY INDEX(1)
<S> <C> <C>
3/3/97* $10,000 $10,000
12/31/97 $11,799 $11,917
12/31/98 $10,518 $9,832
</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.
The U.S. Real Estate Portfolio seeks to provide above-average current income and
long-term capital appreciation by investing primarily in equity securities of
U.S. and non-U.S. companies principally engaged in the U.S. real estate
industry, including real estate investment trusts ("REITS").
For the year ended December 31, 1998, the Portfolio had a total return of
- -10.86% compared to -17.50% for the National Association of Real Estate
Investment Trusts (NAREIT) Equity Index (the "Index"). For the period since
inception on March 3, 1997 through December 31, 1998, the Portfolio had an
average annual total return of 2.79% compared to -0.92% for the Index.
Following the worst quarter for real estate securities in almost a decade, the
fourth quarter of 1998 was tame in comparison as the Index posted a loss of
2.5%. However, real estate investors had difficulty enjoying this calm given the
dramatic gains in the broad equity markets in the quarter and the resulting
relative underperformance. The Index declined 17.5% for the year, which marks
the worst year for real estate securities in recent history (exceeding the loss
of 13.4% posted in 1990). In
1
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
U.S. REAL ESTATE PORTFOLIO
- --------------------------------------------------------------------------------
INVESTMENT OVERVIEW (CONT.)
comparison, the Russell 2000 Index of small capitalization stocks ended the year
down 2.5% and the S&P 500 achieved new highs gaining over 20% for an
unprecedented fourth consecutive year. As a result of the fourth quarter's
performance, we remain in a valuation cycle in which it is cheaper for investors
to buy real estate assets on Wall Street (through the ownership of securities)
than on Main Street (through the direct ownership of assets).
The fourth quarter featured three phases. REITs fell over 10% to start the
quarter, achieving their lowest level for the year on October 8th. REITs
proceeded to recover from these lows and continued to rally following the Fed's
surprise interest rate cut on October 15th. However, this rally faded before
month-end and drove the Index up by less than 7.5%. In the third and longest
phase of the quarter, the REIT market made several attempts at gaining territory
but retreated each time. Causes for the retreat included broad equity market
declines as well as a constant stream of highly-publicized, negative news from
the most prominent REITs.
We have previously discussed our perspective that, over the medium and long
term, the largest determinant of the value of the shares of real estate stocks
will be underlying real estate fundamentals. We measure REITs based on their
price to net asset value ratio ("P/NAV"). Last quarter was the first in which
P/NAV had fallen below 100% since early 1995. At the annual NAREIT meeting held
in Boston in mid-October, the mood reflected the tone of an industry prepared to
remain in this new environment for some period of time. There are a number of
features that investors can expect during this period, which we have outlined
below.
Although there was a modest level of equity issuance late in the fourth quarter,
it was in the form of small retail-oriented equity offerings by a select group
of the more favored REITs (e.g.; Kimco, Post Properties, Duke Realty and JDN
Realty). The industry continues to be closed for large institutionally oriented
equity offerings and most companies have come to realize that they may not be
able to return to the equity markets for a lengthy period of time. As a result,
they are focusing on alternative methods to raise capital. This includes the
concept of selling certain non-core assets (clearly a difficult strategy given
the current investment environment) as well as forming joint ventures. The
typical joint venture model involves teaming with a pension fund to acquire or
develop assets, utilizing property level financing. This is a popular idea,
although many companies admit to being in a preliminary stage on the concept.
Significant joint ventures were announced by Burnham Pacific (with CalPers) and
First Industrial. In addition, given the difficult market for financing of real
estate, companies are focused on refinancing debt that will come due in the near
term and on extending credit lines with existing lending relationships.
By the end of the third quarter, many companies had received Board approval and
some had implemented share repurchase programs as their share prices were
rapidly declining. We applauded this activity as it reflects the idea that the
company's best "external growth" alternative is buying its stock in the open
market (since it provides a better return than development or acquisitions at
the current share price). We have noticed a decline in this activity as
companies have realized that their shares may not recover quickly and they feel
a need to treat their remaining capital availability with great care. Those that
have capital availability have taken a selective attitude and have increased
targeted investment returns as a result of treating this capital as a scarce
resource. Many companies have determined that they cannot acquire assets due to
their capital constraints or their relative attractiveness versus their current
share price. Assuming this environment will persist, a number of companies have
initiated layoffs in their acquisitions departments, including Taubman Centers
and Federal Realty. Each company will focus exclusively on their development
pipeline. We believe that these announcements also reflect a strategic direction
for REITs to focus on "value added" external growth. This is in contrast to the
theme in 1997, which reflected more of a growth and expansion mentality for many
REITs, a theme predicated on the availability of equity.
The merger and acquisition market also heated-up in the fourth quarter as a
result of the new environment. In two similar transactions, the largest public
company in a sector merged with a smaller rival. First, after rebuffing earlier
overtures, Storage Trust agreed to merge with Public Storage, the largest owner
of self-storage facilities, in a stock for stock merger. Then, Meridian
Industrial Trust agreed to merge with Prologis Trust, the largest owner of
industrial buildings, in a stock for stock merger. In each case, the acquiring
company does not intend to retain the management of the smaller company. As a
result, the deals can be viewed as purchases of real estate portfolios as
opposed to companies. Not surprisingly, the prices paid are approximately the
Net Asset Values (NAV) of the target companies. One may assume that the board of
directors of each of the target companies believed that they could no longer
compete for capital in a more difficult environment and were better off selling
at this point in order to maximize proceeds for the shareholders. We applaud the
decision of the companies and their board of directors to sell.
In addition, there are public companies willing to put themselves up for sale
but having difficulty concluding transactions. These stories have been prevalent
in the private markets as purchasers are walking away from transactions in the
anticipation of
2
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
U.S. REAL ESTATE PORTFOLIO
- --------------------------------------------------------------------------------
INVESTMENT OVERVIEW (CONT.)
acquiring assets at better prices. In one example, Bedford Realty announced that
its expected sale of a large portion of its assets (predominantly office
properties in California) was not going to proceed as the acquirer informed the
company it was not able to arrange financing to conclude the transaction. In
addition, Tower Realty announced that the joint venture formed by Crescent and
Reckson was pulling from the transaction to purchase the New York based office
company. Later in the quarter, Reckson did agree to purchase Tower for a lower
price. Crescent elected not to participate in the new company but did make an
investment in Reckson in order to honor their previous commitment.
Given the deterioration in share prices, there was tremendous debate as to
whether the industry was about to see a wave of leveraged buyouts ("LBO's"). We
agree with the general consensus that the sector is not likely to see LBO's at
this time since the stocks are not discounted to a level that merits an LBO,
combined with a difficult financing environment. However, the quarter did
feature the offer by The Irvine Company ("TIC", a private company) to purchase
and take private Irvine Apartment Communities ("IAC"), a public apartment REIT
originally sponsored by TIC, for a 20% premium to the prevailing share price. We
consider this situation to be unique given the approximate 70% stake that TIC
holds in IAC as well as certain unique legal advantages granted to TIC at the
initial public offering of IAC. An interesting highlight of the premium bid for
IAC is that many of the sell-side analysts had IAC rated as a "market performer"
since it already traded at the highest funds-from-operations multiple of all of
the multifamily REITs. However, based on our NAV model, we thought that the
stock was trading at a significant discount to NAV, and, as a result, held it as
one of our larger positions.
After monitoring third quarter earnings reported for the REITs, it is our
observation that the property market continues to perform well and the internal
growth is coming in better than expected. This has served to offset the slower
pace of earnings growth arising from external growth. As a result, most
companies are meeting analysts expectations. However, analysts may have to take
down earnings estimates for 1999 due to the potential slowing of internal growth
and the continued decline in external sources. Even with reduced estimates,
earnings growth for 1999 is estimated at 10%.
Perhaps the most troubling aspect of the quarter for the overall REIT market was
the constant stream of highly-publicized, negative news from the most prominent
REITs. The media spotlighted two large REITs that announced restructurings
following unsuccessful growth plans. Patriot American announced the sale of
non-strategic hotel assets, the hiring of financial advisors to explore all
strategic alternatives and, by quarter end, the placement of convertible
preferred stock. The stock has fallen from a 52-week high of $32 to a current $7
trading range. Patriot also decided to suspend their dividend payment for the
quarter. Meditrust announced a restructuring of the company that included
selling non-core assets and splitting the company into two separate companies.
This stock has fallen from a high of $38 to a $15 trading range. Meditrust
elected to reduce their dividend payment. The quarter also featured a negative
pre-release of earnings expectations for both the fourth quarter and 1999 from
Starwood. This stock has declined from a high of $58 to a $25 trading range.
Another high-flying real estate stock badly damaged in the fourth quarter was
Security Capital Group, which declined to $13 after achieving a high of $32.
Although this company is not structured as a REIT, it is a large real estate
company that was heavily marketed to pension funds and non-dedicated real estate
investors. We believe that the overall message delivered by this group of
companies served as a warning to the universe of non-dedicated investors in real
estate securities. As we have discussed in the past, our style is value oriented
and opportunistic. As a result, we took the opportunity of price declines in
each of these stocks to add them to the Portfolio.
It has become apparent that the overall U.S. real estate market has become
dependent for receiving its direction from the public debt market (known as
"CMBS" or commercial mortgage backed securities) and equity markets. Just as the
REIT equity market has slowed, the CMBS market has come to a virtual halt as
credit spreads have widened, particularly for lower rated securities. Generally,
transaction volumes have slowed as sellers are pulling properties from the
market rather than selling at reduced prices. It is our expectation that when
transactions begin again we will see prices decline by 10% or more. Consistent
with the credit markets, it appears that prices of the higher quality assets
have fallen (or will fall) less than those of second tier properties.
Taking its cue from questions regarding the direction of the economy, it is now
the demand side of the equation that has become the most debated in the real
estate market. Although there is no current evidence of a slowdown in
absorption, demand for real estate space will obviously be affected by GDP
growth and business and consumer confidence. The difficulties in the capital
markets, by comparison, create quite favorable news from the supply side of the
equation. Developers will complete existing developments but will not be able to
arrange financing for new developments. As a result, the net effect appears to
be one where if the current market environment persists, when the supply
pipeline is complete and as long as absorption is positive, we will continue to
have favorable real estate fundamentals.
3
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
U.S. REAL ESTATE PORTFOLIO
- --------------------------------------------------------------------------------
INVESTMENT OVERVIEW (CONT.)
The multifamily market has faced modest changes. Transaction volume has slowed
but remains active at modestly lower prices. Recent reports of strong levels of
new apartment construction can be attributed to large supply in three specific
markets: Manhattan, Houston and Seattle. It is interesting to note that each of
these markets face potential demand problems due to issues in the financial,
oil-related and aircraft industries.
Despite a drop in consumer confidence for much of the second half of the year,
retail sales have not slowed materially. The pace of construction has also not
slowed as retailers continue to demand new stores. Once again, the focus in
retailing was upon the Christmas season. Although the sales growth of 5.2% was
above the consensus estimates for the season, there remain questions about the
profitability of those sales.
The surging supply of new office space appears to be grinding to a halt after
existing projects are completed. In addition, the office market has shown signs
of easing rental growth. With the exception of the hotel sector, this market has
suffered the largest deterioration in property prices. As opposed to previous
years when portfolios were able to command premium pricing, portfolio
transactions must be offered at a discount given the dramatic decline in large
buyers, largely due to financing constraints.
The hotel market has been the most effected by current recession fears. It is
extremely difficult to find buyers for hotel assets and for those assets that
have sold, prices have declined dramatically -- by as much as 20%. Fears in the
hotel market have eased to some degree along with the general consensus for a
brighter economic outlook in 1999.
We have continued to shape the Portfolio with companies offering attractive
fundamental valuations relative to their underlying real estate value. Given the
expected deterioration in capital values and the potential slowdown in the
demand for real estate, we have shifted the Portfolio to be modestly more
defensive. From a top-down perspective, we have increased our overweighting to
the less volatile sectors such as residential housing (both apartments and
manufactured home communities) and maintained an underweighting to the more
volatile sectors such as hotels (which feature daily re-pricing of rents). In
addition, we favored a more opportunistic approach to investing in the fourth
quarter following a relatively dramatic defensive shift in the third quarter. As
discussed above, this was evidenced in the purchase of a number of large cap
companies that fell into disfavor with investors as a result of negative
announcements. In addition, once again we took advantage of a weak market and
price declines to add a number of the most talented companies in the REIT
universe to the Portfolio, including Apartment Investment and Management.
January 1999
4
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
U.S. REAL ESTATE PORTFOLIO
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS
DECEMBER 31, 1998
<TABLE>
<CAPTION>
VALUE
SHARES (000)
<C> <S> <C>
- ------------------------------------------------------------------------
COMMON STOCK (92.0%)
DIVERSIFIED (10.1%)
15,500 Crescent Real Estate Equities Co. REIT........... $ 356
24,600 Pacific Gulf Properties, Inc. REIT............... 494
11,000 Pennsylvania REIT................................ 214
5,400 Vornado Realty Trust REIT........................ 182
(a)27,607 Wellsford Real Properties, Inc................... 285
-------
1,531
-------
HEALTH CARE (0.2%)
1,100 Omega Healthcare Investors, Inc. REIT............ 33
-------
LODGING/RESORTS (2.4%)
(a)870 Crestline Capital Corp. REIT..................... 13
8,700 Host Marriott Corp............................... 120
10,387 Starwood Lodging Trust REIT...................... 236
-------
369
-------
OFFICE/INDUSTRIAL (24.3%)
INDUSTRIAL (1.9%)
19,200 Prime Group Realty Trust REIT.................... 290
-------
OFFICE/INDUSTRIAL--MIXED (1.6%)
8,700 Bedford Property Investors, Inc. REIT............ 147
2,600 Spieker Properties, Inc. REIT.................... 90
-------
237
-------
OFFICE (20.8%)
32,500 Arden Realty Group, Inc.......................... 754
400 Boston Properties, Inc........................... 12
24,400 Brandywine Realty Trust REIT..................... 436
50,700 Brookfield Properties Corp....................... 620
14,900 CarrAmerica Realty Corp. REIT.................... 358
300 Cornerstone Properties, Inc...................... 5
22,287 Equity Office Properties Trust REIT.............. 535
23,800 Great Lakes, Inc. REIT........................... 373
2,800 SL Green Realty Corp. REIT....................... 60
-------
3,153
-------
TOTAL OFFICE/INDUSTRIAL...................................... 3,680
-------
OTHER (0.1%)
(a)10,848 Atlantic Gulf Communities Corp................... 8
(a)1,165 Merry Land Properties, Inc....................... 4
-------
12
-------
RESIDENTIAL (32.6%)
RESIDENTIAL APARTMENTS (23.8%)
5,100 Amli Residential Properties Trust REIT........... 113
8,800 Apartment Investment & Management Co. REIT....... 327
21,183 Archstone Communities Trust REIT................. 429
17,100 Avalon Bay Communities, Inc. REIT................ 586
15,149 Equity Residential Properties Trust REIT......... 613
16,300 Essex Property Trust, Inc. REIT.................. 485
17,600 Irvine Apartment Communities, Inc. REIT.......... 561
9,800 Smith (Charles E.) Residential Realty, Inc.
REIT........................................... 315
10,200 Summit Properties, Inc........................... 176
-------
3,605
-------
<CAPTION>
VALUE
SHARES (000)
<C> <S> <C>
- ------------------------------------------------------------------------
RESIDENTIAL MANUFACTURED HOMES (8.8%)
30,300 Chateau Properties, Inc. REIT.................... $ 888
4,000 Manufactured Home Communities, Inc. REIT......... 100
9,700 Sun Communities, Inc. REIT....................... 338
-------
1,326
-------
TOTAL RESIDENTIAL............................................ 4,931
-------
RETAIL (17.1%)
RETAIL REGIONAL MALLS (7.3%)
48,900 Taubman Centers, Inc. REIT....................... 673
13,200 Urban Shopping Centers, Inc. REIT................ 432
-------
1,105
-------
RETAIL STRIP CENTERS (9.8%)
38,000 Burnham Pacific Property Trust REIT.............. 458
25,800 Federal Realty Investment Trust REIT............. 610
1,800 First Washington Realty Trust, Inc. REIT......... 43
8,100 Pan Pacific Retail Properties, Inc. REIT......... 161
100 Ramco-Gershenson Properties Trust REIT........... 1
9,600 Regency Realty Corp.............................. 214
-------
1,487
-------
TOTAL RETAIL................................................. 2,592
-------
SELF STORAGE (5.2%)
16,500 Public Storage, Inc. REIT........................ 447
7,300 Shurgard Storage Centers, Inc., Series A REIT.... 188
6,200 Storage Trust Realty REIT........................ 145
-------
780
-------
TOTAL COMMON STOCK (COST $14,913).............................. 13,928
-------
</TABLE>
<TABLE>
<C> <S> <C>
PREFERRED STOCK (0.1%)
OTHER (0.1%)
(a)1,401 Atlantic Gulf Communities Corp. (COST $14)....... 7
-------
CONVERTIBLE PREFERRED STOCK (0.6%)
OTHER (0.1%)
(a)2,003 Atlantic Gulf Communities Corp................... 10
RETAIL (0.5%)
RETAIL STRIP CENTERS (0.5%)
2,700 First Washington Realty Trust, Series A REIT..... 80
-------
TOTAL CONVERTIBLE PREFERRED STOCKS (COST $101)................. 90
-------
</TABLE>
<TABLE>
<CAPTION>
NO. OF
WARRANTS
<C> <S> <C>
- -----------
WARRANTS (0.0%)
OTHER (0.0%)
(a)2,812 Atlantic Gulf Communities Corp., Class A,
expiring 6/23/04............................... 1
(a)2,812 Atlantic Gulf Communities Corp., Class B,
expiring 6/23/04............................... 1
(a)2,812 Atlantic Gulf Communities Corp., Class C,
expiring 6/23/04............................... 1
-------
TOTAL WARRANTS (COST $0)....................................... 3
-------
</TABLE>
The accompanying notes are an integral part of the financial statements.
5
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
U.S. REAL ESTATE PORTFOLIO
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS (CONT.)
DECEMBER 31, 1998
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- ------------------------------------------------------------------------
<C> <S> <C>
SHORT-TERM INVESTMENT (5.5%)
REPURCHASE AGREEMENT (5.5%)
$838 Chase Securities, Inc. 4.45%, dated 12/31/98, due
1/4/99, to be repurchased at $838,
collateralized by U.S. Treasury Bonds, 10.375%,
due 11/15/12, valued at $847
(COST $838).................................... $ 838
-------
TOTAL INVESTMENTS (98.2%) (COST $15,866)....................... 14,866
--------
OTHER ASSETS (2.1%)
Cash................................................ $ 5
Dividends Receivable................................ 127
Receivable for Investments Sold..................... 109
Receivable for Portfolio Shares Sold................ 69 310
-------
LIABILITIES (-0.3%)
Professional Fees Payable........................... (18)
Investment Advisory Fees Payable.................... (10)
Payable for Portfolio Shares Redeemed............... (5)
Custodian Fees Payable.............................. (5)
Administrative Fees Payable......................... (3)
Other Liabilities................................... (1) (42)
------- --------
NET ASSETS (100%)..................................... $15,134
--------
--------
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 1,544,974 outstanding $0.001 par value shares
(authorized 500,000,000 shares).............................. $ 9.80
--------
--------
NET ASSETS CONSIST OF:
Paid in Capital................................................ $16,496
Undistributed Net Investment Income............................ 130
Accumulated Net Realized Loss.................................. (492)
Unrealized Depreciation on Investments......................... (1,000)
--------
NET ASSETS..................................................... $15,134
--------
--------
</TABLE>
- ---------------
(a) -- Non-income producing security
REIT -- Real Estate Investment Trust
- ----------------------------------------------------------------
- ---------------
At December 31, 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>
$ 16,036 $ 256 $ (1,426) $ (1,170)
</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 $17,638,000 and $13,813,000,
respectively. There were no purchases and sales of U.S. Government securities
for the year ended December 31, 1998.
At December 31, 1998, the Portfolio had available capital loss carryforwards to
offset future net capital gains, to the extent provided by regulations, through
December 31, 2006 of approximately $259,000. To the extent that capital loss
carryforwards are used to offset any 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 a 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 of approximately $87,000.
The accompanying notes are an integral part of the financial statements.
6
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
U.S. REAL ESTATE PORTFOLIO
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1998
(000)
<S> <C>
- --------------------------------------------------------
INVESTMENT INCOME:
Dividends $ 725
Interest 37
-------
Total Income 762
-------
EXPENSES:
Investment Advisory Fees 116
Less: Fees Waived (92)
-------
Net Investment Advisory Fees 24
Administrative Fees 40
Shareholder Reports 36
Professional Fees 32
Custodian Fees 22
Directors' Fees and Expenses 2
Other 4
-------
Net Expenses 160
-------
Net Investment Income 602
-------
NET REALIZED LOSS ON:
Investments Sold (484)
-------
CHANGE IN UNREALIZED
APPRECIATION/DEPRECIATION ON:
Investments (1,853)
-------
Net Realized Loss and Change in
Unrealized
Appreciation/Depreciation (2,337)
-------
NET DECREASE IN NET ASSETS RESULTING
FROM OPERATIONS $ (1,735)
-------
-------
</TABLE>
- --------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED PERIOD FROM MARCH 3,
DECEMBER 31, 1998 1997* TO DECEMBER
(000) 31, 1997 (000)
<S> <C> <C>
- ------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS:
Net Investment Income $ 602 $ 193
Net Realized Gain (Loss) (484) 318
Change in Unrealized
Appreciation/Depreciation (1,853) 853
------- -------
Net Increase/Decrease in Net Assets
Resulting from Operations (1,735) 1,364
------- -------
DISTRIBUTIONS:
Net Investment Income (421) (189)
Net Realized Gain (124) (227)
------- -------
Total Distributions (545) (416)
------- -------
CAPITAL SHARE TRANSACTIONS (1):
Subscribed 11,443 13,434
Distributions Reinvested 402 228
Redeemed (7,486) (1,555)
------- -------
Net Increase in Net Assets Resulting
from Capital Share Transactions 4,359 12,107
------- -------
Total Increase in Net Assets 2,079 13,055
NET ASSETS:
Beginning of Period 13,055 --
------- -------
End of Period (Including
undistributed net investment
income of $130 and $4,
respectively) $ 15,134 $ 13,055
------- -------
------- -------
- ------------------------------------------------------------------------------
(1) Capital Share Transactions:
Shares Subscribed 1,090 1,259
Shares Issued on Distributions
Reinvested 40 21
Shares Redeemed (730) (135)
------- -------
Net Increase in Capital Shares
Outstanding 400 1,145
------- -------
------- -------
</TABLE>
- --------------------------------------------------------------------------------
* Commencement of operations
The accompanying notes are an integral part of the financial statements.
7
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
U.S. REAL ESTATE PORTFOLIO
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
PERIOD FROM MARCH
YEAR ENDED 3, 1997* TO
SELECTED PER SHARE DATA AND RATIOS DECEMBER 31, 1998 DECEMBER 31, 1997
<S> <C> <C>
- ---------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $ 11.41 $ 10.00
------- -------
INCOME FROM INVESTMENT OPERATIONS
Net Investment Income 0.40 0.17
Net Realized and Unrealized Gain
(Loss) (1.63) 1.61
------- -------
Total From Investment Operations (1.23) 1.78
------- -------
DISTRIBUTIONS
Net Investment Income (0.29) (0.17)
Net Realized Gain (0.09) (0.20)
------- -------
Total Distributions (0.38) (0.37)
------- -------
NET ASSET VALUE, END OF PERIOD $ 9.80 $ 11.41
------- -------
------- -------
TOTAL RETURN (10.86)% 17.99%
------- -------
------- -------
RATIOS AND SUPPLEMENTAL DATA:
Net Assets, End of Period (000's) $ 15,134 $ 13,055
Ratio of Expenses to Average Net
Assets 1.10% 1.10%**
Ratio of Net Investment Income to
Average Net Assets 4.14% 3.14%**
Portfolio Turnover Rate 100% 114%
- ---------------------------------------------------------------------------------
Effect of Voluntary Expense
Limitation During the Period:
Per Share Benefit to Net Investment
Income $ 0.06 $ 0.07
Ratios Before Expense Limitation:
Expenses to Average Net Assets 1.73% 2.32%**
Net Investment Income to Average
Net Assets 3.51% 1.92%**
</TABLE>
- --------------------------------------------------------------------------------
* Commencement of operations
** Annualized
The accompanying notes are an integral part of the financial statements.
8
<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 U.S. Real Estate Portfolio.
Please refer to the 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 it invests.
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. Federal income
tax regulations, gains and losses from certain foreign currency transactions and
the foreign currency
9
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
DECEMBER 31, 1998
- --------------------------------------------------------------------------------
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 (5-11)
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. 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 is 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 acquired
by the Portfolio as the purchaser of an Assignment may differ from, and be more
limited than, those held by the assigning Lender.
10
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
DECEMBER 31, 1998
- --------------------------------------------------------------------------------
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 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
11
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
DECEMBER 31, 1998
- --------------------------------------------------------------------------------
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 their 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. 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 U.S. Real Estate Portfolio owns shares of real estate investment trusts
("REITs") which report information on the source of their distributions
annually. A portion of distributions received from REITs during the year are
estimated to be a return of capital and is recorded as a reduction of their
cost.
The amount and character of income and capital gain distributions to be paid by
Portfolios of the Fund are determined in accordance with Federal income tax
regulations which may differ from generally accepted accounting principles.
These differences are primarily due to differing book and tax treatments for the
character and timing of the recognition of gains or losses on securities and
foreign currency exchange contracts, the timing of the deductibility of certain
foreign taxes and dividends received from real estate investment trusts.
Permanent book and tax basis differences relating to shareholder distributions
may result in reclassifications among undistributed net investment income
(loss), accumulated net realized gain (loss) and paid in capital.
Permanent book and tax differences, if any, are not included in ending
undistributed (distributions in excess of) net investment income/accumulated net
investment loss for the purpose of calculating net investment income (loss) per
share in the Financial Highlights.
Settlement and registration of foreign securities transactions may be subject to
significant risks not normally associated with investments in the United States.
In certain markets, including Russia, ownership of shares is defined according
to entries in the issuer's share register. In Russia, there currently exists no
central registration system and the share registrars may not be subject to
effective state supervision. It is possible that a Portfolio holding these
securities could lose its share registration through fraud, negligence or even
mere oversight. In addition, shares being delivered for sales and cash being
paid for purchases may be delivered before the exchange is complete. This may
subject the 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>
0.80% 0.75% 0.70%
</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 1.10%.
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 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.
12
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
NOTES TO FINANCIAL STATEMENTS (CONT.)
DECEMBER 31, 1998
- --------------------------------------------------------------------------------
D. CUSTODIANS: 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, an account maintenance fee,
plus reimbursement for certain out-of-pocket expenses.
E. OTHER: 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.
13
<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.)--
U.S. Real Estate 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.--U.S. Real Estate Portfolio
(hereafter referred to as the "Fund") at December 31, 1998, the results of its
operations for the year then ended, and the changes in its net assets and the
financial highlights for the year then ended and for the period March 3, 1997
(commencement of operations) through December 31, 1997, 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
14
<PAGE>
MORGAN STANLEY UNIVERSAL FUNDS, INC.
FEDERAL TAX INFORMATION (UNAUDITED)
- --------------------------------------------------------------------------------
For the year ended December 31, 1998, the percentage of distributions taxable as
ordinary income for the Portfolio, as reported on Form 1099-DIV, that qualify
for the dividends received deduction for corporations is 1.7%.
For the year ended December 31, 1998, the Portfolio has designated a 20% and 25%
long-term capital gain of approximately $6,000 and $3,000, respectively.
15
<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.
16
