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P R O S P E C T U S
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MORGAN STANLEY STRATEGIC ADVISER FUND, INC.
P.O. BOX 2798, BOSTON, MA 02208-2798
1-800-548-7786
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MORGAN STANLEY MILLER ANDERSON &
ASSET MANAGEMENT INC. SHERRERD, LLP
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Morgan Stanley Strategic Adviser Fund, Inc. (the "Fund") is a mutual fund
that offers investors a range of asset allocation strategies designed to
accommodate different investors' philosophies, goals and risk tolerances. These
strategies are implemented through investment in underlying portfolios of the
Morgan Stanley Institutional Fund, Inc. ("MSIF") and the MAS Funds (each an
"Underlying Fund" and, collectively, the "Underlying Funds"). The Underlying
Funds are managed by either Morgan Stanley Asset Management Inc. ("MSAM") or
Miller Anderson & Sherrerd, LLP ("MAS"). Morgan Stanley & Co. Incorporated is
the distributor of the Fund's shares. The Fund makes available in a single
product the combined strengths of these leading investment firms, each of which
is a subsidiary of Morgan Stanley, Dean Witter, Discover & Co.
This Prospectus pertains to the Class A and the Class B shares of the
Strategic Adviser Conservative Portfolio, the Strategic Adviser Moderate
Portfolio and the Strategic Adviser Aggressive Portfolio (each a "Portfolio" and
collectively, the "Portfolios"). The Class A and Class B shares currently
offered by the Portfolios are intended for classes of investors having different
shareholder servicing needs and have different expenses. Shares of the
Portfolios are offered with no sales charge, exchange fee or redemption fee.
This Prospectus contains important information about the Fund's investments
and services. You should read it before investing, and keep it on file for
future reference. A Statement of Additional Information ("SAI") dated December
10, 1997, has been filed with the Securities and Exchange Commission and is
incorporated herein by reference, and, therefore, legally forms a part of the
Prospectus. For a free copy, contact the Fund at the address or toll-free number
above.
THE FUND'S SHARES ARE NOT OBLIGATIONS, DEPOSITS OR ACCOUNTS OF, OR ENDORSED
OR GUARANTEED BY, ANY BANK OR DEPOSITARY INSTITUTION, OR ANY AFFILIATES OR
CORRESPONDENTS THEREOF. THE FUND'S SHARES ARE NOT FEDERALLY INSURED BY THE
FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER
AGENCY. SHARES OF THE FUND INVOLVE INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS
OF PRINCIPAL.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
PROSPECTUS DATED DECEMBER 10, 1997
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PROSPECTUS OUTLINE PAGE
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FUND EXPENSES 3
Tables showing the direct and indirect expenses of the Portfolios.
THE PORTFOLIOS 5
For each Portfolio, the investment objective and a summary of
strategy, potential investors, and investment characteristics and risks.
THE UNDERLYING FUNDS 9
A review of the investment characteristics and risks of each
current Underlying Fund.
SECURITIES AND INVESTMENT TECHNIQUES 14
Information about the principal types of investment strategies that
may be used by some or all of the Underlying Funds and discussion of
investment risks and limitations.
FUNDAMENTAL INVESTMENT LIMITS 24
Certain policies that may be changed only by shareholders.
MANAGEMENT OF THE FUND 25
General information about the organization and operation of the
Fund, including details about MSAM, MAS and the Fund's Portfolio Manager,
as well as fees, expenses and performance calculations.
ACCOUNT POLICIES 30
Information on income and capital gain distributions, transaction
details, including net asset value calculation, and purchases and
redemptions.
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THE FUND'S PORTFOLIOS:
STRATEGIC ADVISER CONSERVATIVE PORTFOLIO
The Strategic Adviser Conservative Portfolio seeks the highest level of
long-term total return that is consistent with a relatively conservative level
of risk. The Portfolio invests primarily in Underlying Fixed Income Funds and,
to a lesser extent, in Underlying Equity Funds. The Portfolio may be appropriate
for relatively conservative investors who have a shorter time horizon for their
investments and seek some capital appreciation while generally preserving
principal.
STRATEGIC ADVISER MODERATE PORTFOLIO
The Strategic Adviser Moderate Portfolio seeks the highest level of long-term
total return that is consistent with a relatively moderate level of risk. The
Portfolio invests in a mix of Underlying Equity Funds and Underlying Fixed
Income Funds. The Portfolio may be appropriate for moderately aggressive
investors who have an intermediate time horizon for their investments and are
willing to bear a moderate level of risk to achieve capital appreciation.
STRATEGIC ADVISER AGGRESSIVE PORTFOLIO
The Strategic Adviser Aggressive Portfolio seeks the highest level of long-term
capital appreciation that is consistent with a relatively high level of risk.
The Portfolio invests primarily in Underlying Equity Funds and, to a lesser
extent, in Underlying Fixed Income Funds. The Portfolio may be appropriate for
relatively aggressive investors who have a longer time horizon for their
investments and are willing to bear a higher level of risk to achieve greater
return.
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FUND EXPENSES
The purpose of the following table is to help you understand the various costs
and expenses that you, as a shareholder, will bear in connection with an
investment in each Portfolio's Class A or Class B shares.
SHAREHOLDER TRANSACTION EXPENSES
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STRATEGIC STRATEGIC STRATEGIC
ADVISER ADVISER ADVISER
CONSERVATIVE MODERATE AGGRESSIVE
PORTFOLIO PORTFOLIO PORTFOLIO
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Maximum Sales Load Imposed on Purchases
Class A............................... None None None
Class B............................... None None None
Maximum Sales Load Imposed
on Reinvested Dividends
Class A............................... None None None
Class B............................... None None None
Deferred Sales Load
Class A............................... None None None
Class B............................... None None None
Redemption Fees
Class A............................... None None None
Class B............................... None None None
Exchange Fees
Class A............................... None None None
Class B............................... None None None
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ANNUAL FUND OPERATING EXPENSES
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
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STRATEGIC STRATEGIC STRATEGIC
ADVISER ADVISER ADVISER
CONSERVATIVE MODERATE AGGRESSIVE
PORTFOLIO PORTFOLIO PORTFOLIO
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Management Fee
Class A............................... None None None
Class B............................... None None None
12b-1 Fees
Class A............................... None None None
Class B............................... 0.25% 0.25% 0.25%
Other Expenses
Administration Fee(1)(2)
Class A............................. 0.15% 0.14% 0.15%
Class B............................. 0.15% 0.14% 0.15%
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STRATEGIC STRATEGIC STRATEGIC
ADVISER ADVISER ADVISER
CONSERVATIVE MODERATE AGGRESSIVE
PORTFOLIO PORTFOLIO PORTFOLIO
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Underlying Fund
Expenses(3)
Class A............................. 0.51% 0.67% 0.86%
Class B............................. 0.51% 0.67% 0.86%
Other
Expenses(2)
Class A............................. 0.09% 0.09% 0.09%
Class B............................. 0.09% 0.09% 0.09%
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Total Operating Expenses(2)
Class A............................... 0.75% 0.90% 1.10%
Class B............................... 1.00% 1.15% 1.35%
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(1) Paid to the Adviser for general administration, fund accounting and
shareholder servicing and transfer agent services.
(2) The Adviser has voluntarily agreed to waive its administration fees and/or
reimburse each Portfolio, if necessary, if such fees, the expenses of the
Portfolios or the expenses of the Underlying Funds would cause the total
operating expenses for the current fiscal year to exceed 0.80% for the Class
A shares and 1.05% for the Class B shares of the Strategic Adviser
Conservative Portfolio; 0.90% for the Class A shares and 1.15% for the Class
B shares of the Strategic Adviser Moderate Portfolio; and 1.10% for the
Class A shares and 1.35% for the Class B shares of the Strategic Adviser
Aggressive Portfolio. The administration fee, absent fee waivers or expense
reimbursements, for each Portfolio is 0.15%. Other expenses for the
Portfolios are based on estimates assuming that the average daily net assets
of each Portfolio will be $50,000,000. Absent the fee waiver and/or expense
reimbursement, the Strategic Adviser Moderate Portfolio's total operating
expenses would be 0.91% for the Class A shares and 1.16% for the Class B
shares. If the average daily net assets of a Portfolio does not reach
$50,000,000, that Portfolio's total operating expenses, in the absence of
any waivers or reimbursements, may be higher than indicated. The Adviser
reserves the right to terminate any of its fee waivers and/or expense
reimbursements at any time in its sole discretion. For further information
on Portfolio expenses, see "Management of the Fund--Underlying Fund
Expenses."
(3) Underlying Fund expenses for each Portfolio are estimated based upon the
initial allocation of each Portfolio's investment in Underlying Funds and
the total operating expenses of (i) the MSIF Underlying Funds for the fiscal
year ended December 31, 1996 and (ii) the MAS Underlying Funds for the
fiscal year ended September 30, 1997. Actual Underlying Fund
3
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expenses incurred by each Portfolio may vary with changes in the allocation
of each Portfolio's assets among the Underlying Funds and with other events
that directly affect the expenses of the Underlying Funds. For additional
information on the total operating expenses of each Underlying Fund, please
refer to "Management of the Fund--Underlying Fund Expenses."
An investor in the Portfolios will bear no direct expenses. Shareholders will,
however, bear their proportionate share of the expenses of the Portfolios and
the Underlying Funds. The purpose of the above table is to help you understand
these indirect costs. Due to the continuous nature of Rule 12b-1 fees, long-term
Class B shareholders may pay more than the equivalent of the maximum front-end
sales charges otherwise permitted by the National Association of Securities
Dealers, Inc. ("NASD") Conduct Rules.
EXAMPLE
The following example illustrates the direct and indirect expenses that you
would pay assuming (i) an investment of $1,000; (ii) a 5% annual return; and
(iii) redemption at the end of each time period. As noted in the table above,
the Portfolios charge no redemption fees of any kind. The following example is
based on the total operating expenses of each Portfolio. The actual expenses may
vary with changes in the allocation of each Portfolio's assets among the
Underlying Funds and with other events that directly affect the expenses of the
Underlying Funds.
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ONE THREE FIVE TEN
YEAR YEARS YEARS YEARS
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Strategic Adviser Conservative Portfolio
Class A............................... $ 8 $26 * *
Class B............................... $11 $33 * *
Strategic Adviser Moderate Portfolio
Class A............................... $ 9 $29 * *
Class B............................... $12 $37 * *
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ONE THREE FIVE TEN
YEAR YEARS YEARS YEARS
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Strategic Adviser Aggressive Portfolio
Class A............................... $11 $35 * *
Class B............................... $14 $43 * *
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* Because the Portfolios are new, the Fund has not projected expenses for the
Portfolios beyond the three year period shown.
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES OR PERFORMANCE. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE
SHOWN.
THE FUND
The Fund is a type of mutual fund often described as a "fund of funds." The Fund
currently consists of three separate investment portfolios (each a "Portfolio"
and, collectively, the "Portfolios") that invest primarily in different
combinations of the Class A shares of investment portfolios of Morgan Stanley
Institutional Fund, Inc. ("MSIF") and Institutional Class shares of investment
portfolios of MAS Funds (each an "Underlying Fund" and, collectively, the
"Underlying Funds"). The Portfolios have distinct investment objectives and are
designed to offer investors a range of choices suited to differing philosophies,
goals and tolerances for risk. Each Portfolio has different risk/ reward
characteristics. However, investment in each of the Portfolios entails risk in
that the value of shares of each Portfolio ultimately reflects changes in the
market values of securities held in the portfolios of the Underlying Funds. The
following pages describe these investment objectives and the Underlying Funds
each Portfolio may use to seek its objective, as well as the risks inherent in
investing in the Portfolios.
4
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INVESTMENT MANAGEMENT
Morgan Stanley Asset Management Inc. ("MSAM" or the "Adviser") serves as
investment adviser to the Portfolios and is responsible for allocating each
Portfolio's investments among the Underlying Funds. Underlying Funds are advised
by MSAM or Miller Anderson & Sherrerd, LLP ("MAS").
MSAM and MAS are both subsidiaries, and part of the worldwide investment
advisory business, of Morgan Stanley, Dean Witter, Discover & Co., a global
financial services company. As of October 31, 1997, MSAM and MAS, together with
their other affiliated institutional investment advisory companies, had assets
under management, including assets under fiduciary advisory control, totaling
approximately $144 billion.
OFFERING OF SHARES
The Portfolios are offered primarily to institutional investors, including
certain employee benefit plans that permit participants to select among
investment options.
THE PORTFOLIOS
The Portfolios offer a range of investment objectives for investors with
differing philosophies, goals and risk tolerances. Each Portfolio is a
diversified investment company under the Investment Company Act of 1940, as
amended (the "1940 Act") and seeks to achieve its objective by investing in
combinations of Underlying Funds which, in turn, have their own varying
investment objectives and policies. The Underlying Funds pursue their investment
objectives by purchasing the instruments and using the strategies described
under "Securities and Investment Techniques" below.
MSAM will allocate each Portfolio's investments among Underlying Funds, within
the broad ranges for Fixed Income and Equity investments set forth below for
each Portfolio. MSAM's allocation process is strategic rather than tactical and
focuses on longer term trends in market forces. Accordingly, the allocation of
each Portfolio's investments in Underlying Funds is expected to be relatively
static, with subtle adjustments periodically in response to market developments.
MSAM may also from time to time rebalance each Portfolio's investments in
Underlying Funds to restore weightings to the percentages it believes
appropriate. As with any mutual fund, there is no assurance that the Portfolios
will achieve their objectives.
The Portfolios initially will invest in combinations of the following Underlying
Funds:
EQUITY:
U.S. Equity Funds:
MSIF Equity Growth Portfolio
MSIF U.S. Equity Plus Portfolio
MSIF U.S. Real Estate Portfolio
MAS Mid Cap Growth Portfolio
MAS Mid Cap Value Portfolio
MAS Value Portfolio
International Equity Funds:
MSIF Active Country Allocation Portfolio
MSIF Asian Equity Portfolio
MSIF Emerging Markets Portfolio*
MSIF European Equity Portfolio
MSIF International Equity Portfolio*
MSIF International Magnum Portfolio
MSIF Japanese Equity Portfolio
MSIF Latin American Portfolio
MAS International Equity Portfolio
FIXED INCOME:
U.S. Fixed Income Funds:
MSIF Fixed Income Portfolio
MAS Fixed Income Portfolio
5
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MAS High Yield Portfolio
MAS Intermediate Duration Portfolio
MAS Limited Duration Portfolio
MAS Mortgage-Backed Securities
Portfolio
International Fixed Income Fund:
MAS International Fixed Income
Portfolio
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* This Underlying Fund is currently closed to new investors. However, MSAM may
in its discretion permit investment by certain classes of investors, such as
the Fund.
The Portfolios may also invest in other Underlying Funds (i.e., other investment
portfolios of MSIF or MAS Funds that currently are offered or that may be
offered in the future). It is anticipated that each Portfolio will be fully
invested in shares of Underlying Funds, however, each Portfolio also may invest
in U.S. Government Securities (including Agencies) and Money Market Instruments.
Certain terms used below have initial capital letters ("Underlying Fixed Income
Fund," for example). These terms are further described under "Securities and
Investment Techniques" below.
STRATEGIC ADVISER CONSERVATIVE PORTFOLIO
OBJECTIVE AND STRATEGY: The Strategic Adviser Conservative Portfolio seeks the
highest level of long-term total return that is consistent with a relatively
conservative level of risk. The Portfolio invests primarily in Underlying Fixed
Income Funds and, to a lesser extent, in Underlying Equity Funds, within the
following permitted ranges:
Fixed Income (70%-80%) Equity (20%-30%)
- -------------------------------- ----------------------
It is anticipated that the Portfolio will invest primarily in Underlying Funds
which focus their investments on the U.S. market and which invest primarily in
short-duration Fixed Income Securities and, to a lesser extent, Equity
Securities of larger issuers.
EXAMPLE: The following is an example of how the investments of the Strategic
Adviser Conservative Portfolio may be allocated, based on MSAM's effective
allocations on the date of this Prospectus:
70% MAS Limited Duration Portfolio
10% MAS High Yield Portfolio
13% MSIF U.S. Equity Plus Portfolio
7% MSIF Equity Growth Portfolio
This example is for illustration purposes only. MSAM may alter the allocation of
investments for the Portfolio at any time.
INVESTOR PROFILE: The Portfolio may be appropriate for relatively conservative
investors who have a shorter time horizon for their investments and seek some
capital appreciation while generally preserving principal. Example: investors
who are investing within 3-5 years prior to retirement or during retirement.
RISK PROFILE: LOW TO MODERATE POTENTIAL RISK AND REWARD. The value of the
Portfolio's investments in Underlying Fixed Income Funds, as well as any direct
investments in U.S. Government Securities and Money Market Instruments, can be
expected to vary inversely to changes in prevailing interest rates. The
Portfolio may invest, to a limited extent, in Underlying Fixed Income Funds that
purchase High Yield Securities. High Yield Securities usually entail greater
risk and may be more volatile and less liquid than other Fixed Income
Securities. The value of the Portfolio's investments in Underlying Equity Funds
will fluctuate with
6
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changes in the stock market and changes in the economy.
STRATEGIC ADVISER MODERATE PORTFOLIO
OBJECTIVE AND STRATEGY: The Strategic Adviser Moderate Portfolio seeks the
highest level of long-term total return that is consistent with a relatively
moderate level of risk. The Portfolio invests in a mix of Underlying Equity
Funds and Underlying Fixed Income Funds within the following permitted ranges:
Fixed Income (40%-50%) Equity (50%-60%)
- -------------------------------- ----------------------
It is anticipated that the Portfolio will invest in Underlying Funds which focus
their investments on Equity Securities of mid- to large-size U.S. and foreign
issuers, and on short- to intermediate-duration Fixed Income Securities,
including High Yield Securities and Mortgage-Backed Securities ("MBSs").
EXAMPLE: The following is an example of how the investments of the Strategic
Adviser Moderate Portfolio may be allocated, based on MSAM's effective
allocations on the date of this Prospectus:
40% MAS Intermediate Duration Portfolio
10% MAS High Yield Portfolio
15% MSIF International Magnum Portfolio
15% MSIF U.S. Equity Plus Portfolio
10% MSIF Equity Growth Portfolio
10% MAS Value Portfolio
This example is for illustration purposes only. MSAM may alter the allocation of
investments for the Portfolio at any time.
INVESTOR PROFILE: The Portfolio may be appropriate for moderately aggressive
investors who have an intermediate time horizon for their investments and are
willing to bear a moderate level of risk to achieve capital appreciation.
Example: investors who are in their 40's and 50's who plan to retire in their
early to mid-60's and those who are investing during early retirement.
RISK PROFILE: MODERATE POTENTIAL RISK AND REWARD. The value of the Portfolio's
investments in Underlying Funds will fluctuate with changes in the stock market
and changes in the economy. The value of the Portfolio's investments in
Underlying Fixed Income Funds, as well as any direct investments in U.S.
Government Securities and Money Market Instruments, will also be influenced by
market and economic factors and can be expected to vary inversely to changes in
prevailing interest rates. While Fixed Income Securities with longer maturities
tend to produce higher yields, the prices of longer maturity securities are also
subject to greater market fluctuations as a result of changes in interest rates.
Certain Underlying Funds in which the Portfolio invests may purchase High Yield
Securities and MBSs. High Yield Securities usually entail greater risk and may
be more volatile and less liquid than other Fixed Income Securities. MBSs are
subject to the same risks as Fixed Income Securities in general, but also may
react differently and more or less favorably to changes in interest rates as a
result of prepayment risk (i.e., the risk that early principal payments on
underlying mortgages will result in prepayment of a portion of the principal of
MBSs). In addition, investing in Underlying Funds that invest internationally
involves different or increased risks. Foreign Investment means that the
performance of the Portfolio will be affected by currency values, the political
and regulatory environment, greater volatility of securities exchanges and
overall political and economic factors in the countries in which the Underlying
Funds invest.
7
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STRATEGIC ADVISER AGGRESSIVE PORTFOLIO
OBJECTIVE AND STRATEGY: The Strategic Adviser Aggressive Portfolio seeks the
highest level of long-term capital appreciation that is consistent with a
relatively high level of risk. The Portfolio invests primarily in Underlying
Equity Funds and, to a lesser extent, in Underlying Fixed Income Funds within
the following permitted ranges:
Fixed Income (10%-20%) Equity (80%-90%)
- -------------------------------- ----------------------
It is anticipated that the Portfolio will invest in Underlying Funds which focus
their investments on Equity Securities of U.S. and foreign issuers, including
Emerging Market Country Securities, and, to a lesser extent, on intermediate-to
long-duration Fixed Income Securities, including High Yield Securities and MBSs.
EXAMPLE: The following is an example of how the investments of the Strategic
Adviser Aggressive Portfolio may be allocated, based on MSAM's effective
allocations on the date of this Prospectus:
25% MSIF International Magnum Portfolio
15% MSIF Equity Growth Portfolio
15% MAS Value Portfolio
10% MSIF Emerging Markets Portfolio
10% MAS Mid Cap Growth Portfolio
10% MSIF U.S. Equity Plus Portfolio
15% MAS Fixed Income Portfolio
This example is for illustration purposes only. MSAM may alter the allocation of
investments for the Portfolio at any time.
INVESTOR PROFILE: The Portfolio may be appropriate for relatively aggressive
investors who have a longer time horizon for their investments and are willing
to bear a higher level of risk to achieve greater return. Example: investors in
their 20s, 30s, or 40s who are saving for their retirements and who plan to
retire in their early to mid-60s.
RISK PROFILE: MODERATE TO HIGH POTENTIAL RISK AND REWARD. The value of the
Portfolio's investments in Underlying Funds will fluctuate with changes in the
stock market and changes in the economy. The value of the Portfolio's
investments in Underlying Fixed Income Funds, as well as any direct investments
in U.S. Government Securities and Money Market Instruments, will also be
influenced by market and economic factors and can be expected to vary inversely
to changes in prevailing interest rates. While Fixed Income Securities with
longer maturities tend to produce higher yields, the prices of longer maturity
securities are also subject to greater market fluctuations as a result of
changes in interest rates. Underlying Funds that invest in MBSs will be subject
to the same risks as Fixed Income Securities in general, but also may react
differently and more or less favorably to changes in interest rates as a result
of prepayment risk (i.e., the risk that early principal payments on underlying
mortgages will result in prepayment of a portion of the principal of MBSs). In
addition, investing in Underlying Funds that invest internationally involves
different or increased risks. Foreign Investment means that the performance of
the Portfolio will be affected by currency values, the political and regulatory
environment, greater volatility of securities exchanges and overall political
and economic factors in the countries in which the Underlying Funds invest.
Certain Underlying Funds may invest in Emerging Market Country Securities which
may increase these risks, but may offer superior growth opportunities.
8
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THE UNDERLYING FUNDS
The Underlying Funds that initially will be considered for investment by each
Portfolio are described below. The Underlying Funds in which the Portfolios
intend to invest may change from time to time and the Portfolios may invest in
Underlying Funds in addition to those described below at the discretion of the
Adviser without shareholder approval.
The value of each Underlying Fund's investments and the income they generate
will vary from day-to-day and generally reflect market conditions, interest
rates, and other company, political, or economic developments both in the United
States and abroad. When a Portfolio redeems shares of an Underlying Fund, they
may be worth more or less than their original cost. As with any mutual fund,
there is no assurance that an Underlying Fund will achieve its objective.
The Underlying Funds spread investment risk in varying degrees by limiting their
holdings in any one company or industry. Nevertheless, each Underlying Fund will
experience price volatility the extent of which will be affected by the types of
securities and techniques the particular Underlying Fund uses.
The MAS International Fixed Income Portfolio and the MSIF International Magnum,
U.S. Real Estate, Emerging Markets and Latin American Portfolios are
non-diversified portfolios under the 1940 Act. Accordingly, the 1940 Act does
not limit the proportion of their assets that may be invested in the securities
of a single issuer. These Underlying Funds have the investment flexibility to
invest a greater proportion of their assets in the securities of a small number
of issuers. As a result, they will be subject to a greater risk of loss in the
event such an investment underperforms expectations. However, these Underlying
Funds attempt to comply with diversification requirements imposed by the
Internal Revenue Code of 1986, as amended (the "Code"), for qualification as
regulated investment companies.
In addition to the Underlying Funds' investments described below, each
Underlying Fund may invest in Derivatives and securities described under Other
Securities to pursue portfolio strategy. Derivatives involve certain risks that
are different from the risks associated with other securities.
Each Underlying Fund normally will be invested according to its investment
strategy. However, the Underlying Funds also have the ability to invest without
limitation in high quality Money Market Instruments or other Temporary
Investments for temporary, defensive purposes.
U.S. EQUITY FUNDS
MSIF EQUITY GROWTH PORTFOLIO
The MSIF Equity Growth Portfolio seeks long-term capital appreciation by
investing in growth-oriented Equity Securities of medium and large
capitalization U.S. corporations and, to a limited extent, foreign corporations.
The Underlying Fund invests primarily in rapidly growing, high quality
companies, and companies with lower, but accelerating, earnings growth,
generally with market capitalizations of $500 million or more. The Underlying
Fund may invest in both Common Stocks and Convertible Securities. In addition to
the general risks associated with Equity Securities, to the extent that it
invests in securities of foreign issuers, the Underlying Fund will be subject to
the risks described under Foreign Investment.
9
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MSIF U.S. EQUITY PLUS PORTFOLIO
The MSIF U.S. Equity Plus Portfolio seeks long-term capital appreciation by
investing primarily in Common Stocks and other Equity Securities of issuers
included in the Standard & Poor's Ratings Group ("S&P") 500 Index.
MSIF U.S. REAL ESTATE PORTFOLIO
The MSIF U.S. Real Estate Portfolio seeks above-average current income and
long-term capital appreciation by investing primarily in Equity Securities of
companies in the U.S. real estate industry, including real estate investment
trusts ("REITs"). In addition to the general risks associated with Equity
Securities, the Underlying Fund's investments will be subject to risks
associated with real estate investments generally and REITs in particular.
MAS MID CAP GROWTH PORTFOLIO
The MAS Mid Cap Growth Portfolio seeks long-term capital growth by investing
primarily in Common Stocks and other Equity Securities of smaller and medium
size U.S. companies that offer long-term growth potential. The Underlying Fund
generally invests in companies with capitalizations between $300 million and $3
billion. The Underlying Fund will be subject to the risks associated with
investing in the instruments described under Equity Securities.
MAS MID CAP VALUE PORTFOLIO
The MAS Mid Cap Value Portfolio seeks above-average total return over a market
cycle of three to five years by investing primarily in Equity Securities of U.S.
companies with equity capitalizations in the range of the companies represented
in the S&P MidCap 400 Index (currently from $800 million to $3 billion) that are
deemed to be undervalued. The Underlying Fund will be subject to the risks
associated with investing in the instruments described under Equity Securities.
MAS VALUE PORTFOLIO
The MAS Value Portfolio seeks above-average total return over a market cycle of
three to five years by investing primarily in Equity Securities of U.S.
companies with equity capitalizations usually greater than $300 million that are
deemed to be relatively undervalued. The Underlying Fund will be subject to the
risks associated with investing in the instruments described under Equity
Securities.
INTERNATIONAL EQUITY FUNDS
MSIF ACTIVE COUNTRY ALLOCATION PORTFOLIO
The MSIF Active Country Allocation Portfolio seeks long-term capital
appreciation by investing in Equity Securities of non-U.S. issuers which, in the
aggregate, replicate broad country indices. In addition to the general risks
associated with Equity Securities, the Underlying Fund will be subject to the
risks described under Foreign Investment. Investing in Emerging Market Country
Securities may increase these risks, but may offer superior growth
opportunities.
MSIF ASIAN EQUITY PORTFOLIO
The MSIF Asian Equity Portfolio seeks long-term capital appreciation by
investing primarily in Equity Securities that are traded on recognized stock
exchanges in Asia (excluding Japan) and in Equity Securities of companies
organized under the laws of an Asian country
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(excluding Japan) whose business is conducted principally in Asia. The
Underlying Fund will invest primarily in the more established markets in Asia.
Nevertheless, since these markets are considered to be emerging, the Underlying
Fund will be subject to the risks associated with investing in Emerging Market
Country Securities, in addition to the risks associated with Equity Securities
and Foreign Investment.
MSIF EMERGING MARKETS PORTFOLIO
The MSIF Emerging Markets Portfolio seeks long-term capital appreciation by
investing primarily in Equity Securities of emerging market country issuers. The
Underlying Fund also may invest in Fixed Income Securities, including High Yield
Securities, of issuers in emerging and developed countries. The Underlying Fund
will be subject to the risks associated with investing in Emerging Market
Country Securities, in addition to the risks associated with Equity Securities
and Foreign Investment.
MSIF EUROPEAN EQUITY PORTFOLIO
The MSIF European Equity Portfolio seeks long-term capital appreciation by
investing primarily in Equity Securities of European issuers. Investments
generally will be made in issuers located in the more developed countries in
Europe, but the Underlying Fund may also invest in the smaller and emerging
markets of Europe. In addition to the general risks associated with Equity
Securities, the Underlying Fund will be subject to the risks described under
Foreign Investment. Investing in Emerging Market Country Securities may increase
these risks, but may offer superior growth opportunities.
MSIF INTERNATIONAL EQUITY PORTFOLIO
The MSIF International Equity Portfolio seeks long-term capital appreciation by
investing primarily in the Equity Securities of non-U.S. issuers. Investments
will be made primarily in issuers domiciled in developed countries, but may also
be made in issuers domiciled in emerging markets. In addition to the general
risks associated with Equity Securities, the Underlying Fund will be subject to
the risks described under Foreign Investment. Investing in Emerging Market
Country Securities may increase these risks, but may offer superior growth
opportunities.
MSIF INTERNATIONAL MAGNUM PORTFOLIO
The MSIF International Magnum Portfolio seeks long-term capital appreciation by
investing primarily in Equity Securities of non-U.S. issuers domiciled in
countries comprising the Morgan Stanley Capital International EAFE Index, which
include Australia, Japan, New Zealand, most nations located in Western Europe
and certain developed countries in Asia. In addition to the general risks
associated with Equity Securities, the Underlying Fund will be subject to the
risks described under Foreign Investment.
MSIF JAPANESE EQUITY PORTFOLIO
The MSIF Japanese Equity Portfolio seeks long-term capital appreciation by
investing primarily in Equity Securities and, to a limited extent, Fixed Income
Securities of Japanese issuers. The Underlying Fund will be subject to the
general risks associated with Equity Securities and, to a limited extent, Fixed
Income Securities, as well as the risks described under Foreign Investment.
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MSIF LATIN AMERICAN PORTFOLIO
The MSIF Latin American Portfolio seeks long-term capital appreciation by
investing primarily in Equity Securities of Latin American issuers and also in
Fixed Income Securities issued or guaranteed by Latin American governments or
governmental entities. The Underlying Fund may invest greater than 25% of its
total assets in securities of issuers in the telecommunications or financial
services industries if the Underlying Fund's Board of Directors determines that,
in view of the importance of these sectors to the markets in one or more Latin
American countries, it is in the Underlying Fund's best interest to do so.
Certain of the Fixed Income Securities in which the Underlying Fund may invest
are High Yield Securities. The Underlying Fund focuses its investments in the
more developed markets in Latin America. Nevertheless, since these markets are
considered to be emerging, the Underlying Fund will be subject to the risks
associated with investing in Emerging Market Country Securities, in addition to
the risks associated with Equity Securities, Fixed Income Securities and Foreign
Investment.
MAS INTERNATIONAL EQUITY PORTFOLIO
The MAS International Equity Portfolio seeks above-average total return over a
market cycle of three to five years, by investing primarily in Equity Securities
of non-U.S. issuers, including issuers located in emerging markets. In addition
to the general risks associated with Equity Securities, the Underlying Fund will
be subject to the risks described under Foreign Investment. Investing in
Emerging Market Country Securities may increase these risks, but may offer
superior growth opportunities.
U.S. FIXED INCOME FUNDS
MSIF FIXED INCOME PORTFOLIO
The MSIF Fixed Income Portfolio seeks a high total return consistent with the
preservation of capital by investing primarily in a diversified portfolio of
U.S. Government Securities, Corporate Bonds, MBSs, other Fixed Income Securities
of U.S. issuers and, to a limited extent, Fixed Income Securities of non-U.S.
issuers. Short- and intermediate-term bonds form the core of the Underlying
Fund's portfolio, and long-term bonds are purchased on a short-term
opportunistic basis. In addition to the general risks associated with Fixed
Income Securities, to the extent that it invests in securities of foreign
issuers, the Underlying Fund will be subject to the risks described under
Foreign Investment.
MAS FIXED INCOME PORTFOLIO
The MAS Fixed Income Portfolio seeks above-average total return over a market
cycle of three to five years by investing primarily in a diversified portfolio
of U.S. Government Securities (including Agencies), Corporate Bonds, MBSs,
Foreign Bonds and other Fixed Income Securities. The Underlying Fund will focus
on Investment Grade Securities and investments of intermediate maturity, but may
invest in High Yield Securities to a limited extent. Average weighted maturity
will ordinarily exceed five years and will usually be between five and fifteen
years. The Underlying Fund will be subject to the general risks associated with
Fixed Income Securities and, to a lesser extent, the risks described under High
Yield Securities.
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MAS HIGH YIELD PORTFOLIO
The MAS High Yield Portfolio seeks above-average total return over a market
cycle of three to five years by investing primarily in a diversified portfolio
of High Yield Securities, including Corporate Bonds and other Fixed Income
Securities. The Underlying Fund's average weighted maturity will ordinarily
exceed five years and will usually be between five and fifteen years. The
Underlying Fund will be subject to the general risks associated with Fixed
Income Securities and the risks described under High Yield Securities.
MAS INTERMEDIATE DURATION PORTFOLIO
The MAS Intermediate Duration Portfolio seeks above-average total return over a
market cycle of three to five years, by investing primarily in a diversified
portfolio of Fixed Income Securities, including U.S. Government Securities,
Corporate Bonds and other Investment Grade Securities of U.S. and foreign
issuers. The Underlying Fund ordinarily will have a portfolio duration between
two and five years. Investments are diversified among a wide variety of
Investment Grade Fixed Income Securities in all market sectors, including MBSs.
The Underlying Fund will be subject to the general risks associated with Fixed
Income Securities.
MAS LIMITED DURATION PORTFOLIO
The MAS Limited Duration Portfolio seeks above-average total return over a
market cycle of three to five years, consistent with reasonable risk, by
investing in a diversified portfolio of Fixed Income Securities, including U.S.
Government Securities, Corporate Bonds and other Investment Grade Fixed Income
Securities. The Underlying Fund will maintain a duration of between one and
three years. The Underlying Fund will be subject to the general risks associated
with Fixed Income Securities.
MAS MORTGAGE-BACKED SECURITIES PORTFOLIO
The MAS Mortgage-Backed Securities Portfolio seeks above-average total return
over a market cycle of three to five years, by investing primarily in MBSs. The
Underlying Fund also may invest in U.S. Government Securities, and other
short-term Fixed Income Securities. The average weighted maturity ordinarily
will be greater than seven years, while the duration will generally be between
two and seven years. The Underlying Fund will be subject to the general risks
associated with Fixed Income Securities and the risks described under MBSs.
INTERNATIONAL FIXED INCOME FUND
MAS INTERNATIONAL FIXED INCOME PORTFOLIO
The MAS International Fixed Income Portfolio seeks above-average total return
over a market cycle of three to five years, by investing primarily in Investment
Grade Fixed Income Securities of foreign issuers. In addition to the general
risks associated with Fixed Income Securities, the Underlying Fund will be
subject to the risks described under Foreign Investment. Investing in Emerging
Market Country Securities may increase these risks, but may offer superior
growth opportunities.
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SECURITIES AND INVESTMENT TECHNIQUES
The following pages contain more detailed information about types of instruments
in which the Underlying Funds may invest and strategies MSAM or MAS may employ
in pursuit of an Underlying Fund's investment objective. A summary of risks and
restrictions associated with these instruments and investment practices is
included as well.
EQUITY SECURITIES. Equity Securities commonly include, but are not limited to,
Common Stocks, Preferred Stocks, Depositary Receipts, Rights, Warrants, Foreign
Equities and certain types of Structured Investments. Convertible Securities,
Preferred Stocks and Structured Investments are contained in both the definition
of Equity Securities and Fixed Income Securities because they may exhibit
characteristics commonly associated with each type of security.
Underlying Equity Funds may pursue varying management styles, particularly
growth investing and value investing. Underlying Funds that emphasize growth
investing seek to invest in Equity Securities generally characterized by higher
growth rates of revenues and earnings. These stocks tend to have higher price
volatility, higher price/earnings ratios, and lower yields than the stock market
in general.
Underlying Funds that emphasize value investing seek to invest in Equity
Securities that are undervalued relative to the stock market in general, based
on value measures such as price/earnings ratios and price/book ratios. Value
stocks are generally dividend-paying Common Stocks. However, non-dividend paying
stocks may also be selected for their value characteristics.
COMMON STOCKS. Common Stocks are Equity Securities which represent an ownership
interest in a corporation, entitling the stockholder to voting rights and
receipt of dividends paid based on proportionate ownership.
CONVERTIBLE SECURITIES. Convertible Securities are securities that may be
exchanged under certain circumstances for a fixed number of shares of Common
Stock or other Equity Securities.
DEPOSITARY RECEIPTS. Depositary Receipts are Equity Securities representing
ownership interests in securities of foreign companies (an "underlying issuer")
which are deposited with the depositary. Depositary Receipts include American
Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs"), Global
Depositary Receipts ("GDRs") and other types of Depositary Receipts (which,
together with ADRs, EDRs and GDRs, are hereinafter collectively referred to as
"Depositary Receipts").
Depositary Receipts may be "sponsored" or "unsponsored." Sponsored Depositary
Receipts are established jointly by a depositary and the underlying issuer,
whereas unsponsored Depositary Receipts may be established by a depositary
without participation by the underlying issuer. Holders of an unsponsored
Depositary Receipt generally bear all the costs associated with establishing the
unsponsored Depositary Receipt. In addition, the issuers of the securities
underlying unsponsored Depositary Receipts are not obligated to disclose
material information in the United States and, therefore, there may be less
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information available regarding such issuers and there may not be a correlation
between such information and the market value of the Depositary Receipts.
INVESTMENT COMPANY SECURITIES. Investment Company Securities are securities of
other open-end or closed-end investment companies. The 1940 Act generally
prohibits an Underlying Fund from acquiring more than 3% of the outstanding
voting shares of an investment company and limits such investments to no more
than 5% of the Underlying Fund's total assets in any one investment company and
no more than 10% in any combination of investment companies. To the extent an
Underlying Fund invests a portion of its assets in Investment Company
Securities, those assets will be subject to the expenses of the purchased
investment company as well as to the expenses of the Underlying Fund itself.
PREFERRED STOCKS. Preferred Stocks are generally non-voting securities which
evidence ownership in a corporation and which pay a fixed or variable stream of
dividends.
RIGHTS. Rights represent a preemptive right of stockholders to purchase
additional shares of a stock at the time of a new issuance, before the stock is
offered to the general public, allowing the stockholder to retain the same
ownership percentage after the new stock offering.
WARRANTS. Warrants are instruments giving holders the right, but not the
obligation, to buy shares of a company at a given price during a specified
period.
FIXED INCOME SECURITIES. Fixed Income Securities commonly include, but are not
limited to, debentures, U.S. Government Securities, Zero Coupons, Agencies,
Corporate Bonds, High Yield Securities, MBSs, SMBSs, CMOs, Asset-Backeds,
Convertible Securities, Brady Bonds, Floaters, Inverse Floaters, Money Market
Instruments, Municipals, Repurchase Agreements, Preferred Stocks, Structured
Investments and Foreign Bonds. Convertible Securities, Preferred Stocks and
Structured Investments are contained in both the definition of Equity Securities
and Fixed Income Securities since they may exhibit characteristics commonly
associated with each type of security.
MSAM and MAS may actively manage the maturity and duration structure of certain
Underlying Fixed Income Funds in anticipation of cyclical interest rate changes.
Most Fixed Income Securities provide interest (coupon) payments in addition to a
final (par) payment at maturity and some also have call provisions. Depending on
the relative magnitude of these payments and the nature of the call provisions,
the market value of Fixed Income Securities may respond differently to interest
rate changes. Traditionally, term to maturity has been used as a barometer of a
Fixed Income Security's sensitivity to interest rate changes. However, this
measure considers only the time until final payment and takes no account of the
pattern of payments prior to maturity. Duration is a more precise measure of the
expected life of a Fixed Income Security that combines consideration of yield,
coupon interest payments, final maturity and call features and measures the
expected life of a Fixed Income Security on a present value basis. The duration
of a Fixed Income Security is always shorter than its term to maturity.
AGENCIES. Agencies are securities which are not guaranteed by, or backed by the
full faith and credit of the U.S. Government, but which are issued, sponsored or
guaranteed by a
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federal agency or federally sponsored agency such as the Student Loan Marketing
Association, Resolution Funding Corporation, or any of several other agencies.
See "Money Market Instruments" below.
ASSET-BACKEDS. Asset-backed securities ("Asset-Backeds") are securities
collateralized by shorter-term loans such as automobile loans, home equity
loans, computer leases or credit card receivables. The payments from the
collateral are passed through to the security holder. The collateral behind
Asset-Backeds tends to have prepayment rates that usually do not vary with
interest rates. In addition, the short-term nature of the loans reduces the
impact of any change in prepayment level. However, it is possible that
prepayments (on automobile loans and other collateral) will alter the cash flow
on Asset-Backeds and it is not possible to determine in advance the actual final
maturity date or average life. Faster prepayment will shorten the average life
and slower prepayment will lengthen it. However, it is possible to determine
what the range of that movement could be and to calculate the effect that it
will have on the price of the security. The maturity of Asset-Backeds will be
based on the expected average life of the instrument. In selecting these
securities, the Underlying Funds will look for those securities that offer a
higher yield to compensate for any variation in average maturity.
CMOs. Collateralized Mortgage Obligations ("CMOs") are instruments which are
collateralized by mortgage pass-through securities. Cash flows from the mortgage
pass-through securities are allocated to various tranches in a predetermined,
specified order. Each tranche has a stated maturity and an average life. The
average life is typically used as a proxy for maturity because the debt is
amortized (repaid a portion at a time), rather than paid off entirely at
maturity. CMOs are subject to prepayment risk. See "MBSs" below.
CORPORATE BONDS. Corporate Bonds are Fixed Income Securities issued by
corporations. Bondholders, as creditors, have a prior legal claim over holders
of Common Stock and Preferred Stock of the corporation as to both income and
assets for the principal and interest due to the bondholder.
FLOATERS. Floaters are Fixed Income Securities with a floating or variable rate
of interest, i.e. the rate of interest varies with changes in specified market
rates or indices, such as the prime rate, or at specified intervals. Certain
Floaters may carry a demand feature that permits the holder to tender them back
to the issuer of the underlying instrument, or to a third party, at par value
prior to maturity. When the demand feature of certain Floaters represents an
obligation of a foreign entity, the demand feature will be subject to certain
risks discussed under "Foreign Investment."
HIGH YIELD SECURITIES. High Yield Securities are generally considered to
include Corporate Bonds, Preferred Stocks, Convertible Securities and other
Fixed Income Securities rated Ba through C by Moody's Investors Service, Inc.
("Moody's") or BB through D by S&P, and unrated securities considered to be of
equivalent quality. Securities rated less than Baa by Moody's or BBB by S&P are
classified as non-Investment Grade Securities and are commonly referred to as
junk bonds or high yield, high risk securities. Such securities carry a high
degree of risk and are considered speculative by the major credit rating
agencies.
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While such securities offer higher yields, they also normally carry with them a
greater degree of risk than securities with higher ratings. Lower-rated bonds
are considered speculative by traditional investment standards. Also, High Yield
Securities are often issued by smaller, less credit worthy companies, or by
highly leveraged (indebted) companies, which are generally less able than more
established or less leveraged companies to make scheduled payments of interest
and principal. The price movement of these securities is influenced less by
changes in interest rates and more by the financial and business position of the
issuing corporation when compared to Investment Grade Securities.
INVERSE FLOATERS. Inverse floating rate obligations ("Inverse Floaters") are
Fixed Income Securities which have coupon rates that vary inversely at a
multiple of a designated floating rate, such as LIBOR (London Inter-Bank Offered
Rate). Any rise in the reference rate of an Inverse Floater (as a consequence of
an increase in interest rates) causes a drop in the coupon rate while any drop
in the reference rate of an Inverse Floater causes an increase in the coupon
rate. Inverse Floaters may exhibit substantially greater price volatility than
fixed rate obligations having similar credit quality, redemption provisions and
maturity, and Inverse Floater CMOs exhibit greater price volatility than the
majority of mortgage pass-through securities or CMOs.
INVESTMENT GRADE SECURITIES. Investment Grade Securities are those rated by one
or more of the rating agencies in one of the four highest rating categories at
the time of purchase (e.g., AAA, AA, A or BBB by S&P or Fitch, or Aaa, Aa, A or
Baa by Moody's). Securities rated BBB or Baa represent the lowest of four levels
of Investment Grade Securities and are regarded as borderline between definitely
sound obligations and those in which the speculative element begins to
predominate.
LOAN PARTICIPATIONS AND ASSIGNMENTS. Loan Participations are interests in loans
or other direct debt instruments relating to amounts owed by a corporate,
governmental or other borrower to another party. They may represent interests in
amounts owed to lenders or lending syndicates, to suppliers of goods or services
(trade claims or other receivables), or to other parties. Direct debt
instruments involve the risk of loss in case of default or insolvency of the
borrower. Direct debt instruments may offer less legal protection than other
securities in the event of fraud or misrepresentation. In addition, Loan
Participations involve a risk of insolvency of the lending bank or other
financial intermediary.
An Underlying Fund may also invest in loans in the form of assignments of all or
a portion of a loan ("Assignments"). When an Underlying Fund purchases
Assignments from lenders, it will acquire direct rights against the borrower on
the loan. However, because Assignments are arranged through private negotiations
between potential assignees and potential assignors, the rights and obligations
acquired by an Underlying Fund as the purchaser of an Assignment may differ
from, and be more limited than, those held by the assigning lender. Generally,
the secondary market for Loan Participations or Assignments is relatively
illiquid. An Underlying Fund may have difficulty disposing of Loan
Participations or Assignments and the lack of a liquid secondary market may have
an adverse impact on the value of Loan Participations or Assignments.
MONEY MARKET INSTRUMENTS. Money Market Instruments are short-term, high quality
debt
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instruments that include obligations of the U.S. Government and its agencies and
instrumentalities; obligations of foreign sovereignties; obligations of the
International Bank for Reconstruction and Development; other debt securities;
commercial paper, including bank obligations; certificates of deposit (including
Eurodollar certificates of deposit and Yankee dollar obligations); and
Repurchase Agreements.
MBSs. MBSs are securities which represent pools of mortgage loans made by
lenders, such as commercial banks, savings and loan associations, mortgage
bankers and others. The pools are assembled by various governmental,
government-related and private organizations. An Underlying Fund will invest in
securities issued by the Government National Mortgage Association ("GNMA"),
Federal Home Loan Mortgage Corporation ("FHLMC"), Fannie Mae, other government
agencies, and private issuers. It is expected that such Underlying Fund's
primary emphasis will be in MBSs issued by the various government-related
organizations. Due to the possibility that prepayments on home mortgages will
alter cash flow on MBSs, it is not possible to determine in advance the actual
final maturity date or average life.
MUNICIPALS. Municipal securities ("Municipals") are debt obligations issued by
local, state and regional governments that provide interest income that is
exempt from federal income taxes. Municipals include both municipal bonds (those
securities with maturities of five years or more) and municipal notes (those
securities with maturities of less than five years). Certain industrial
development bonds also are considered municipal bonds if their interest is
exempt from federal income taxes. Industrial development bonds ordinarily are
dependent on the credit quality of a private user, not the public issuer.
REPURCHASE AGREEMENTS. Repurchase Agreements are transactions in which a
Portfolio or an Underlying Fund purchases a security and simultaneously commits
to resell that security to the seller (a bank, broker or dealer) at a mutually
agreed upon date and price. The term of these agreements is usually from
overnight to one week, and never exceeds one year. Repurchase Agreements may be
viewed as fully collateralized loans of money by the Underlying Fund to the
seller. The resale price reflects the purchase price plus an agreed upon market
rate of interest which is unrelated to the coupon rate or date of maturity of
the purchased security.
SMBSs. Stripped Mortgage-Backed Securities ("SMBSs") are multi-class mortgage
securities. SMBSs may be issued by agencies or instrumentalities of the U.S.
Government and private originators of, or investors in, mortgage loans. SMBSs
are usually structured with two classes that receive different proportions of
the interest and principal distributions on a pool of mortgage assets. In some
cases, one class will receive all of the interest ("interest-only" or "IO
class"), while the other class will receive all of the principal
("principal-only" or "PO class"). The yield to maturity on IO classes and PO
classes is extremely sensitive to the rate of principal payments (including
prepayments) on the related underlying mortgage assets, and a rapid rate of
principal repayments may have a material adverse effect on the portfolio yield
to maturity.
TEMPORARY INVESTMENTS. During periods in which MSAM or MAS believes changes in
economic, financial or political conditions make
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it advisable, each Underlying Fund may, for temporary, defensive purposes,
invest up to 100% of its total assets in certain short-term and medium-term debt
obligations or hold cash. The short-term and medium-term debt obligations in
which an Underlying Fund may invest consist of (i) obligations of the U.S. or
foreign governments, their respective agencies or instrumentalities; (ii) Money
Market Instruments; and (iii) instruments denominated in any currency issued by
international development agencies. Further, each Underlying MAS Fund may invest
in any Fixed Income Securities that it is permitted to invest in without limit
for temporary, defensive purposes.
U.S. GOVERNMENT SECURITIES. U.S. Government Securities are Fixed Income
Securities that are backed by the full faith and credit of the U.S. Government
as to the payment of both principal and interest. U.S. Government Securities may
include securities issued by the U.S. Treasury and securities issued by federal
agencies and U.S. Government sponsored instrumentalities.
ZERO COUPONS, PAY-IN-KIND SECURITIES OR DEFERRED PAYMENT SECURITIES. Zero
Coupons are Fixed Income Securities that do not make regular interest payments.
Instead, Zero Coupons are sold at substantial discounts from their face value.
The difference between a Zero Coupon's issue or purchase price and its face
value represents the imputed interest an investor will earn if the obligation is
held until maturity. However, Zero Coupon prices may exhibit greater price
volatility than ordinary Fixed Income Securities because of the manner in which
their principal and interest are returned to the investor. Pay-In-Kind
Securities are securities that have interest payable by delivery of additional
securities. Upon maturity, the holder is entitled to receive the aggregate par
value of the securities. Deferred Payment Securities are securities that remain
Zero Coupons until a predetermined date, at which time the stated coupon rate
becomes effective and interest becomes payable at regular intervals.
FOREIGN INVESTMENT. Investment in securities and obligations of foreign issuers
and in foreign branches of domestic banks involves somewhat different investment
risks from those affecting obligations of U.S. issuers. There may be limited
publicly available information with respect to foreign issuers, and foreign
issuers are not generally subject to uniform accounting, auditing and financial
standards and requirements comparable to those applicable to U.S. companies.
There may also be less government supervision and regulation of foreign
securities exchanges, brokers and listed companies than in the United States.
Many foreign securities markets have substantially less volume than U.S.
national securities exchanges, and securities of some foreign issuers are less
liquid and more volatile than securities of comparable domestic issuers.
Brokerage commissions and other transaction costs on foreign securities
exchanges are generally higher than in the United States. Dividends and interest
paid by foreign issuers may be subject to withholding and other foreign taxes,
which may decrease the net return on Foreign Investments as compared to
dividends and interest paid by U.S. companies. Additional risks include future
political and economic developments, the possibility that a foreign jurisdiction
will impose or change withholding taxes on income payable with respect to
foreign securities, and the possible adoption of foreign governmental
restrictions such as exchange controls. These risks may be
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greater in the case of Emerging Market Country Securities.
Investments in securities of foreign issuers generally are denominated in
foreign currencies. Accordingly, the value of the Underlying Fund's assets, as
measured in U.S. dollars, may be affected favorably or unfavorably by changes in
currency exchange rates and in exchange control regulations and an Underlying
Fund may incur costs in connection with conversions between various currencies.
Certain Underlying Funds may engage in Foreign Currency Transactions, to control
their exposure to foreign currency risks.
BRADY BONDS. Brady Bonds are Fixed Income Securities that are created through
the exchange of existing commercial bank loans to foreign entities for new
obligations in connection with debt restructuring. Brady Bonds have been issued
only in recent years and, accordingly, do not have a long payment history. They
may be collateralized or uncollateralized and issued in various currencies
(although most are U.S. dollar-denominated) and they are actively traded in the
over-the-counter secondary market. Investment in Brady Bonds should be viewed as
speculative in light of the history of defaults with respect to commercial bank
loans by public and private entities of countries issuing Brady Bonds.
EMERGING MARKET COUNTRY SECURITIES. An Emerging Market Country Security is a
security issued by a company that has one or more of the following
characteristics: (i) its principal securities trading market is in an emerging
market; (ii) alone or on a consolidated basis it derives 50% or more of its
annual revenue from either goods produced, sales made or services performed in
emerging markets; or (iii) it is organized under the laws of, and has a
principal office in, an emerging market country.
Emerging market describes any country which is generally considered to be an
emerging or developing country by major organizations in the international
financial community, such as the International Bank for Reconstruction and
Development (more commonly known as the World Bank) and the International
Finance Corporation. There are currently over 130 countries which are generally
considered to be emerging or developing countries by the international financial
community, approximately 40 of which currently have securities markets. Emerging
markets can include every nation in the world except the United States, Canada,
Japan, Australia, New Zealand and most nations located in Western Europe.
Investing in emerging market countries may entail purchasing securities issued
by or on behalf of entities that are insolvent, bankrupt, in default or
otherwise engaged in an attempt to reorganize or reschedule their obligations,
and in entities that have little or no proven credit rating or credit history.
With respect to any emerging market country, there is the possibility of
nationalization, expropriation or confiscatory taxation, political changes,
government regulation, social instability or diplomatic developments (including
war) that could affect adversely the economies of such countries or the value of
an Underlying Fund's investments in those countries. In addition, it may be
difficult to obtain and enforce a judgment in a court outside of the United
States.
Underlying Funds that invest in emerging markets may also be exposed to an extra
degree of custodial and/or market risk, especially where the securities
purchased are
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not traded on an official exchange or where ownership records regarding the
securities are maintained by an unregulated entity (or even the issuer itself).
FOREIGN BONDS. Foreign Bonds are Fixed Income Securities denominated in foreign
currency and issued and traded primarily outside the United States, including:
(i) obligations issued or guaranteed by foreign national governments, their
agencies, instrumentalities, or political subdivisions; (ii) Fixed Income
Securities issued, guaranteed or sponsored by supranational organizations
established or supported by several national governments, including the World
Bank, the European Community, the Asian Development Bank and others; (iii)
non-government foreign corporate debt securities; (iv) foreign MBSs and various
other MBSs and Asset-Backeds denominated in a foreign currency; and (v) Brady
Bonds.
FOREIGN CURRENCY TRANSACTIONS. Underlying Funds investing in Foreign Bonds or
Foreign Equity Securities will regularly purchase and sell securities
denominated in foreign currencies. To reduce the risks associated with investing
in securities denominated in foreign currencies, an Underlying Fund may also
enter into Foreign Currency Forward Contracts ("Forward Contracts"), foreign
currency Futures and Options on Futures and foreign currency Options.
Forward Contracts provide for the purchase or sale of an amount of a specified
currency at a future date. An Underlying Fund may use Forward Contracts to
protect against a decline in a foreign currency against the U.S. dollar, lock in
the U.S. dollar value of dividends and interest on securities held by such
Underlying Fund, and generally to protect the U.S. dollar value of portfolio
securities against exchange rate fluctuation. While Forward Contracts may limit
losses as a result of exchange rate fluctuation, they will also limit any gain
that might otherwise have been realized. An Underlying Fund may be required to
maintain cash or liquid securities in a segregated account in an amount equal to
the value of such Underlying Fund's total assets committed to the consummation
of Forward Contracts. See "Futures" and "Options."
INVESTMENT FUNDS. Some emerging market countries have laws and regulations that
currently preclude direct investment in the securities of their companies.
However, indirect investment in the securities of companies listed and traded on
the stock exchanges in these countries is permitted by certain emerging market
countries through Investment Funds that have been specifically authorized. An
Underlying Fund may invest in these Investment Funds subject to the provisions
of the 1940 Act, as applicable, and other applicable laws. The Underlying Funds
may invest, to the extent permitted under the 1940 Act and other applicable law,
in Investment Funds advised by MSAM or MAS.
DERIVATIVES. The Underlying Funds are permitted to invest in various
Derivatives for both hedging and non-hedging purposes. Derivatives include
Options, Futures, Structured Investments, Structured Notes, Caps, Floors,
Collars and Swaps. Additionally, the Underlying Funds may invest in other
Derivatives that are developed over time if their use would be consistent with
the objectives of the Underlying Funds.
CAPS, FLOORS AND COLLARS. The Underlying Funds may invest in Caps, Floors and
Collars on various rates or indices, including, but not limited to, interest
rates and the prices of equity
21
<PAGE>
securities. The buyer of a Cap pays a premium for the right to receive a payment
on specified dates if the actual rate or index, such as an actual floating
interest rate, on the relevant date exceeds a specified level (known as a
"strike rate"). The size of the payment is related to the size of the excess
over the strike rate for the amount and period of time being protected.
Similarly, the buyer of a Floor pays a premium in return for the right to
receive a payment related to the size of the deficit if an actual rate or index,
such as a floating interest rate, is below the strike rate on the specified
payment date. A Collar is a combination product in which the same party buys a
Cap and sells a Floor. In a zero-cost Collar, the premiums paid for the Cap and
received on the sale of the Floor net to zero. Since Caps, Collars and Floors
are analyzable in economic terms as Options, the risks associated with these
products are similar to those associated with Options. In addition, Caps, Floors
and Collars are privately negotiated instruments subject to the risk of
counterparty default.
FUTURES. The Underlying Funds may purchase and sell futures contracts and
options on futures contracts, including but not limited to securities index
futures, foreign currency exchange futures, interest rate futures contracts and
other financial futures (collectively, "Futures"). Futures contracts provide for
the sale by one party and purchase by another party of a specified amount of a
specific security, instrument or basket thereof, at a specific future date and
at a specified price. An option on a futures contract is a legal contract that
gives the holder the right to buy or sell a specified amount of futures
contracts at a fixed or determinable price upon the exercise of the option.
Underlying Funds will maintain liquid assets sufficient to meet their
obligations under futures contracts in a segregated account or will otherwise
comply with the SEC's requirements for asset coverage.
Gains and losses on futures contracts and options thereon depend on MSAM or
MAS's ability to predict correctly the direction of movements in securities
prices, interest rates and other economic factors. Other risks associated with
the use of futures and options are (i) imperfect correlation between the change
in market value of investments held by an Underlying Fund and the prices of
Futures and Options relating to investments purchased or sold by the Underlying
Fund; and (ii) possible lack of a liquid secondary market for a Futures contract
and the resulting inability to close a Futures position.
OPTIONS. Purchasing a put Option gives an Underlying Fund the right to sell a
specified security, currency or basket of securities or currencies at the
exercise price until the expiration of the Option. Purchasing a call Option
gives an Underlying Fund the right to purchase a specified security, currency or
basket of securities or currencies at the exercise price until the expiration of
the Option. An Underlying Fund also may write (i.e., sell) put and call Options
on investments held in its portfolio, as well as with respect to foreign
currency.
The primary risks associated with the use of Options are (i) imperfect
correlation between the change in market value of investments held, purchased or
sold by an Underlying Fund and the prices of Options relating to such
investments; (ii) possible lack of a liquid secondary market for an Option;
(iii) the risk that an Option will expire worthless; (iv) the risk that the
issuer of an over-the-counter Option will be unable to fulfill its obligation to
the Underlying Fund due to bankruptcy or related circumstances; (v) the risk
that Options may exhibit greater short-term price volatility than the underlying
security; and (vi) the risk
22
<PAGE>
that an Underlying Fund may be forced to forego participation in the
appreciation of the value of underlying securities, Futures contracts or
currency.
STRUCTURED INVESTMENTS. Structured Investments consist of one or more units
representing an undivided interest(s) in assets held in a trust that is not an
investment company as defined in the 1940 Act and which pay a return based on
the total return of securities and other instruments held by the trust.
STRUCTURED NOTES. Structured Notes are Derivatives on which the amount of
principal repayment and/or interest payments is based upon the movement of one
or more factors. These factors include, but are not limited to, currency
exchange rates, interest rates (such as the prime lending rate and LIBOR) and
stock indices such as the S&P 500 Index. In some cases, the impact of the
movements of these factors may increase or decrease through the use of
multipliers or deflators. The use of Structured Notes allows an Underlying Fund
to tailor its investments to the specific risks and returns MSAM and MAS wish to
accept while avoiding or reducing certain other risks.
SWAPS. Swap Contracts ("Swaps") are Derivatives in the form of a contract or
other similar instrument in which two parties agree to exchange the returns
generated by a security, instrument, basket thereof or index for the returns
generated by another security, instrument, basket thereof or index. The payment
streams are calculated by reference to a specific security, index or instrument
and an agreed upon notional amount. The relevant indices include, but are not
limited to, currencies, fixed interest rates, prices and total return on
interest rate indices, fixed income indices, stock indices and commodity indices
(as well as amounts derived from arithmetic operations on these indices).
The use of Swaps is a highly specialized activity which involves investment
techniques and risks different from those associated with ordinary portfolio
securities transactions. If MSAM or MAS is incorrect in its forecasts of market
values, interest rates, and currency exchange rates, the investment performance
of the Underlying Funds would be less favorable than it would have been if this
investment technique had not been used.
OTHER SECURITIES.
BORROWING AND OTHER FORMS OF LEVERAGE. Certain of the Underlying Funds are
authorized to borrow money from banks and other entities and may use the
proceeds of the borrowing for investment purposes or to pay dividends. Borrowing
will create the opportunity for increased net income but, at the same time, will
involve special risk considerations. Leverage that results from borrowing will
magnify declines as well as increases in the Underlying Fund's net asset value
per share and net yield.
LOANS OF PORTFOLIO SECURITIES. The Underlying Funds may lend securities to
brokers, dealers, domestic and foreign banks or other financial institutions for
the purpose of increasing net investment income. These loans must be secured
continuously by cash or equivalent collateral, or by a letter of credit at least
equal to the market value of the securities loaned plus accrued interest or
income. There may be a risk of delay in recovery of the securities or even loss
of rights in the collateral should the borrower of the securities fail
financially.
23
<PAGE>
NON-PUBLICLY TRADED SECURITIES, PRIVATE PLACEMENTS AND RESTRICTED
SECURITIES. The Underlying Funds may invest in securities that are neither
listed on a stock exchange nor traded over-the-counter, including privately
placed securities. Such unlisted securities may involve a higher degree of
business and financial risk that can result in substantial losses.
As a general matter, an Underlying Fund may not invest more than 15% of its net
assets in illiquid securities, including securities for which there is no
readily available secondary market and securities that are restricted from sale
to the public without registration ("Restricted Securities") under the
Securities Act of 1933, as amended (the "1933 Act") and are deemed to be
illiquid. However, the Underlying Funds may invest in Restricted Securities that
can be offered and sold to qualified institutional buyers pursuant to Rule 144A
under the 1933 Act ("Rule 144A Securities") and are deemed to be liquid under
guidelines adopted by the Underlying Fund's Board of Directors. These guidelines
delegate to MSAM or MAS the daily function of determining and monitoring the
liquidity of Rule 144A Securities. Rule 144A Securities may become illiquid if
qualified institutional buyers are not interested in acquiring the securities.
SHORT SALES. Certain of the Underlying Funds may from time to time sell
securities short, consistent with applicable legal requirements. A short sale is
a transaction in which the Underlying Fund sells securities it owns or has the
right to acquire at no added cost (i.e., "against the box") or does not own (but
has borrowed) in anticipation of a decline in the market price of the
securities. When the Underlying Fund makes a short sale, the proceeds it
receives from the sale will be held on behalf of a broker until the Underlying
Fund replaces the borrowed securities. The Underlying Fund may have to pay a
premium to borrow the securities and must pay any dividends or interest payable
on the securities until they are replaced.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. When-Issued and Delayed Delivery
Securities are securities purchased with payment and delivery taking place in
the future in order to secure what is considered to be an advantageous yield or
price at the time of the transaction. Delivery of and payment for these
securities may take as long as a month or more after the date of the purchase
commitment, but will take place no more than 120 days after the trade date. The
payment obligation and the interest rates that will be received are each fixed
at the time an Underlying Fund enters into the commitment and no interest
accrues to the Underlying Fund until settlement. Thus, it is possible that the
market value at the time of settlement could be higher or lower than the
purchase price if the general level of interest rates has changed.
UNDERLYING EQUITY FUND. An Underlying Equity Fund is an Underlying Fund that
invests primarily in Equity Securities of U.S or foreign issuers.
UNDERLYING FIXED INCOME FUND. An Underlying Fixed Income Fund is an Underlying
Fund that invests primarily in Fixed Income Securities of U.S or foreign
issuers.
FUNDAMENTAL INVESTMENT LIMITS
The investment objective of each Portfolio discussed under "The Portfolios"
above is a fundamental policy, that is, a policy subject to change only with
shareholder approval. All
24
<PAGE>
policies stated throughout this Prospectus, other than those identified as
fundamental, can be changed without shareholder approval. For additional
fundamental and non-fundamental investment limits, see "Investment Limitations"
in the SAI.
MANAGEMENT OF THE FUND
GENERAL INFORMATION
DESCRIPTION OF COMMON STOCK. The Fund was organized as a Maryland Corporation
on May 20, 1997. The Articles of Incorporation currently permit the Fund to
issue three billion shares of common stock, par value $.001 per share. Pursuant
to the Fund's By-Laws, the Board of Directors may increase the number of shares
the Fund is authorized to issue without the approval of the shareholders of the
Fund. The Board of Directors has the power to designate one or more series or
classes of shares of common stock and to classify and reclassify only unissued
shares with respect to such classes. The shares of common stock of each
Portfolio are currently divided into two classes, the Class A shares and the
Class B shares.
The shares of each Portfolio, when issued, will be fully paid, nonassessable,
fully transferrable and redeemable at the option of the holder. The shares have
no preference as to conversion, exchange, dividends, retirement or other
features and have no pre-emptive rights. The shares of each Portfolio have non-
cumulative voting rights, which means that the holders of more than 50% of the
shares voting for the election of Directors can elect 100% of the Directors if
they choose to do so. Persons or organizations owning 25% or more of the
outstanding shares of a Portfolio may be presumed to "control" (as defined in
the 1940 Act) such Portfolio.
BOARD OF DIRECTORS. Pursuant to the Fund's Articles of Incorporation, the Board
of Directors decides upon matters of general policy and reviews the actions of
the Fund's Adviser, Administrator, Distributor and other service providers. The
majority of the Fund's Directors are not affiliated with MSAM, any of its
affiliates, any of the other companies that provide services to the Fund or any
of their affiliates. The officers of the Fund conduct and supervise its daily
business operations.
REPORTS TO SHAREHOLDERS. The Fund will send to its shareholders annual and
semi-annual reports. The financial statements appearing in annual reports are
audited by independent accountants. Monthly unaudited portfolio data is also
available from the Fund upon request.
SHAREHOLDER MEETINGS. The Fund will generally not hold annual shareholder
meetings, but may call special meetings when required by law, when requested by
a sufficient number of shareholders or for other reasons.
INVESTMENT MANAGEMENT
INVESTMENT ADVISER. MSAM, as Adviser, allocates the Portfolios' investments in
the Underlying Funds within the ranges set forth herein. MSAM does not receive a
fee for serving as investment adviser to the Portfolios. MSAM also advises
certain of the Underlying Funds. The remaining Underlying Funds are advised by
MAS.
25
<PAGE>
MSAM, with principal offices at 1221 Avenue of the Americas, New York, New York
10020, conducts a worldwide investment management business, providing a broad
range of portfolio management services to customers in the United States and
abroad, and serves as investment adviser to numerous open-end and closed-end
investment companies. MAS, with principal offices at One Tower Bridge, West
Conshohocken, Pennsylvania 19428, provides investment advisory services to
employee benefit plans, endowment funds, foundations and other institutional
investors, and serves as investment adviser to several open-end investment
companies. MSAM and MAS are both registered investment advisers under the
Investment Advisers Act of 1940, as amended, and MSAM and MAS are both
subsidiaries, and part of the worldwide investment advisory business, of Morgan
Stanley, Dean Witter, Discover & Co., a global financial services company. As of
October 31, 1997, MSAM and MAS, together with their other affiliated
institutional investment advisory companies, had assets under management,
including assets under fiduciary advisory control, totaling approximately $144
billion. See "Management of the Fund" in the SAI.
PORTFOLIO MANAGER. The following individual has primary responsibility for the
Portfolios.
FRANCINE J. BOVICH. Francine Bovich joined MSAM in 1993 and is currently a
Managing Director. She is responsible for product development, portfolio
management and communication of MSAM's asset allocation strategy to
institutional investor clients. Previously, Ms. Bovich was a Principal and
Executive Vice President of Westwood Management Corp. She holds a B.A. in
Economics from Connecticut College and an M.B.A. in Finance from New York
University. Ms. Bovich has had primary responsibility for managing the
Portfolio's assets since inception.
OTHER SERVICES
DISTRIBUTOR. Morgan Stanley & Co. Incorporated ("Morgan Stanley") serves as the
exclusive Distributor of the shares of the Fund. Under its Distribution
Agreement with the Fund, Morgan Stanley sells shares of each Portfolio upon the
terms and at the current offering price described in this Prospectus. Morgan
Stanley is not obligated to sell any certain number of shares of any Portfolio.
The Portfolios currently offer only the classes of shares offered by this
Prospectus. The Portfolios may in the future offer one or more classes of shares
with features, distribution expenses or other expenses that are different from
those of the classes currently offered.
The Fund has adopted a Plan of Distribution with respect to the Class B shares
for each Portfolio, pursuant to Rule 12b-1 under the 1940 Act (each, a "Plan").
Under each Plan, the Distributor is entitled to receive compensation from the
Portfolios, which is accrued daily and paid quarterly, equal to 0.25% of the
Class B shares' average daily net assets on an annualized basis. Each Plan is
designed to compensate the Distributor for its services in connection with
distribution assistance. The Distributor may retain any portion of the fee that
it does not expend in meeting its obligations to the Fund. The Distributor may
compensate financial intermediaries, plan fiduciaries and administrators for
providing distribution-related services, including account maintenance services,
to shareholders (including, where applicable, underlying beneficial owners) of
26
<PAGE>
Class B shares. The Distributor may, in its discretion, voluntarily waive from
time to time all or a portion of its compensation and each of the Distributor
and the Adviser is free to make payments out of its own assets to promote the
sale of Fund shares, including payments that compensate financial institutions
for distribution services or shareholder services.
ADMINISTRATION. The Adviser also provides administrative services to the Fund,
subject to the supervision of the officers and the Board of Directors of the
Fund. The Fund pays the Adviser a monthly fee which on an annual basis equals
0.15% of the average daily net assets of each Portfolio. The Chase Manhattan
Bank ("Chase") provides certain administrative services to the Fund through its
corporate affiliate, Chase Global Funds Services Company ("CGFSC"). The Adviser
supervises and monitors administrative services provided by CGFSC and
compensates CGFSC. Their services are also subject to the supervision of the
Board of Directors of the Fund. CGFSC's business address is 73 Tremont Street,
Boston, Massachusetts 02108-3913.
CUSTODIAN. Chase serves as the Custodian of the securities and cash of the
Portfolios. Chase is not an affiliate of either MSAM or Morgan Stanley.
DIVIDEND DISBURSING AND TRANSFER AGENT. CGFSC acts as dividend disbursing and
transfer agent for the Fund.
INDEPENDENT ACCOUNTANTS. Price Waterhouse LLP serves as independent accountants
for the Fund and will audit the annual financial statements of each Portfolio.
LEGAL COUNSEL. Morgan, Lewis & Bockius LLP serves as legal counsel to the Fund.
FUND EXPENSES
The Portfolios pay fees and other costs related to their daily operations.
Expenses paid out of a Portfolio's assets are reflected in its share price. Each
Portfolio pays an administration fee to MSAM for managing its business affairs.
MSAM pays fees to affiliates who provide assistance with these services. Each
Portfolio also pays other expenses, which are explained below. MSAM may, from
time to time, reduce its fees or reimburse the Portfolios for expenses above a
specified limit. These fee reductions or expense reimbursements, which may be
terminated at any time without notice, can decrease a Portfolio's expenses and
boost its performance.
OTHER EXPENSES. Each Portfolio pays all expenses not assumed by MSAM. Such
expenses include or could include investment-related expenses, such as brokers'
commissions, transfer taxes and fees related to the purchase, sale, or loan of
securities; fees and expenses for Directors not affiliated with MSAM; fees and
expenses of its independent accountants and legal counsel; costs of Directors
and shareholder meetings; Securities and Exchange Commission ("SEC") fees;
expenses of preparing and filing registration statements; the cost of providing
proxy statements, prospectuses and statements of additional information to
existing shareholders; expenses of preparing and printing the annual and
semiannual shareholder reports; bank transaction charges and certain custodians'
fees and expenses; federal, state or local income or other taxes; costs of
maintaining the Fund's corporate existence; membership fees for the Investment
Company Institute and similar organizations; fidelity bond and Directors'
liability insurance premiums; and any
27
<PAGE>
extraordinary expenses such as indemnification payments or damages awarded in
litigation or settlements made.
UNDERLYING FUND EXPENSES. Each Portfolio will invest primarily in Underlying
Funds. The Portfolios' shareholders will not only bear their proportionate share
of the expenses of the Portfolios, but also will indirectly bear similar
expenses of the Underlying Funds. MSAM will allocate the Portfolios' investments
in Underlying Funds in the manner believed to best enable each Portfolio to meet
its investment objective. Because the advisory fees paid to MSAM or MAS by the
Underlying Funds vary, however, the fees paid to MSAM or MAS would increase if
MSAM allocated a greater portion of the Portfolios' investments to Underlying
Funds with higher advisory fees. Set forth below for each of the Underlying
Funds in which the Portfolios initially intend to invest are the advisory fees,
other expenses and total operating expenses (i) of the MSIF Underlying Funds for
the fiscal year ended December 31, 1996; and (ii) of the MAS Underlying Funds
for the fiscal year ended September 30, 1997.
<TABLE>
<CAPTION>
TOTAL
ADVISORY OTHER OPERATING
UNDERLYING FUND FEE EXPENSES EXPENSES
- ------------------------ ----------- ----------- -----------
<S> <C> <C> <C>
U.S. Equity Funds:
MSIF Equity Growth
Portfolio 0.52% 0.28% 0.80%*
MSIF U.S. Equity Plus
Portfolio+ 0.34% 0.46% 0.80%*
MSIF U.S. Real Estate
Portfolio 0.66% 0.34% 1.00%*
MAS Mid Cap Growth
Portfolio 0.50% 0.13% 0.63%
MAS Mid Cap Value
Portfolio 0.71% 0.17% 0.88%*
MAS Value Portfolio 0.50% 0.12% 0.62%
International Equity
Funds:
MSIF Active Country
Allocation Portfolio 0.36% 0.44% 0.80%*
<CAPTION>
TOTAL
ADVISORY OTHER OPERATING
UNDERLYING FUND FEE EXPENSES EXPENSES
- ------------------------ ----------- ----------- -----------
<S> <C> <C> <C>
MSIF Asian Equity
Portfolio 0.55% 0.45% 1.00%*
MSIF Emerging Markets
Portfolio 1.25% 0.49% 1.74%*
MSIF European Equity
Portfolio 0.64% 0.36% 1.00%*
MSIF International
Equity Portfolio 0.78% 0.22% 1.00%*
MSIF International
Magnum Portfolio 0.26% 0.74% 1.00%*
MSIF Japanese Equity
Portfolio 0.73% 0.27% 1.00%*
MSIF Latin American
Portfolio 0.62% 1.08% 1.70%
MAS International
Equity Portfolio 0.50% 0.16% 0.66%
U.S. Fixed Income Funds:
MSIF Fixed Income
Portfolio 0.20% 0.25% 0.45%*
MAS Fixed Income
Portfolio 0.38% 0.10% 0.48%
MAS High Yield
Portfolio 0.38% 0.13% 0.51%
MAS Intermediate
Duration Portfolio 0.30% 0.22% 0.52%*
MAS Limited Duration
Portfolio 0.29% 0.13% 0.42%*
MAS Mortgage-Backed
Securities Portfolio 0.34% 0.16% 0.50%*
International Fixed
Income Fund:
MAS International
Fixed Income
Portfolio 0.38% 0.15% 0.53%
</TABLE>
- ------------
* MSAM and MAS each have voluntarily agreed to a reduction in the fees payable
to them and/or to reimburse certain Underlying Funds, if necessary, if payment
of advisory fees would cause the total annual operating expenses of these
Underlying Funds to exceed certain maximums. Each of MSAM and MAS reserve the
right to terminate any of their fee waivers and/or expense reimbursements at
any time in their sole discretion.
+ Expenses for the MSIF U.S. Equity Plus Portfolio are based on estimates
because the Underlying Fund has only recently become operational.
28
<PAGE>
PERFORMANCE OF THE PORTFOLIOS
Each Portfolio's total return and yield may be quoted in advertising.
Performance is based on historical results and is not intended to indicate
future performance of the Portfolios.
TOTAL RETURN. Total return is the change in value of an investment in a
Portfolio over a given period, assuming reinvestment of any dividends and
capital gains. A CUMULATIVE TOTAL RETURN reflects actual performance over a
stated period of time. An AVERAGE ANNUAL TOTAL RETURN is a hypothetical rate of
return that, if achieved annually, would have produced the same cumulative total
return if performance had been constant over the entire period. Average annual
total returns smooth out variations in performance; they are not the same as
actual year-by-year results.
Average annual total returns covering periods of less than one year assume that
performance will remain constant for the rest of the year.
YIELD. Yield refers to the income generated by an investment in a Portfolio
over a given period of time, expressed as an annual percentage rate. When a
yield assumes that income is reinvested, it is called an effective yield.
PERFORMANCE OF THE UNDERLYING FUNDS
MSAM and MAS manage portfolios of MSIF and MAS Funds, respectively, which serve
as the Underlying Funds of the Portfolios.
Past investment performance of the Underlying Funds, as shown in the table
below, is provided to indicate the experience of MSAM and MAS in managing the
Underlying Funds and may be relevant to your consideration of the Portfolios.
However, the past investment performance of the Underlying Funds should not be
considered to be indicative of future performance of the Underlying Funds or the
Portfolios. Investors should consider that, because each Portfolio will invest
in varying combinations of Underlying Funds, the performance of a Portfolio will
reflect the combined performance of the Underlying Funds in which it invests and
will be affected by the varying allocation of investments in Underlying Funds.
Moreover, in addition to the expenses borne by each Underlying Fund, the
Portfolios will incur their own direct expenses. Accordingly, the investment
performance of the Portfolios will be less than the weighted average of the
returns of the Underlying Funds in which they invest.
<TABLE>
<CAPTION>
Average Average
Total Return Total Return Total Return Annual Total Annual Total Average
One Year Five Years Ten Years Return Five Return Ten Annual Total
Inception Ended Ended Ended Years Ended Years Ended Return Since
Fund Name Date 12/31/96+ 12/31/96+ 12/31/96+ 12/31/96+ 12/31/96+ Inception+
- ------------------------------ --------- ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
U.S. EQUITY FUNDS:
MSIF Equity Growth
Portfolio................... 4/2/91 30.97% 119.19% NA 16.99% NA 17.06%
MSIF U.S. Equity Plus
Portfolio................... 8/1/97 NA NA NA NA NA NA
MSIF U.S. Real Estate
Portfolio................... 2/24/95 39.56% NA NA NA NA 32.73%
MAS Mid Cap Growth
Portfolio................... 3/30/90 18.79% 86.31% NA 13.25% NA 19.11%
MAS Mid Cap Value Portfolio... 12/30/94 40.77% NA NA NA NA 36.62%
MAS Value Portfolio........... 11/5/84 27.63% 140.12% 333.56% 19.15% 15.80% 17.57%
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
Average Average
Total Return Total Return Total Return Annual Total Annual Total Average
One Year Five Years Ten Years Return Five Return Ten Annual Total
Inception Ended Ended Ended Years Ended Years Ended Return Since
Fund Name Date 12/31/96+ 12/31/96+ 12/31/96+ 12/31/96+ 12/31/96+ Inception+
- ------------------------------ --------- ------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
INTERNATIONAL EQUITY FUNDS:
MSIF Active Country Allocation
Portfolio................... 1/17/92 9.71% NA NA NA NA 8.71%
MSIF Asian Equity Portfolio... 7/1/91 3.49% 142.14% NA 19.35% NA 18.28%
MSIF Emerging Markets
Portfolio................... 9/25/92 12.19% NA NA NA NA 12.93%
MSIF European Equity
Portfolio................... 4/2/93 22.29% NA NA NA NA 19.62%
MSIF International Equity
Portfolio................... 8/4/89 19.64% 113.75% NA 16.41% NA 11.96%
MSIF International Magnum
Portfolio................... 3/15/96 8.25%* NA NA NA NA NA
MSIF Japanese Equity
Portfolio................... 4/25/94 (1.40)% NA NA NA NA (2.51)%
MSIF Latin American
Portfolio................... 1/18/95 48.77% NA NA NA NA 16.98%
MAS International Equity
Portfolio................... 11/25/88 10.38% 45.17% NA 7.74% NA 8.22%
U.S. FIXED INCOME FUNDS:
MSIF Fixed Income Portfolio... 5/15/91 4.61% 40.26% NA 7.00% NA 8.35%
MAS Fixed Income Portfolio.... 11/14/84 7.36% 49.18% 143.25% 8.33% 9.30% 11.03%
MAS High Yield Portfolio...... 2/28/84 15.29% 96.04% NA 14.41% NA 11.66%
MAS Intermediate Duration
Portfolio................... 10/3/94 5.94% NA NA NA NA 9.12%
MAS Limited Duration
Portfolio................... 3/31/92 5.27% NA NA NA NA 5.91%
MAS Mortgage-Backed Securities
Portfolio................... 1/31/92 5.78% NA NA NA NA 7.17%
INTERNATIONAL FIXED INCOME
FUND:
MAS International Fixed Income
Portfolio................... 4/29/94 6.20% NA NA NA NA 9.87%
</TABLE>
- -------------
* Cumulative (unannualized) total return since inception.
+ Performance information is for the Underlying Funds in which the Portfolios
will invest: Class A shares of the investment portfolios of MSIF and the
Institutional Class shares of the investment portfolios of MAS Funds.
Average annual total return since inception is through December 31, 1996.
Note that all performance numbers are net of fee waivers and expense
reimbursements.
ACCOUNT POLICIES
DISTRIBUTIONS AND TAXES
The following summary of certain federal income tax consequences is based on
current tax laws and regulations, which may be changed by legislative, judicial,
or administrative action.
No attempt has been made to present a detailed explanation of the federal,
state, or local income tax treatment of the Portfolios or their shareholders.
Accordingly, shareholders are urged to consult their tax advisers regarding
specific questions as to federal, state and local income taxes.
Each Portfolio is treated as a separate entity for federal income tax purposes
and is not combined with the Fund's other portfolios. Each Portfolio intends to
qualify for the special tax treatment afforded regulated investment companies
under Subchapter M of the Code, so that each Portfolio will be relieved of
federal income tax on that part of its net investment income and net capital
gain that is distributed to shareholders.
Each Portfolio intends to distribute substantially all of its taxable net
investment income (including, for this purpose, the excess of net short-term
capital gain over net long-term capital loss) to shareholders. Dividends from
each Portfolio's net investment income are taxable to shareholders as ordinary
income, whether received in cash or in additional shares. Such dividends paid by
each Portfolio may qualify
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for the dividends-received deduction for corporate shareholders to the extent of
qualifying dividend income received by each Portfolio from U.S. corporations.
Each Portfolio will report annually to its shareholders the amount of dividend
income qualifying for such treatment.
Distributions of net capital gains (the excess of net long-term capital gain
over net short-term capital loss) are taxable to shareholders as gain from the
sale of assets held for more than one year, regardless of how long the
shareholder has held each Portfolio's shares. Each Portfolio will send reports
annually to shareholders of the federal income tax status of all distributions
made during the preceding year.
Each Portfolio intends to make sufficient distributions or deemed distributions
of its ordinary income and capital gain net income (the excess of short-term and
long-term capital gain over short-term and long-term capital loss, including any
available capital loss carryforwards), prior to the end of each calendar year to
avoid liability for federal excise tax.
Dividends and other distributions declared by each Portfolio in October,
November or December of any year and payable to shareholders of record on a date
in such month will be deemed to have been paid by each Portfolio and received by
the shareholders in that year if the distributions are paid by each Portfolio at
any time during the following January.
Each Portfolio may be required to withhold and remit to the U.S. Treasury 31% of
any dividends, capital gains distributions and redemption proceeds paid to any
individual or certain other non-corporate shareholder (i) who has failed to
provide a correct taxpayer identification number (generally an individual's
social security number or non-individual's employer identification number); (ii)
who is subject to backup withholding by the Internal Revenue Service; or (iii)
who has not certified to the Fund that such shareholder is not subject to backup
withholding. This backup withholding is not an additional tax, and any amounts
withheld may be credited against the shareholder's ultimate U.S. tax liability.
The sale, redemption or exchange of shares will result in taxable gain or loss
to the selling, redeeming or exchanging shareholder, depending upon whether the
fair market value of the sale, redemption or exchange proceeds exceed or is less
than the shareholder's adjusted basis in the sold, redeemed or exchanged shares.
If capital gain distributions have been made with respect to shares that are
sold at a loss after being held for six months or less, then the loss is treated
as a long-term capital loss to the extent of the capital gain distributions.
Conversion of shares between classes should not be a taxable event to the
shareholder.
IRAs and participants in tax-qualified retirement plans generally will not be
subject to federal tax liability on either dividend and capital gain
distributions from the Portfolios or redemption of shares of the Portfolios.
Rather, participants in such plans will be taxed when they begin taking
distributions from their IRAs and/or the plans. There are various restrictions
under the Code on eligibility, contributions and withdrawals, depending on the
type of tax-deferred account or tax-qualified retirement plan. The rules
governing tax-deferred accounts and tax-qualified retirement plans are complex,
and failure to comply with the governing rules
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and regulations may result in a substantial cost to you, including the loss of
tax advantages and the imposition of additional taxes and penalties by the IRS.
You should consult with a tax professional on the specific rules governing your
own plan.
THE TAX DISCUSSION SET FORTH ABOVE IS INCLUDED FOR GENERAL INFORMATION ONLY.
PROSPECTIVE INVESTORS SHOULD CONSULT THEIR OWN TAX ADVISERS WITH RESPECT TO THE
TAX CONSEQUENCES TO THEM OF AN INVESTMENT IN THE FUND.
TRANSACTION DETAILS
The Portfolios are open for business each day the New York Stock Exchange
("NYSE") is open. Each Portfolio's net asset value ("NAV") is determined as of
the close of business of the NYSE (normally 4:00 p.m. Eastern Time) on each day
that the NYSE is open for business. The NYSE is currently scheduled to be closed
on New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day,
and on the preceding Friday or subsequent Monday when any of these holidays
falls on a Saturday or Sunday, respectively.
Each Portfolio's NAV is the value of a single share. The NAV is computed by
adding the value of the Portfolio's investments, cash and other assets,
subtracting its liabilities, and then dividing the result by the number of
shares outstanding.
Each Portfolio's investments are valued primarily on the basis of the NAVs of
the Underlying Funds and market quotations. If quotations are not readily
available or if the values have been materially affected by events occurring
after the closing of a foreign market, assets are valued by a method that the
Fund's Board of Directors believes accurately reflects fair value.
Each Portfolio's offering price (price to buy one share) and redemption price
(price to sell one share) are its NAV.
Each Portfolio reserves the right to suspend the offering of shares for a period
of time. Each Portfolio also reserves the right to reject any specific order.
Purchase orders may be refused if, in the Adviser's opinion, they would disrupt
management of a Portfolio.
Although the legal rights of Class A and Class B shares are identical, the
different expenses borne by each class will result in different net asset values
and dividends. The net asset value of Class B shares generally will be lower
than the net asset value of Class A shares as a result of the Rule 12b-1 fee
charged to Class B shares. It is expected, however, that the net asset value per
share of the two classes will tend to converge immediately after the recording
of dividends, which will differ by approximately the amount of the distribution
expense accrual differential between the classes.
In the interest of economy and convenience, and because of the operating
procedures of the Fund, certificates representing shares of the Portfolio will
not be issued. All shares purchased are confirmed to shareholders and credited
to each shareholder's account on the Fund's books maintained by the Adviser or
its agents. Shareholders will have the same rights and ownership with respect to
such shares as if certificates had been issued.
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INVESTMENTS AND REDEMPTIONS
Class A shares and Class B shares of each Portfolio may be purchased, without
sales commission, at the net asset value per share next determined after receipt
of the purchase order by the Portfolio. Investors in Class B shares will be
subject to an additional Rule 12b-1 fee at the annual rate of 0.25% of the
average daily value of their shares. This additional fee will be paid by each
Portfolio to the Distributor to compensate the Distributor for its services in
connection with distribution assistance. The Distributor expects to compensate
plan administrators for services provided to various retirement and deferred
compensation plans in connection with investments by such plans in Class B
shares.
Shares of the Portfolios are currently offered only to participants in various
retirement and deferred compensation plans whose plan sponsors or plan
administrators have made arrangements with the Fund to offer such shares to
participants. Such plan participants should refer to materials provided by their
plan sponsor or plan administrator for information on how to invest in and
redeem shares of the Portfolios.
Plan sponsors and plan administrators who have made arrangements with the Fund
will receive orders from their plan participants to purchase or redeem shares of
the Portfolios, generally on each business day. That night, all orders received
by that plan sponsor or plan administrator prior to the close of the NYSE on
that business day are aggregated, and the plan sponsor or plan administrator
places a net purchase and/or redemption order(s) for shares of the Portfolios on
the morning of the next business day. These orders are normally executed at the
NAV that was computed for each Portfolio as of the close of the previous
business day.
Plan sponsors and plan administrators who choose not to enter into arrangements
of the type described above will need to transmit orders for receipt by the Fund
prior to the close of the NYSE in order for those orders to be executed at the
NAV computed for that business day.
Redemption proceeds will normally be wired to the plan sponsor or plan
administrator on the next business day after receipt of the redemption
instructions by the Fund, but in no event later than seven days following
receipt of such instructions. The Fund may suspend redemptions or postpone
payment dates on days when the NYSE is closed (other than weekends or holidays),
when trading on the NYSE is restricted or as permitted by the SEC.
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NO DEALER, SALES REPRESENTATIVE OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS, OTHER THAN THOSE CONTAINED
IN THIS PROSPECTUS, IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS AND, IF
GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON
AS HAVING BEEN AUTHORIZED BY THE FUND OR THE DISTRIBUTOR. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER BY THE FUND OR THE DISTRIBUTOR TO SELL OR A SOLICITATION
OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO
ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION IN SUCH
JURISDICTION.
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TABLE OF CONTENTS
<TABLE>
<S> <C>
PAGE
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Fund Expenses........................... 3
The Portfolios.......................... 5
The Underlying Funds.................... 9
Securities and Investment Techniques.... 14
Fundamental Investment Limits........... 24
Management of the Fund.................. 25
Account Policies........................ 30
</TABLE>
STRATEGIC ADVISER CONSERVATIVE PORTFOLIO
STRATEGIC ADVISER MODERATE PORTFOLIO
STRATEGIC ADVISER AGGRESSIVE PORTFOLIO
PORTFOLIOS OF THE
MORGAN STANLEY
STRATEGIC ADVISER FUND, INC.
Common Stock
($.001 PAR VALUE)
-------------
PROSPECTUS
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Morgan Stanley
Asset Management Inc.
Miller Anderson &
Sherrerd, LLP
Distributor
Morgan Stanley & Co.
Incorporated
MORGAN STANLEY
STRATEGIC ADVISER FUND, INC.
P.O. BOX 2798, BOSTON, MA 02208-2798
- ---------------------------------------
- ---------------------------------------
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<PAGE>
MORGAN STANLEY STRATEGIC ADVISER FUND, INC.
P.O. BOX 2798, BOSTON, MA 02208-2798
STATEMENT OF ADDITIONAL INFORMATION
Morgan Stanley Strategic Adviser Fund, Inc. (the "Fund") is a no-load,
open-end management investment company with Class A and Class B shares of three
series ("Portfolios"). Each Portfolio offers to investors a distinct risk/return
profile by investing primarily in different combinations of Class A shares of
various investment portfolios of Morgan Stanley Institutional Fund, Inc. and
Institutional Class shares of various investment portfolios of MAS Funds
("Underlying Funds"). Class A and Class B shares of each Portfolio are offered
with no sales charge, exchange or redemption fee. The Portfolios are advised by
Morgan Stanley Asset Management Inc. ("MSAM" or the "Adviser"). Morgan Stanley &
Co. Incorporated ("Morgan Stanley") is the distributor of the Fund's shares. The
Underlying Funds are managed by either MSAM or Miller Anderson & Sherrerd, LLP
("MAS"), an affiliate of MSAM.
This Statement of Additional Information addresses information about the
Fund applicable to each of the Portfolios and certain information regarding the
Underlying Funds. The Fund was incorporated under the laws of the State of
Maryland on May 20, 1997. The Fund has filed a registration statement with the
Securities and Exchange Commission (the "SEC") registering itself as an open-end
management investment company under the Investment Company Act of 1940, as
amended (the "1940 Act"), and its shares under the Securities Act of 1933, as
amended (the "1933 Act").
This Statement of Additional Information is not a prospectus, but should be
read in conjunction with the prospectus for the Fund's Portfolios (the
"Prospectus"). This Statement of Additional Information is incorporated by
reference into the Prospectus in its entirety. To obtain the Prospectus, please
contact the Fund.
STATEMENT OF ADDITIONAL INFORMATION DATED DECEMBER 10, 1997 RELATING TO
PROSPECTUS DATED DECEMBER 10, 1997.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
THE UNDERLYING FUNDS.................... 2
SECURITIES AND INVESTMENT TECHNIQUES.... 3
CERTAIN FEDERAL INCOME TAX
CONSEQUENCES........................... 18
PURCHASE OF SHARES...................... 19
REDEMPTION OF SHARES.................... 20
INVESTMENT LIMITATIONS.................. 20
MANAGEMENT OF THE FUND.................. 21
PORTFOLIO TRANSACTIONS.................. 24
PERFORMANCE INFORMATION................. 24
GENERAL INFORMATION..................... 31
DESCRIPTION OF CERTAIN SECURITIES
RATINGS................................ 31
FINANCIAL STATEMENTS.................... 33
APPENDIX A.............................. 34
</TABLE>
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THE UNDERLYING FUNDS
Each Portfolio will invest primarily in shares of Underlying Funds, which
are investment portfolios of Morgan Stanley Institutional Fund, Inc. ("MSIF") or
MAS Funds and are advised by MSAM or MAS, respectively. The Portfolios currently
intend to invest in various combinations of the following Underlying Funds:
EQUITY:
U.S. Equity Funds:
MSIF Equity Growth Portfolio
MSIF U.S. Equity Plus Portfolio
MSIF U.S. Real Estate Portfolio
MAS Mid Cap Growth Portfolio
MAS Mid Cap Value Portfolio
MAS Value Portfolio
International Equity Funds:
MSIF Active Country Allocation Portfolio
MSIF Asian Equity Portfolio
MSIF Emerging Markets Portfolio
MSIF European Equity Portfolio
MSIF International Equity Portfolio
MSIF International Magnum Portfolio
MSIF Japanese Equity Portfolio
MSIF Latin American Portfolio
MAS International Equity Portfolio
FIXED INCOME:
U.S. Fixed Income Funds:
MSIF Fixed Income Portfolio
MAS Fixed Income Portfolio
MAS High Yield Portfolio
MAS Intermediate Duration Portfolio
MAS Limited Duration Portfolio
MAS Mortgage-Backed Securities Portfolio
International Fixed Income Funds:
MAS International Fixed Income Portfolio
The Portfolios, at the discretion of the Adviser and without shareholder
approval, reserve the right to invest in additional Underlying Funds that are
currently offered or that may be offered in the future. A complete listing of
Underlying Funds currently available for investment by the Portfolios, along
with their investment objectives, is included in Appendix A to this Statement of
Additional Information.
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SECURITIES AND INVESTMENT TECHNIQUES
The following discussion of certain securities and investment techniques
supplements the discussion of investment policies, securities and investment
techniques of the Portfolios and Underlying Funds set forth in the Fund's
Prospectus:
EQUITY SECURITIES
DEPOSITARY RECEIPTS. Depositary Receipts are Equity Securities representing
ownership interests in securities of foreign companies and include American
Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs") and Global
Depositary Receipts ("GDRs"). Depositary Receipts are not necessarily
denominated in the same currency as the underlying securities. ADRs are
dollar-denominated Depositary Receipts typically issued by a U.S. financial
institution which evidence ownership interests in a security or pool of
securities issued by a foreign issuer. ADRs are listed and traded in the United
States. GDRs, EDRs and other types of Depositary Receipts are typically issued
by foreign banks or trust companies, although they also may be issued by U.S.
financial institutions, and evidence ownership interests in a security or pool
of securities issued by either a foreign or a U.S. corporation. Generally,
Depositary Receipts in registered form are designed for use in the U.S.
securities market and Depositary Receipts in bearer form are designed for use in
securities markets outside the United States.
FIXED INCOME SECURITIES
The value of Fixed Income Securities held by each Underlying Fund generally
will vary inversely to changes in prevailing interest rates. Each Underlying
Fund's investments in fixed rate Fixed Income Securities with longer terms to
maturity are subject to greater volatility than the Underlying Fund's
investments in shorter-term obligations. Debt obligations acquired at a discount
are subject to greater fluctuations of market value in response to changing
interest rates than debt obligations of comparable maturities which are not
subject to such discount. Most Fixed Income Securities provide interest (coupon)
payments in addition to a final (par) payment at maturity. Some securities also
have call provisions. Depending on the relative magnitude of these payments and
the nature of the call provisions, the market values of Fixed Income Securities
may respond differently to changes in the level and structure of interest rates.
One of the strategies MSAM and MAS may use to manage the Underlying Funds'
investments in Fixed Income Securities is Duration management. Duration is a
measure of the expected life of a Fixed Income Security on a present value basis
that was developed as a more precise alternative to the concept of
term-to-maturity. Underlying Funds investing in Fixed Income Securities actively
manage their portfolio maturity and duration in anticipation of cyclical
interest rate changes. Adjustments are not made in an effort to capture
short-term, day-to-day movements in the market, but instead are implemented in
anticipation of longer-term shifts in the levels of interest rates. Adjustments
made to shorten Portfolio maturity and duration are made to limit capital losses
during periods when interest rates are expected to rise. Conversely, adjustments
made to lengthen maturity and duration are intended to produce capital
appreciation in periods when interest rates are expected to fall. The foundation
for maturity and duration strategy lies in analysis of the U.S. and global
economies, focusing on levels of real interest rates, monetary and fiscal policy
actions, and cyclical indicators.
Duration incorporates a Fixed Income Security's yield, coupon interest
payments, final maturity and call features into one measure. Duration takes the
length of the time intervals between the present time and the time that the
interest and principal payments are scheduled or, in the case of a callable
bond, expected to be received, and weights them by the present values of the
cash to be received at each future point in time. For any Fixed Income Security
with interest payments occurring prior to the payment of principal, duration is
always less than maturity. In general, all other factors being the same, the
lower the stated or coupon rate of interest of a Fixed Income Security, the
longer the duration of the security; conversely, the higher the stated or coupon
rate of interest of a Fixed Income Security, the shorter the duration of the
security. However, there are some situations where even the standard duration
calculation does not properly reflect the interest rate exposure of a security.
For example, floating rate securities often have final maturities of ten or more
years; however, their interest rate exposure corresponds to the frequency of the
coupon reset. Another example where the interest rate exposure is not properly
captured by duration is the case of mortgage pass-through securities. The stated
final maturity of such securities is generally 30 years, but current prepayment
rates are more critical in determining the securities' interest rate exposure.
In these and other similar situations, MSAM or MAS's analysis of interest rate
exposure incorporates the economic life of a security.
BRADY BONDS. Certain Underlying Funds may invest in Fixed Income Securities
customarily referred to as "Brady Bonds," which are created through the exchange
of existing commercial bank loans to foreign entities for new obligations in
connection with debt restructuring under a plan introduced by former U.S.
Secretary of the Treasury Nicholas F. Brady. Brady Bonds have been issued only
in recent years and, accordingly, do not have a long payment history. They may
be collateralized or uncollateralized and issued in various currencies (although
most are U.S. dollar-denominated) and they are actively traded in the over-the-
counter secondary market. An Underlying Fund may purchase Brady Bonds either in
the primary or secondary markets. The price and yield of Brady Bonds purchased
in the secondary market will reflect the market conditions at the time of
purchase, regardless of the stated face amount and the stated interest rate.
With respect to Brady Bonds with no or limited collateralization, each
Underlying Fund will rely for payment of interest and principal primarily on the
willingness and ability of the issuing government to make payment in accordance
with the terms of the bonds.
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U.S. dollar-denominated, collateralized Brady Bonds may be fixed rate par
bonds or floating rate discount bonds and are generally collateralized in full
as to principal due at maturity by U.S. Treasury zero coupon obligations which
have the same maturity as the Brady Bonds. Interest payments on these Brady
Bonds generally are collateralized by cash or securities in an amount that, in
the case of fixed rate bonds, is equal to at least one year of rolling interest
payments or, in the case of floating rate bonds, initially is equal to at least
one year's rolling interest payments based on the applicable interest rate at
that time and is adjusted at regular intervals thereafter. Certain Brady Bonds
are entitled to "value recovery payments" in certain circumstances, which in
effect constitute supplemental interest payments but generally are not
collateralized. Brady Bonds are often viewed as having three or four valuation
components: (i) the collateralized repayment of principal at final maturity;
(ii) the collateralized interest payments; (iii) the uncollateralized interest
payments; and (iv) any uncollateralized repayment of principal at maturity
(these uncollateralized amounts constitute the "residual risk"). In the event of
a default with respect to collateralized Brady Bonds as a result of which the
payment obligations of the issuer are accelerated, the U.S. Treasury zero coupon
obligations held as collateral for the payment of principal will not be
distributed to investors, nor will such obligations be sold and the proceeds
distributed. The collateral will be held to the scheduled maturity of the
defaulted Brady Bonds by the collateral agent, at which time the face amount of
the collateral will equal the principal payments which would have then been due
on the Brady Bonds in the normal course.
CASH EQUIVALENTS. Cash Equivalents are short-term Fixed Income Securities
comprising:
(1) Time deposits, certificates of deposit (including marketable variable
rate certificates of deposit) and bankers' acceptances issued by a commercial
bank or savings and loan association. Time deposits are non-negotiable deposits
maintained in a banking institution for a specified period of time at a stated
interest rate. Certificates of deposit are negotiable short-term obligations
issued by commercial banks or savings and loan associations against funds
deposited in the issuing institution. Variable rate certificates of deposit are
certificates of deposit on which the interest rate is periodically adjusted
prior to their stated maturity based upon a specific market rate. A bankers'
acceptance is a time draft drawn on a commercial bank by a borrower, usually in
connection with an international commercial transaction (to finance the import,
export, transfer or storage of goods).
Underlying Funds may invest in obligations of U.S. banks, obligations of
foreign branches of U.S. banks ("Eurodollars") and obligations of U.S. branches
of foreign banks ("Yankee dollars"). Investments in Eurodollars and Yankee
dollars involve some of the same risks of investing in international securities
that are discussed in "Foreign Investment" below.
Underlying Funds will not invest in any security issued by a commercial bank
unless (i) the bank has total assets of at least $1 billion, or the equivalent
in other currencies, or, in the case of domestic banks which do not have total
assets of at least $1 billion, the aggregate investment made in any one such
bank is limited to $100,000 and the principal amount of such investment is
insured in full by the Federal Deposit Insurance Corporation ("FDIC"); (ii) in
the case of a U.S. bank, it is a member of the FDIC; and (iii) in the case of a
foreign branch of a U.S. bank, the security is deemed to be of an investment
quality comparable with other Fixed Income Securities which may be purchased by
the Underlying Fund.
(2) Commercial paper rated at time of purchase by one or more NRSROs in one
of their two highest categories, (e.g., A-1 or A-1+ by the Standard & Poor's
Rating Group ("S&P") or Prime 1 by Moody's Investors Service, Inc. ("Moody's")
or, if not rated, issued by a corporation having an outstanding unsecured debt
issue rated high-grade by an NRSRO (e.g., A or better by Moody's, S&P, or Fitch
Investors Service, Inc. ("Fitch")).
(3) Short-term corporate obligations rated high-A or better by Moody's,
S&P, or Fitch.
(4) U.S. Governments and Agencies.
(5) Repurchase Agreements collateralized by securities listed above.
EURODOLLAR AND YANKEE DOLLAR OBLIGATIONS. The Underlying Funds may invest
in Eurodollar and Yankee dollar obligations. Eurodollar bank obligations are
dollar-denominated certificates of deposit and time deposits issued outside the
U.S. capital markets by foreign branches of U.S. banks and by foreign banks.
Yankee dollar bank obligations are dollar-denominated obligations issued in the
U.S. capital markets by foreign banks.
Eurodollar and Yankee dollar obligations are subject to the same risks that
pertain to domestic issues, notably credit risk, market risk and liquidity risk.
Additionally, Eurodollar (and to a limited extent, Yankee dollar) obligations
are subject to certain sovereign risks. One such risk is the possibility that a
sovereign country might prevent capital, in the form of dollars, from flowing
across their borders. Other risks include adverse political and economic
developments; the extent and quality of government regulation of financial
markets and institutions; the imposition of foreign withholding taxes; and the
expropriation or nationalization of foreign issuers.
LOAN PARTICIPATIONS AND ASSIGNMENTS. The Underlying Funds may invest in
loans and other direct debt instruments which are interests in amounts owed by
corporate, governmental or other borrowers ("Loans") to third parties
("Lenders"). They may represent amounts owed to lenders or lending syndicates,
to suppliers of goods or services (trade claims or other receivables), or to
other parties. An Underlying Fund's investments in Loans are expected in most
instances to be in the form of participations in Loans ("Participations") and
assignments of all or portions of Loans ("Assignments") from third parties. Each
Underlying
4
<PAGE>
Fund's investment in Participations typically will result in each Underlying
Fund having a contractual relationship only with the Lender and not with the
borrower. Each Underlying Fund will have the right to receive payments of
principal, interest and any fees to which it is entitled only from the Lender
selling the Participation and only upon receipt by the Lender of the payments
from the borrower. In connection with purchasing Participations, each Underlying
Fund generally will have no right to enforce compliance by the borrower with the
terms of the loan agreement relating to the Loan, nor any rights of set-off
against the borrower, and each Underlying Fund may not directly benefit from any
collateral supporting the Loan in which it has purchased the Participation. As a
result, each Underlying Fund may be subject to the credit risk of both the
borrower and the Lender that is selling the Participation. In the event of the
insolvency of the Lender selling a Participation, each Underlying Fund may be
treated as a general creditor of the Lender and may not benefit from any set-off
between the Lender and the borrower. Certain Participations may be structured in
a manner designed to avoid purchasers of Participations being subject to the
credit risk of the Lender with respect to the Participation, but even under such
a structure, in the event of the Lender's insolvency, the Lender's servicing of
the Participation may be delayed and the assignability of the Participation
impaired. Each Underlying Fund will acquire Participations only if the Lender
interpositioned between the Underlying Fund and the borrower is determined by
MSAM or MAS to be creditworthy. Certain Underlying Funds that invest in foreign
securities may invest in fixed and floating rate Loans arranged through private
negotiations between an issuer of sovereign debt obligations and one or more
financial institutions.
When an Underlying Fund purchases Assignments from Lenders it will acquire
direct rights against the borrower on the Loan. Because Assignments are arranged
through private negotiations between potential assignees and potential
assignors, however, the rights and obligations acquired by each Underlying Fund
as the purchaser of an Assignment may differ from, and be more limited than,
those held by the assigning Lender. The assignability of certain sovereign debt
obligations is restricted by the governing documentation as to the nature of the
assignee, such that the only way in which an Underlying Fund may acquire an
interest in a Loan is through a Participation and not an Assignment. An
Underlying Fund may have difficulty disposing of Assignments and Participations
because to do so it will have to assign such securities to a third party.
Because the secondary market for such securities is relatively illiquid, the
Underlying Funds anticipate that such securities could be sold only to a limited
number of institutional investors. The lack of a liquid secondary market may
have an adverse impact on the value of such securities and each Underlying
Fund's ability to dispose of particular Assignments or Participations when
necessary to meet each Underlying Fund's liquidity needs or in response to a
specific economic event, such as a deterioration in the creditworthiness of the
borrower. The possible lack of a liquid secondary market for Assignments and
Participations also may make it more difficult for each Underlying Fund to
assign a value to these securities for purposes of valuing the Underlying Fund's
securities and calculating its net asset value. To the extent that an Underlying
Fund invests in them, investment in Assignments or Participations will be
monitored pursuant to liquidity guidelines and will be subject to the Underlying
Fund's investment policies concerning illiquid securities.
Direct debt instruments involve the risk of loss in case of default or
insolvency of the borrower. Direct debt instruments may offer less legal
protection to an Underlying Fund in the event of fraud or misrepresentation and
may involve a risk of insolvency of the lending bank or other financial
intermediary. Direct debt instruments also may include standby financing
commitments that obligate the investing Underlying Fund to supply additional
cash to the borrower on demand. Further, Participations involving emerging
market country issuers may relate to Loans as to which there has been or
currently exists an event of default or other failure to make payment when due,
and may represent amounts owed to financial institutions that are themselves
subject to political and economic risks, including the risk of currency
devaluation, expropriation, or failure. Such Participations present additional
risk of default or loss.
MORTGAGE RELATED SECURITIES. Mortgage related securities are securities
that, directly or indirectly, represent a participation in, or are secured by
and payable from, mortgage loans on real property. Mortgage related securities
include Collateralized Mortgage Obligations and Mortgage-Backed Securities
issued or guaranteed by agencies or instrumentalities of the U.S. Government or
by private sector entities. At times it is anticipated that a substantial
portion of an Underlying Fixed Income Fund's assets may be invested in mortgage
related securities.
COLLATERALIZED MORTGAGE OBLIGATIONS. Collateralized Mortgage Obligations
("CMOs") are debt obligations or multiclass pass-through certificates issued by
agencies or instrumentalities of the U.S. government or by private originators
or investors in mortgage loans. They are backed by Mortgage-Backed Securities
(discussed below) or whole loans (all such assets, the "Mortgage Assets") and
are evidenced by a series of bonds or certificates issued in multiple classes.
Each class of a CMO, often referred to as a "tranche," may be issued with a
specific fixed or floating coupon rate and has a stated maturity or final
scheduled distribution date. The principal and interest on the underlying
Mortgage Assets may be allocated among the several classes of a series of CMOs
in many ways. Interest is paid or accrues on CMOs on a monthly, quarterly or
semi-annual basis.
CMOs may be issued by agencies or instrumentalities of the U.S. Government,
or by private originators of, or investors in, mortgage loans, including savings
and loan associations, mortgage bankers, commercial banks, investment banks and
special purpose subsidiaries of the foregoing. CMOs that are issued by private
sector entities and are backed by assets lacking a guarantee of an entity having
the credit status of a governmental agency or instrumentality are generally
structured with one or
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more types of credit enhancement as described below. An issuer of CMOs may elect
to be treated, for federal income tax purposes, as a Real Estate Mortgage
Investment Conduit (a "REMIC"). An issuer of CMOs issued after 1991 must elect
to be treated as a REMIC or it will be taxable as a corporation under rules
regarding taxable mortgage pools.
The principal of and interest on the Mortgage Assets may be allocated among
the several classes of a CMO in many ways. The general goal in allocating cash
flows on Mortgage Assets to the various classes of a CMO is to create certain
tranches on which the expected cash flows have a higher degree of predictability
than the underlying Mortgage Assets. As a general matter, the more predictable
the cash flow is on a particular CMO tranche, the lower the anticipated yield
will be on that tranche at the time of issuance relative to prevailing market
yields on Mortgage Assets. As part of the process of creating more predictable
cash flows on certain tranches of a CMO, one or more tranches generally must be
created that absorb most of the changes in the cash flows on the underlying
Mortgage Assets. The yields on these tranches are generally higher than
prevailing market yields on other mortgage related securities with similar
average lives. Principal prepayments on the underlying Mortgage Assets may cause
the CMOs to be retired substantially earlier than their stated maturities or
final scheduled distribution dates. Because of the uncertainty of the cash flows
on these tranches, the market prices of and yields on these tranches are more
volatile. In addition, some inverse floating rate obligation CMOs exhibit
extreme sensitivity to changes in prepayments. As a result, the yield to
maturity of these CMOs is sensitive not only to changes in interest rates, but
also to changes in prepayment rates on the related underlying Mortgage Assets.
Included within the category of CMOs are PAC Bonds. PAC Bonds are a type of
CMO tranche or series designed to provide relatively predictable payments of
principal provided that, among other things, the actual prepayment experience on
the underlying mortgage loans falls within a predefined range. If the actual
prepayment experience on the underlying mortgage loans is at a rate faster or
slower than the predefined range or if deviations from other assumptions occur,
principal payments on the PAC Bond may be earlier or later than predicted. The
magnitude of the predefined range varies from one PAC Bond to another; a
narrower range increases the risk that prepayments on the PAC Bond will be
greater or smaller than predicted. Because of these features, PAC Bonds
generally are less subject to the risks of prepayment than are other types of
mortgage related securities.
MORTGAGE-BACKED SECURITIES. With Mortgage-Backed Securities ("MBSs"), many
mortgagees' monthly payments to their lending institution are pooled together
and passed through to investors such as an Underlying Fund. The pools are
assembled by various governmental, Government-related and private organizations.
An Underlying Fund may invest in securities issued or guaranteed by Government
National Mortgage Association ("GNMA" or "Ginnie Mae"), Federal Home Loan
Mortgage Corporation ("FHLMC" or "Freddie Mac"), Fannie Mae, private issuers and
other government agencies. There can be no assurance that the private issuers
can meet their obligations under the policies. MBSs issued by non-agency
issuers, whether or not such securities are subject to guarantees, may entail
greater risk. If there is no guarantee provided by the issuer, MBSs purchased by
an Underlying Fund will be those which at the time of purchase are rated
investment grade by one or more nationally recognized statistical rating
organizations ("NRSRO") or, if unrated, are deemed by MSAM or MAS to be of
comparable quality.
MBSs are issued or guaranteed by private sector originators of or investors
in mortgage loans and are structured similarly to governmental pass-through
securities. Because private pass-throughs typically lack a guarantee by an
entity having the credit status of a governmental agency or instrumentality,
they are generally structured with one or more types of credit enhancement
described below. Fannie Mae and FHLMC obligations are not backed by the full
faith and credit of the U.S. Government as GNMA certificates are, but Fannie Mae
and FHLMC securities are supported by the instrumentalities' right to borrow
from the U.S. Treasury. Each of GNMA, Fannie Mae and FHLMC guarantees timely
distributions of interest to certificate holders. Each of GNMA and Fannie Mae
also guarantees timely distributions of scheduled principal. FHLMC has in the
past guaranteed only the ultimate collection of principal of the underlying
mortgage loan; however, FHLMC has now issued MBSs (FHLMC Gold PCS) which also
guarantee timely payment of monthly principal reductions. Resolution Funding
Corporation ("REFCORP") obligations are backed, as to principal payments, by
zero coupon U.S. Treasury bonds, and as to interest payment, ultimately by the
U.S. Treasury. Obligations issued by such U.S. Governmental agencies and
instrumentalities are described more fully below.
There are two methods of trading MBSs. A specified pool transaction is a
trade in which the pool number of the security to be delivered on the settlement
date is known at the time the trade is made. This is in contrast with the
typical MBS transaction, called a TBA (to be announced) transaction, in which
the type of MBS to be delivered is specified at the time of trade but the actual
pool numbers of the securities that will be delivered are not known at the time
of the trade. The pool numbers of the pools to be delivered at settlement will
be announced shortly before settlement takes place. The terms of the TBA trade
may be made more specific if desired. Generally, agency pass-through MBSs are
traded on a TBA basis.
Like Fixed Income Securities in general, MBSs will generally decline in
price when interest rates rise. Due to prepayment risk, rising interest rates
also tend to discourage refinancings of home mortgages, with the result that the
average life of MBSs held by an Underlying Fund may be lengthened. This
extension of average life causes the market price of the MBSs to decrease
further than if their average lives were fixed. However, when interest rates
fall, mortgages may not enjoy as large a gain in market value due to prepayment
risk because additional mortgage prepayments must be reinvested at lower
interest rates. Faster prepayment will shorten the average life and slower
prepayments will lengthen it. However, it is possible to determine what the
range of that movement could be and to calculate the effect that it will have on
the price of the MBS. In selecting these MBSs,
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MSAM or MAS will look for those that offer a higher yield to compensate for any
variation in average maturity. If the underlying mortgage assets experience
greater than anticipated prepayments of principal, an Underlying Fund may fail
to fully recoup its initial investment in these securities, even if the security
is in one of the highest rating categories. An Underlying Fund may invest,
without limit, in MBSs issued by private issuers when MSAM or MAS deems that the
quality of the investment, the quality of the issuer, and market conditions
warrant such investments. Securities issued by private issuers will be rated
investment grade by Moody's or S&P or be deemed by MSAM or MAS to be of
comparable investment quality.
FANNIE MAE CERTIFICATES. Fannie Mae is a federally chartered and privately
owned corporation organized and existing under the Federal National Mortgage
Association Charter Act of 1938. The obligations of Fannie Mae are not backed by
the full faith and credit of the U.S. Government.
Each Fannie Mae Certificate represents a pro rata interest in one or more
pools of mortgage loans insured by the Federal Housing Administration under the
Housing Act, or Title V of the Housing Act of 1949 ("FHA Loans"), or guaranteed
by the Department of Veterans Affairs under the Servicemen's Readjustment Act of
1944, as amended ("VA Loans") or conventional mortgage loans (i.e., mortgage
loans that are not insured or guaranteed by any governmental agency) of the
following types: (i) fixed rate level payment mortgage loans; (ii) fixed rate
growing equity mortgage loans; (iii) fixed rate graduated payment mortgage
loans; (iv) variable rate California mortgage loans; (v) other adjustable rate
mortgage loans; and (vi) fixed rate and adjustable mortgage loans secured by
multi-family projects.
FREDDIE MAC CERTIFICATES. Freddie Mac is a corporate instrumentality of the
United States created pursuant to the Emergency Home Finance Act of 1970, as
amended (the "FHLMC Act"). The obligations of Freddie Mac are obligations solely
of Freddie Mac and are not backed by the full faith and credit of the U.S.
Government.
Freddie Mac Certificates represent a pro rata interest in a group of
mortgage loans (a "Freddie Mac Certificate group") purchased by Freddie Mac. The
mortgage loans underlying the Freddie Mac Certificates consist of fixed rate or
adjustable rate mortgage loans with original terms to maturity of between ten
and thirty years, substantially all of which are secured by first liens on
one-to four-family residential properties or multi-family projects. Each
mortgage loan must meet the applicable standards set forth in the FHLMC Act. A
Freddie Mac Certificate group may include whole loans, participation interests
in whole loans and undivided interests in whole loans and participations
comprising another Freddie Mac Certificate group.
GINNIE MAE CERTIFICATES. Ginnie Mae is a wholly-owned corporate
instrumentality of the United States within the Department of Housing and Urban
Development. The National Housing Act of 1934, as amended (the "Housing Act"),
authorizes Ginnie Mae to guarantee the timely payment of the principal of and
interest on certificates that are based on and backed by a pool of FHA Loans, VA
Loans or by pools of other eligible mortgage loans. The Housing Act provides
that the full faith and credit of the U.S. Government is pledged to the payment
of all amounts that may be required to be paid under any guaranty. In order to
meet its obligations under such guaranty, Ginnie Mae is authorized to borrow
from the U.S. Treasury with no limitations as to amount.
Each Ginnie Mae Certificate represents a pro rata interest in one or more of
the following types of mortgage loans: (i) fixed rate level payment mortgage
loans; (ii) fixed rate graduated payment mortgage loans; (iii) fixed rate
growing equity mortgage loans; (iv) fixed rate mortgage loans secured by
manufactured (mobile) homes; (v) mortgage loans on multi-family residential
properties under construction; (vi) mortgage loans on completed multi-family
projects; (vii) fixed rate mortgage loans as to which escrowed funds are used to
reduce the borrower's monthly payments during the early years of the mortgage
loans ("buydown" mortgage loans); (viii) mortgage loans that provide for
adjustments in payments based on periodical changes in interest rates or in
other payment terms of the mortgage loans; and (ix) mortgage-backed serial
notes. All of these mortgage loans will be FHA Loans or VA Loans and, except as
otherwise specified above, will be fully-amortizing loans secured by first liens
on one- to four-family housing units.
CREDIT ENHANCEMENT. Mortgage related securities are often backed by a pool
of assets representing the obligations of a number of different parties. To
lessen the effect of failure by obligors on underlying assets to make payments,
such securities may contain elements of credit support. Such credit support
falls into two categories: (i) liquidity protection and (ii) protection against
losses resulting from ultimate default by an obligor on the underlying assets.
Liquidity protection generally refers to the provision of advances, typically by
the entity administering the pool of assets, to ensure that the pass-through of
payments due on the underlying pool occurs in a timely fashion. Protection
against losses resulting from ultimate default enhances the likelihood of
ultimate payment of the obligations on at least a portion of the assets in the
pool. Such protection may be provided through guarantees, insurance policies or
letters of credit obtained by the issuer or sponsor from third parties (referred
to herein as "third party credit support"), through various means of structuring
the transaction or through a combination of such approaches.
The ratings of mortgage related securities for which third party credit
enhancement provides liquidity protection or protection against losses from
default are generally dependent upon the continued creditworthiness of the
provider of the credit enhancement. The ratings of such securities could be
subject to reduction in the event of deterioration in the creditworthiness of
the credit enhancement provider even in cases where the delinquency and loss
experience on the underlying pool of assets is better than expected.
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Examples of credit support arising out of the structure of the transaction
include "senior-subordinated securities" (multiple class securities with one or
more classes subordinate to other classes as to the payment of principal and
interest thereon, with defaults on the underlying assets being borne first by
the holders of the most subordinated class), creation of "reserve funds" (where
cash or investments, sometimes funded from a portion of the payments on the
underlying assets, are held in reserve against future losses) and
"over-collateralization" (where the scheduled payments on, or the principal
amount of, the underlying assets exceed those required to make payment of the
securities and pay any servicing or other fees). The degree of credit support
provided for each security is generally based on historical information with
respect to the level of credit risk associated with the underlying assets.
Delinquency or loss in excess of that which is anticipated could adversely
affect the return on an investment in such a security.
REPURCHASE AGREEMENTS. Each Underlying Fund may invest in Repurchase
Agreements collateralized by liquid, unencumbered assets, the value of which is
marked to market daily. Repurchase Agreements are transactions by which an
Underlying Fund purchases a security and simultaneously commits to resell that
security to the seller (a bank or securities dealer) at an agreed upon price on
an agreed upon date (usually within seven days of purchase). The resale price
reflects the purchase price plus an agreed upon market rate of interest which is
unrelated to the coupon rate or date of maturity of the purchased security. In
these transactions, the securities purchased by an Underlying Fund have a total
value in excess of the value of the Repurchase Agreement and are held by the
Underlying Fund's custodian bank until repurchased. Such agreements permit an
Underlying Fund to keep all its assets at work while retaining "overnight"
flexibility in pursuit of investments of a longer-term nature. MSAM, MAS and the
Underlying Fund's administrator will continually monitor the value of the
underlying securities to ensure that their value always equals or exceeds the
repurchase price.
The use of Repurchase Agreements involves certain risks. For example, if the
seller of the agreements defaults on its obligation to repurchase the underlying
securities at a time when the value of these securities has declined, an
Underlying Fund may incur a loss upon disposition of them. If the seller of the
agreement becomes insolvent and subject to liquidation or reorganization under
the Bankruptcy Code or other laws, a bankruptcy court may determine that the
underlying securities are collateral not within the control of an Underlying
Fund and therefore subject to sale by the trustee in bankruptcy. Finally, it is
possible that an Underlying Fund may not be able to substantiate its interest in
the underlying securities. While the Fund's management acknowledges these risks,
it is expected that they can be controlled through stringent security selection
criteria and careful monitoring procedures.
U.S. GOVERNMENT SECURITIES. The term "U.S. Government securities" refers to
a variety of securities which are issued or guaranteed by the U.S. Government,
and by various instrumentalities which have been established or sponsored by the
U.S. Government.
U.S. Treasury securities are backed by the "full faith and credit" of the
United States. Securities issued or guaranteed by Federal agencies and U.S.
Government sponsored instrumentalities may or may not be backed by the full
faith and credit of the United States. In the case of securities not backed by
the full faith and credit of the United States, the investor must look
principally to the agency or instrumentality issuing or guaranteeing the
obligation for ultimate repayment, and may not be able to assert a claim against
the United States itself in the event the agency or instrumentality does not
meet its commitment. Agencies which are backed by the full faith and credit of
the United States include the Export-Import Bank, Farmers Home Administration,
Federal Financing Bank, and others. Certain agencies and instrumentalities, such
as GNMA, are, in effect, backed by the full faith and credit of the United
States through provisions in their charters that they may make "indefinite and
unlimited" drawings on the Treasury, if needed to service debt. Debt from
certain other agencies and instrumentalities, including the Federal Home Loan
Bank and Fannie Mae, are not guaranteed by the United States, but those
institutions are protected by the discretionary authority for the U.S. Treasury
to purchase certain amounts of their securities to assist the institution in
meeting its debt obligations. However, the U.S. Treasury has no lawful
obligation to assume the financial liabilities of these agencies or others.
Finally, other agencies and instrumentalities, such as the Farm Credit System
and FHLMC, are federally chartered institutions under Government supervision,
but their debt securities are backed only by the creditworthiness of those
institutions, not the U.S. Government.
Some of the U.S. Government agencies that issue or guarantee securities
include the Export-Import Bank of the United States, Farmers Home
Administration, Federal Housing Administration, Maritime Administration, Small
Business Administration, and the Tennessee Valley Authority.
An instrumentality of the U.S. Government is a Government agency organized
under Federal charter with Government supervision. Instrumentalities issuing or
guaranteeing securities include, among others, Federal Home Loan Banks, the
Federal Land Banks, Central Bank for Cooperatives, Federal Immediate Credit
Banks, and Fannie Mae.
ZERO COUPONS. The Underlying Funds may invest in zero coupon bonds ("Zero
Coupons"). Zero Coupons are Fixed Income Securities that have been stripped of
their unmatured interest coupons, or the coupons themselves, but may also be
receipts or certificates representing interests in such stripped debt
obligations and coupons. With respect to U.S. Governments, as defined in the
Prospectus, the timely payment of coupon interest and principal on these
instruments remains guaranteed by the full faith and credit of the U.S.
Government.
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Zero Coupons do not pay interest. Instead, a Zero Coupon is issued at a
substantial discount to its "face value" (what it will be worth at maturity).
The difference between the security's issue or purchase price and its face value
represents the accreted interest an investor will earn if the security is held
until maturity. For tax purposes, a portion of this accreted interest is deemed
to be income received by Zero Coupon bondholders each year. The Underlying
Funds, which expect to qualify as regulated investment companies, intend to pass
along such interest as a component of an Underlying Fund's distributions of net
investment income.
Zero Coupons may offer investors the opportunity to earn higher yields than
those available on U.S. Treasury bonds of similar maturity. However, Zero Coupon
prices also may exhibit greater price volatility than ordinary Fixed Income
Securities because of the manner in which their principal and interest is
returned to the investor.
With respect to U.S. Government Securities, Zero Coupons are sold under a
variety of different names, such as: Certificate of Accrual on Treasury
Securities (CATS), Treasury Receipts (TRs), Separate Trading of Registered
Interest and Principal of Securities (STRIPS) and Treasury Investment Growth
Receipts (TIGERS).
FOREIGN INVESTMENT
Certain of the Underlying Funds will invest in securities of foreign
issuers. Investors should recognize that investing in such foreign securities
involves certain special considerations which are not typically associated with
investing in U.S. issuers. As foreign issuers are not generally subject to
uniform accounting, auditing and financial reporting standards and may have
policies that are not comparable to those of domestic issuers, there may be less
information available about certain foreign companies than about domestic
issuers. Securities of some foreign issuers are generally less liquid and more
volatile than securities of comparable domestic issuers. There is generally less
government supervision and regulation of stock exchanges, brokers and listed
issuers than in the U.S. In addition, with respect to certain foreign countries,
there is the possibility of expropriation or confiscatory taxation, political or
social instability, or diplomatic developments which could affect U.S.
investments in those countries.
Although the Underlying Funds will endeavor to achieve the most favorable
execution costs in their portfolio transactions, fixed commissions on many
foreign stock exchanges are generally higher than negotiated commissions on U.S.
exchanges.
Certain foreign governments levy withholding or other taxes on dividend and
interest income. Although in some countries a portion of these taxes are
recoverable, the non-recovered portion of foreign withholding taxes will reduce
the income received from investments in such countries. Neither an Underlying
Fund nor the Portfolios may be able to claim a credit for U.S. tax purposes with
respect to any such foreign taxes.
Prior governmental approval for Foreign Investments may be required under
certain circumstances in some emerging countries, and the extent of Foreign
Investment in certain Fixed Income Securities and domestic companies may be
subject to limitation in other emerging countries. Foreign ownership limitations
also may be imposed by the charters of individual companies in emerging
countries to prevent, among other concerns, violation of Foreign Investment
limitations. Repatriation of investment income, capital and the proceeds of
sales by foreign investors may require governmental registration and/or approval
in some emerging countries. An Underlying Fund could be adversely affected by
delays in, or a refusal to grant, any required governmental registration or
approval for such repatriation. Any investment subject to such repatriation
controls will be considered illiquid if it appears reasonably likely that this
process will take more than seven days.
EMERGING MARKET COUNTRY SECURITIES. MSAM's and MAS's approach to investing
in Emerging Market Country Securities is based on their evaluation of both
short-term and long-term international economic trends and the relative
attractiveness of emerging markets and individual emerging market securities.
The Underlying Funds' definition of Emerging Market Country Equity Securities or
Fixed Income Securities includes securities of companies that may have
characteristics and business relationships common to companies in a country or
countries other than an emerging market country. As a result, the value of the
securities of such companies may reflect economic and market forces applicable
to other countries, as well as to an emerging market country. MSAM and MAS
believe, however, that investment in such companies will be appropriate because
each Underlying Fund will invest only in those companies which, in its view,
have sufficiently strong exposure to economic and market forces in an emerging
market country such that their value will tend to reflect developments in such
emerging market country to a greater extent than developments in another country
or countries. For example, these Underlying Funds may invest in companies
organized and located in countries other than an emerging market country,
including companies having their entire production facilities outside of an
emerging market country, when securities of such companies meet one or more
elements of the Underlying Fund's definition of an Emerging Market Country
Equity Security or Fixed Income Security and so long as MSAM or MAS believe at
the time of investment that the value of the company's securities will reflect
principally conditions in such emerging market country. MSAM or MAS will base
determinations as to eligibility on publicly available information and inquiries
made to the companies.
The economies of individual emerging market countries may differ favorably
or unfavorably from the U.S. economy in such respects as growth of gross
domestic product, rate of inflation, currency depreciation, capital
reinvestment, resource self-sufficiency and balance of payments position.
Further, the economies of developing countries generally are heavily dependent
upon international trade and, accordingly, have been, and may continue to be,
adversely affected by trade barriers, exchange
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controls, managed adjustments in relative currency values and other
protectionist measures imposed or negotiated by the countries with which they
trade. These economies also have been, and may continue to be, adversely
affected by economic conditions in the countries with which they trade.
Investments in emerging market country government Fixed Income Securities
involve special risks. Certain emerging market countries have historically
experienced, and may continue to experience, high rates of inflation, high
interest rates, exchange rate fluctuations, large amounts of external debt,
balance of payments and trade difficulties and extreme poverty and unemployment.
The issuer or governmental authority that controls the repayment of an emerging
market country's debt may be unable or unwilling to repay the principal and/or
interest when due in accordance with the terms of such debt. As a result of the
foregoing, a government obligor may default on its obligations. If such an event
occurs, the Underlying Fund may have limited legal recourse against the issuer
and/or guarantor. Remedies must, in some cases, be pursued in the courts of the
defaulting party itself, and the ability of the holder of foreign government
Fixed Income Securities to obtain recourse may be subject to the political
climate in the relevant country. In addition, no assurance can be given that the
holders of commercial bank debt will not contest payments to the holders of
other foreign government debt obligations in the event of default under their
commercial bank loan agreements.
FOREIGN CURRENCY TRANSACTIONS. The U.S. dollar value of the assets of the
Underlying Funds may be affected favorably or unfavorably by changes in foreign
currency exchange rates and exchange control regulations, and an Underlying Fund
may incur costs in connection with conversions between various currencies. The
Underlying Funds will conduct their foreign currency exchange transactions
either on a spot (i.e., cash) basis at the spot rate prevailing in the foreign
currency exchange market, or through entering into forward contracts to purchase
or sell foreign currencies ("Forwards" or "forward contracts") and foreign
currency futures contracts.
A forward contract involves an obligation to purchase or sell a specific
currency at a future date, which may be any fixed number of days from the date
of the contract agreed upon by the parties, at a price set at the time of the
contract. These contracts are traded in the interbank market conducted directly
between currency traders (usually large commercial banks) and their customers.
The Underlying Funds generally will not enter into a forward contract with a
term greater than one year. A forward contract generally has no deposit
requirement, and no commissions are charged at any stage for such trades.
The Underlying Funds may enter into forward contracts in several
circumstances. When an Underlying Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, or when an Underlying
Fund anticipates the receipt in a foreign currency of dividends or interest
payments on a security which it holds, the Underlying Fund may desire to
"lock-in" the U.S. dollar price of the security or the U.S. dollar equivalent of
such dividend or interest payment, as the case may be. By entering into a
forward contract for a fixed amount of dollars, for the purchase or sale of the
amount of foreign currency involved in the underlying transactions, each
Underlying Fund will be able to protect itself against a possible loss resulting
from an adverse change in the relationship between the U.S. dollar and the
subject foreign currency during the period between the date on which the
security is purchased or sold, or on which the dividend or interest payment is
declared, and the date on which such payments are made or received.
Additionally, when any of the Underlying Funds anticipates that the currency
of a particular foreign country may suffer a substantial decline against the
U.S. dollar, it may enter into a forward contract for a fixed amount of dollars,
to sell the amount of foreign currency approximating the value of some or all of
such Underlying Fund's securities denominated in such foreign currency. The
precise matching of the forward contract amounts and the value of the securities
involved generally will not be possible since the future value of securities in
foreign currencies will change as a consequence of market movements in the value
of these securities between the date on which the forward contract is entered
into and the date it matures. The projection of short-term currency market
movement is extremely difficult, and the successful execution of a short-term
hedging strategy is highly uncertain. None of the Underlying Funds intend to
enter into such forward contracts to protect the value of portfolio securities
on a continuous basis.
An Underlying Fund also may combine forward contracts with investments in
securities denominated in other currencies in order to achieve desired credit
and currency exposures. Such combinations generally are referred to as synthetic
securities. For example, in lieu of purchasing a foreign Fixed Income Security,
an Underlying Fund may purchase a U.S. dollar-denominated security and at the
same time enter into a forward contract to exchange U.S. dollars for the
contract's underlying currency at a future date. By matching the amount of U.S.
dollars to be exchanged with the anticipated value of the U.S.
dollar-denominated security, an Underlying Fund may be able to lock in the
foreign currency value of the security and adopt a synthetic investment position
reflecting the credit quality of the U.S. dollar-denominated security. There is
a risk in adopting a synthetic investment position to the extent that the value
of a security denominated in U.S. dollars or other foreign currency is not
exactly matched with an Underlying Fund's obligation under the forward contract.
On the date of maturity, an Underlying Fund may be exposed to some risk of loss
from fluctuations in that currency. Although MSAM or MAS will attempt to hold
such mismatching to a minimum, there can be no assurance that they will be able
to do so. When an Underlying Fund enters into a forward contract for purposes of
creating a synthetic security, it will generally be required to hold liquid
assets in a segregated account with a daily value at least equal to its
obligation under the forward contract.
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Under normal circumstances, consideration of the prospect for currency
parities will be incorporated into the long-term investment decisions made with
regard to overall diversification strategies. However, MSAM and MAS believe that
it is important to have the flexibility to enter into such forward contracts
when they determine that the best interests of each Underlying Fund will thereby
be served. Except under circumstances where a segregated account is not required
under the 1940 Act or the rules adopted thereunder, the Underlying Fund's
custodian will place liquid, unencumbered assets, the value of which is marked
to market daily, into a segregated account of an Underlying Fund in an amount
equal to the value of such Underlying Fund's total assets committed to the
consummation of forward contracts. If the value of the securities placed in the
segregated account declines, additional cash or securities will be placed in the
account on a daily basis so that the value of the account will be equal to the
amount of such Underlying Fund's commitments with respect to such Forwards.
At the maturity of a forward contract, an Underlying Fund may either accept
or make delivery of the currency specified in the contract or, prior to
maturity, enter into a closing purchase transaction involving the purchase or
sale of an offsetting contract. Closing purchase transactions with respect to
Forwards usually are effected with the currency trader who is a party to the
original forward contract. An Underlying Fund will only enter into such a
forward contract if it is expected that there will be a liquid market in which
to close out such contract. There can be no assurance, however, that such a
liquid market will exist in which to close a forward contract, in which case the
Underlying Fund may suffer a loss.
It is impossible to forecast with absolute precision the market value of a
particular portfolio security at the expiration of the forward contract.
Accordingly, it may be necessary for an Underlying Fund to purchase additional
foreign currency on the spot market (and bear the expense of such purchase) if
the market value of the security is less than the amount of foreign currency
that such Underlying Fund is obligated to deliver and if a decision is made to
sell the security and make delivery of the foreign currency.
If an Underlying Fund retains the portfolio security and engages in an
offsetting transaction, such Underlying Fund will incur a gain or a loss (as
described below) to the extent that there has been movement in forward contract
prices. Should Forward prices decline during the period between an Underlying
Fund entering into a forward contract for the sale of a foreign currency and the
date it enters into an offsetting contract for the purchase of the foreign
currency, such Underlying Fund will realize a gain to the extent that the price
of the currency it has agreed to sell exceeds the price of the currency it has
agreed to purchase. Should Forward prices increase, such Underlying Fund would
suffer a loss to the extent that the price of the currency it has agreed to
purchase exceeds the price of the currency it has agreed to sell.
The Underlying Funds are not required to enter into such transactions with
regard to their foreign currency-denominated securities. It also should be
realized that this method of protecting the value of portfolio securities
against a decline in the value of a currency does not eliminate fluctuations in
the underlying prices of the securities. It simply establishes a rate of
exchange which one can achieve at some future point in time. Additionally,
although forward contracts tend to minimize the risk of loss due to a decline in
the value of the hedged currency, at the same time, they tend to limit any
potential gain which might result should the value of such currency increase.
The Underlying Funds may also use foreign currency futures contracts and
options on foreign currency futures contracts for purposes similar to those
described for Forwards. Foreign currency futures contracts traded in the United
States are traded on regulated futures exchanges. An Underlying Fund will incur
brokerage fees when it purchases or sells foreign currency futures contracts and
it will be required to maintain margin deposits. Parties to a foreign currency
futures contract must make initial margin deposits to secure performance of the
contract, which generally range from 2% to 5% of the contract price. There also
are requirements to make "variation" margin deposits as the value of the futures
contract fluctuates. Foreign currency futures contracts and options on foreign
currency futures contracts will be used only as a protective measure against the
effects of fluctuating rates of currency exchange and exchange control
regulations. While foreign currency futures contracts and options on foreign
currency futures contracts may limit losses to the Underlying Fund as a result
of exchange rate fluctuation, they will also limit any gains that may otherwise
have been realized.
SPECIAL RISKS ASSOCIATED WITH FORWARD CONTRACTS, FOREIGN CURRENCY FUTURES
CONTRACTS AND OPTIONS THEREON AND OPTIONS ON FOREIGN CURRENCIES. Transactions
in forward contracts, as well as foreign currency futures contracts and options
thereon, are subject to the risk of governmental actions affecting trading in or
the prices of currencies underlying such contracts, which could restrict or
eliminate trading and could have a substantial adverse effect on the value of
positions held by each Underlying Fund permitted to engage in such hedging
transactions. In addition, the value of such positions could be adversely
affected by a number of other complex political and economic factors applicable
to the countries issuing the underlying currencies.
Furthermore, unlike trading in most other types of instruments, there is no
systematic reporting of last sale information with respect to the foreign
currencies underlying forward contracts, futures contracts and options. As a
result, the available information on which an Underlying Fund's trading systems
will be based may not be as complete as the comparable data on which such
Underlying Fund makes investment and trading decisions in connection with other
securities and transactions. Moreover, because the foreign currency market is a
global, twenty-four hour market, events could occur on that market which will
not be reflected in the Forward, futures or options markets until the following
day, thereby preventing an Underlying Fund from responding to such events in a
timely manner.
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Settlements of over-the-counter forward contracts or of the exercise of
foreign currency options generally must occur within the country issuing the
underlying currency, which in turn requires parties to such contracts to accept
or make delivery of such currencies in conformity with any U.S. or foreign
restrictions and regulations regarding the maintenance of foreign banking
relationships, fees, taxes or other charges.
Unlike currency futures contracts and exchange-traded options, options on
foreign currencies and forward contracts are not traded on contract markets
regulated by the Commodity Futures Trading Commission ("CFTC"), a U.S.
government agency or (with the exception of certain foreign currency options)
the SEC. In an over-the-counter trading environment, many of the protections
associated with transactions on exchanges will not be available. For example,
there are no daily price fluctuation limits and adverse market movements could,
therefore, continue to an unlimited extent over a period of time. Although the
purchaser of an option cannot lose more than the amount of the premium plus
related transaction costs, this entire amount could be lost. Moreover, an option
writer could lose amounts substantially in excess of its initial investment due
to the margin and collateral requirements associated with such option positions.
Similarly, there is no limit on the amount of potential losses on forward
contracts to which an Underlying Fund is a party.
In addition, over-the-counter transactions can be entered into only with a
financial institution willing to take the opposite side, as principal, of an
Underlying Fund's position unless the institution acts as broker and is able to
find another counterparty willing to enter into the transaction with such
Underlying Fund. Where no such counterparty is available, it will not be
possible to enter into a desired transaction. There also may be no liquid
secondary market in the trading of over-the-counter contracts, and an Underlying
Fund may be unable to close out options purchased or written, or forward
contracts entered into, until their exercise, expiration or maturity. This in
turn could limit an Underlying Fund's ability to realize profits or to reduce
losses on open positions and could result in greater losses.
Furthermore, over-the-counter transactions are not backed by the guarantee
of an exchange's clearing corporation. An Underlying Fund will therefore be
subject to the risk of default by, or the bankruptcy of, the financial
institution serving as its counterparty. One or more of such institutions also
may decide to discontinue its role as market-maker in a particular currency,
thereby restricting an Underlying Fund's ability to enter into desired hedging
transactions. An Underlying Fund will enter into over-the-counter transactions
only with parties whose creditworthiness has been reviewed and found
satisfactory by MSAM or MAS.
Over-the-counter options on foreign currencies, like exchange-traded
commodity futures contracts and commodity option contracts, are within the
exclusive regulatory jurisdiction of the CFTC. The CFTC currently permits the
trading of such options, but only subject to a number of conditions regarding
the commercial purpose of the purchaser of such options. Forward contracts and
currency swaps are not presently subject to regulation by the CFTC, although the
CFTC may in the future assert or be granted authority to regulate such
instruments. In such event, an Underlying Fund's ability to utilize forward
contracts and currency swaps in the manner set forth above and in the Prospectus
could be restricted.
Options on foreign currencies traded on a national securities exchange are
within the jurisdiction of the SEC, as are other securities traded on such
exchanges. As a result, many of the protections provided to traders on organized
exchanges will be available with respect to such transactions. In particular,
all foreign currency options positions entered into on a national securities
exchange are cleared and guaranteed by The Options Clearing Corporation ("OCC"),
thereby reducing the risk of counterparty default. Further, a liquid secondary
market in options traded on a national securities exchange may be more readily
available than in the over-the-counter market, potentially permitting an
Underlying Fund to liquidate open positions at a profit prior to exercise or
expiration, or to limit losses in the event of adverse market movements.
The purchase and sale of exchange-traded foreign currency options, however,
is subject to the risks of the availability of a liquid secondary market
described above, as well as the risks regarding adverse market movements,
margining of options written, the nature of the foreign currency market,
possible intervention by governmental authorities and the effect of other
political and economic events. In addition, exchange-traded options on foreign
currencies involve certain risks not presented by the over-the-counter market.
For example, exercise and settlement of such options must be made exclusively
through OCC, which has established banking relationships in applicable foreign
countries for this purpose. As a result, OCC may, if it determines that foreign
governmental restrictions or taxes would prevent the orderly settlement of
foreign currency option exercises or would result in undue burdens on OCC or its
clearing member, impose special procedures for exercise and settlement, such as
technical changes in the mechanics of delivery of currency, the fixing of dollar
settlement prices or prohibitions on exercise.
DERIVATIVES
Certain Underlying Funds may use Derivatives under a number of different
circumstances to further their investment objectives. These Underlying Funds may
use Derivatives when doing so provides more liquidity than the direct purchase
of the securities underlying such Derivatives. For example, an Underlying Fund
may purchase Derivatives to quickly gain exposure to a market in response to
changes in the Underlying Fund's asset allocation policy or upon the inflow of
investable cash when the Derivative provides greater liquidity than the
underlying securities market. An Underlying Fund may also use Derivatives when
it is restricted from directly owning the underlying securities due to foreign
investment restrictions or other reasons or when
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doing so provides a price advantage over purchasing the underlying securities
directly, either because of a pricing differential between the Derivatives and
securities markets or because of lower transaction costs associated with the
Derivatives transaction. Derivatives also may be used by an Underlying Fund for
hedging purposes and under other circumstances in which an Underlying Fund's
portfolio managers believe it advantageous to do so consistent with the
Underlying Fund's investment objective. The Underlying Funds will not, however,
use Derivatives in a manner that creates leverage, except to the extent that the
use of leverage is expressly permitted by a particular Underlying Fund's
investment policies, and then only in a manner consistent with such policies.
Some of the Derivatives in which the Underlying Funds may invest and the risks
related thereto are described in more detail below.
CAPS, FLOORS AND COLLARS. The Underlying Funds may invest in caps, floors
and collars on various rates or indices, including, but not limited to, interest
rates and the prices of equity securities. The buyer of a cap pays a premium for
the right to receive a payment on specified dates if the actual rate or index,
such as an actual floating interest rate, on the relevant date exceeds a
specified level (known as a "strike rate"). The size of the payment is related
to the size of the excess over the strike rate for the amount and period of time
being protected. Similarly, the buyer of a floor pays a premium in return for
the right to receive a payment related to the size of the deficit if an actual
rate or index, such as a floating interest rate, is below the strike rate on the
specified payment date. A collar is a combination product in which the same
party buys a cap and sells a floor. In a zero-cost collar, the premiums paid for
the cap and received on the sale of the floor net to zero. Since caps, collars
and floors are analyzable in economic terms as options, the risks associated
with these products are similar to those associated with options. In addition,
caps, floors and collars are privately negotiated instruments subject to the
risk of counterparty default.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. The Underlying Funds
generally may enter into futures contracts and options on futures contracts for
the purpose of remaining fully invested and reducing transactions costs and for
a number of more specialized purposes. An Underlying Fund may sell securities
index futures contracts and/or options thereon in anticipation of or during a
market decline to attempt to offset the decrease in market value of investments
in its portfolio, or purchase securities index futures in order to gain market
exposure. An Underlying Fund may engage in transactions in interest rate futures
transactions involving an obligation to purchase or sell a specific debt
security, instrument or basket thereof at a specified future date at a specified
price to hedge its holdings of debt instruments against future changes in
interest rates. The value of the contract rises and falls inversely with changes
in interest rates. An Underlying Fund may enter into financial futures contracts
relating to financial instruments, such as U.S. Government Securities, foreign
currencies, and certificates of deposit involving an obligation to purchase or
sell a specific security, instrument or basket thereof at a specified future
date at a specified price. Like interest rate futures contracts, the value of
financial futures contracts rises and falls inversely with changes in interest
rates. An Underlying Fund also may enter into futures contracts for hedging
purposes. Futures contracts provide for the future sale by one party and
purchase by another party of a specified amount of a specific security at a
specified future time and at a specified price. Futures contracts, which are
standardized as to maturity date and underlying financial instrument, are traded
on U.S. national futures exchanges and in foreign markets. Futures exchanges and
trading in the United States are regulated under the Commodity Exchange Act by
the CFTC.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities or currencies, in most cases the
contracts are closed out before the settlement date without the making or taking
of delivery. Closing out an open futures position is done by taking an opposite
position ("buying" a contract which has previously been "sold" or "selling" a
contract previously "purchased") in an identical contract to terminate the
position. Brokerage commissions are incurred when a futures contract is bought
or sold.
Futures contracts on securities indices or other indices do not require the
physical delivery of securities, but merely provide for profits and losses
resulting from changes in the market value of a contract to be credited or
debited at the close of each trading day to the respective accounts of the
parties to the contract. On the contract's expiration date a final cash
settlement occurs and the futures position is simply closed out. Changes in the
market value of a particular futures contract reflect changes in the level of
the index on which the futures contract is based.
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements which are higher than the exchange
minimums. Futures contracts are customarily purchased and sold for prices that
may range upward from less than 5% of the value of the contract being traded.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent that
the margin on deposit does not satisfy margin requirements, payment of an
additional "variation" margin will be required. Conversely, a change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The Underlying
Funds expect to earn interest income on their margin deposits. With respect to
each long position in a futures contract or option thereon, the underlying
commodity value of such contract will always be covered by cash and cash
equivalents set aside plus accrued profits held at the futures commission
merchant.
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The Underlying Funds may purchase and write call and put options on futures
contracts which are traded on a U.S. exchange and enter into closing
transactions with respect to such options to terminate an existing position. In
addition, an Underlying Fund may purchase and write call and put options on
futures that are traded on an international exchange, traded over-the-counter or
which are synthetic options or futures or equity swaps, and may enter into
closing transactions with respect to such options to terminate an existing
position. An option on a futures contract gives the purchaser the right (in
return for the premium paid) to assume a position in a futures contract (a long
position if the option is a call and a short position if the option is a put) at
a specified exercise price at any time during the term of the option. Upon
exercise of the option, the accumulated balance in the writer's futures margin
account is delivered to the option holder, which represents the amount by which
the market price of the futures contract at the time of exercise exceeds, in the
case of a call, or is less than, in the case of a put, the exercise price of the
option on the futures contract.
The Underlying Funds will purchase and write options on futures contracts
for identical purposes to those set forth above for the purchase of a futures
contract (purchase of a call option or sale of a put option) and the sale of a
futures contract (purchase of a put option or sale of a call option), or to
close out a long or short position in futures contracts.
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators". Hedgers use the futures markets primarily to offset
unfavorable changes in the value of securities otherwise held for investment
purposes or expected to be acquired by them. Speculators are less inclined to
own the securities underlying futures contracts which they trade, and use
futures contracts with the expectation of realizing profits from market
fluctuations.
Although techniques other than the sale and purchase of futures contracts
could be used to control the Underlying Funds' exposure to market fluctuations,
the use of futures contracts may be a more effective means of hedging this
exposure. While the Underlying Funds will incur commission expenses in both
opening and closing out futures positions, these costs are lower than
transaction costs incurred in the purchase and sale of the underlying
securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS. Regulations of the CFTC
applicable to the Underlying Funds permit the use of futures transactions for
bona fide hedging purposes without regard to the percentage of assets committed
to futures margins and for options premiums. Under rules adopted by the CFTC,
the Underlying Funds may enter into futures contracts and options thereon for
both hedging and non-hedging purposes, provided that not more than 5% of such
Underlying Fund's total assets at the time of entering the transaction are
required as margin and option premiums to secure obligations under such
contracts relating to non-hedging activities. An MSIF Underlying Fund which uses
Derivatives will limit its use of futures contracts and other Derivatives for
non-hedging purposes to 33 1/3% of its total assets measured by the aggregate
notional amount of its outstanding Derivatives instruments. An MAS Underlying
Fund will not enter into futures contracts to the extent that its outstanding
obligations to purchase securities under these contracts in combination with its
outstanding obligations with respect to options transactions would exceed 50% of
its total assets. The risk that an Underlying Fund will be unable to close out a
futures position or options contract will be minimized by only entering into
futures contracts or options transactions for which there appears to be a liquid
exchange or secondary market. The Underlying Funds will maintain liquid assets
sufficient to meet their respective obligations under such contracts in a
segregated account with the custodian bank or will otherwise comply with the
SEC's position on asset coverage.
RISK FACTORS IN FUTURES TRANSACTIONS. Positions in futures contracts may be
closed out only on an exchange which provides a secondary market for such
futures. However, there can be no assurance that a liquid secondary market will
exist for any particular futures contract at any specific time. Thus, it may not
be possible to close a futures position. In the event of adverse price
movements, the Underlying Funds would continue to be required to make daily cash
payments to maintain their required margin. In such situations, if an Underlying
Fund has insufficient cash, it may have to sell portfolio securities to meet its
daily margin requirement at a time when it may be disadvantageous to do so. In
addition, an Underlying Fund may be required to make delivery of the instruments
underlying futures contracts it holds. The inability to close options and
futures positions also could have an adverse impact on an Underlying Fund's
ability to hedge effectively. There currently are limited securities index
futures and options on such futures in many countries, particularly emerging
countries. The nature of the strategies adopted by MSAM or MAS, and the extent
to which those strategies are used, may depend on the development of such
markets.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if, at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit if the contract were closed
out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the amount invested in the contract. However, because the Underlying
Funds may engage in futures strategies only for hedging purposes, MSAM and MAS
do not believe that the Underlying Funds are subject to the risks of loss
frequently associated with futures transactions. An Underlying Fund would
presumably have sustained comparable losses if, instead of the futures contract,
it had invested in the underlying security or currency and sold it after the
decline.
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Utilization of futures transactions by the Underlying Funds does involve the
risk of imperfect or no correlation where the securities underlying futures
contracts have different maturities than the portfolio securities or currencies
being hedged. It is also possible that an Underlying Fund could both lose money
on futures contracts and also experience a decline in value of its portfolio
securities. There is also the risk of loss by an Underlying Fund of margin
deposits in the event of bankruptcy of a broker with whom the Underlying Fund
has an open position in a futures contract or related option.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular type of contract, no trades may
be made on that day at a price beyond that limit. The daily limit governs only
price movement during a particular trading day and therefore does not limit
potential losses, because the limit may prevent the liquidation of unfavorable
positions. Futures contract prices have occasionally moved to the daily limit
for several consecutive trading days with little or no trading, thereby
preventing prompt liquidation of futures positions and subjecting some futures
traders to substantial losses.
OPTIONS. The Underlying Funds may seek to increase their returns or may
hedge their portfolio investments through options transactions with respect to
securities, instruments, indices or baskets thereof in which such Underlying
Funds may invest, as well as with respect to foreign currency. Additional
information with respect to option transactions is set forth below. Call and put
options on Equity Securities are listed on various U.S. and foreign securities
exchanges ("listed options") and are written in over-the-counter transactions
("OTC "). The Underlying Funds may engage in transactions in listed and OTC
options. There currently are limited options markets in many countries,
particularly emerging countries such as Latin American countries, and the nature
of the strategies adopted by MSAM or MAS and the extent to which those
strategies are used will depend on the development of such option markets.
Listed options are issued or guaranteed by the exchange on which they trade
or by a clearing corporation, such as OCC in the United States. Ownership of a
listed call option gives the fund the right to buy from the clearing corporation
or exchange the underlying security covered by the option at the stated exercise
price (the price per unit of the underlying security or currency) (the "exercise
price") by filing an exercise notice prior to the expiration date of the option.
The writer (seller) of the option would then have the obligation to sell to the
clearing corporation or exchange, the underlying security or currency at that
exercise price prior to the expiration date of the option, regardless of its
current market price. Ownership of a listed put option would give an Underlying
Fund the right to sell the underlying security or currency to the clearing
corporation or exchange at the stated exercise price. Upon notice of exercise of
the put option, the writer of the option would have the obligation to purchase
the underlying security from the clearing corporation or exchange at the
exercise price.
OTC options are purchased from or sold (written) to dealers or financial
institutions which have entered into direct agreements with each Underlying
Fund. With OTC options, such variables as expiration date exercise price and
premium will be agreed upon between each Underlying Fund and the transactions
dealer, without the intermediation of a third party such as a clearing
corporation or exchange. If the transacting dealer fails to make or take
delivery of the securities underlying an option it has written, in accordance
with the terms of that option, each Underlying Fund would lose the premium paid
for the option as well as any anticipated benefit of the transaction. The market
for OTC options also may be less liquid than the market for listed options.
COVERED CALL WRITING. Each of the Underlying Funds may write (i.e., sell)
covered call options on portfolio securities. By doing so, the Underlying Fund
would become obligated during the term of the option to deliver the securities
underlying the option should the option holder choose to exercise the option
before the option's termination date. In return for the call it has written,
each Underlying Fund will receive from the purchaser (or option holder) a
premium which is the price of the option, less a commission charged by a broker.
Each Underlying Fund will keep the premium regardless of whether the option is
exercised. The Underlying Funds may only write options that are "covered." A
covered call option means that so long as the Underlying Fund is obligated as
the writer of the option, it will earmark or segregate sufficient liquid assets
to cover its obligations under the option or own (i) the underlying security or
instrument subject to the option; (ii) securities or instruments convertible or
exchangeable without the payment of any consideration into the security or
instrument subject to the option; or (iii) a call option on the same underlying
security with a strike price no higher than the price at which the underlying
instrument was sold pursuant to a short option position. When the Underlying
Fund writes covered call options, it augments its income by the premiums
received and is thereby hedged to the extent of that amount against a decline in
the price of the underlying securities and the premiums received will offset a
portion of the potential loss incurred by the Underlying Fund if the securities
underlying the options are ultimately sold by the Underlying Fund at a loss.
However, during the option period, each Underlying Fund has, in return for the
premium on the option, given up the opportunity for capital appreciation above
the exercise price should the market price of the underlying security increase,
but has retained the risk of loss should the price of the underlying security
decline. The size of premiums will fluctuate with varying market conditions.
COVERED PUT WRITING. Each of the Underlying Funds may write covered put
options on portfolio securities. By doing so, the Underlying Fund incurs an
obligation to buy the security underlying the option from the purchaser of the
put at the option's exercise price at any time during the option period, at the
purchaser's election (certain listed and OTC options written by the
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Underlying Fund will be exercisable by the purchaser only on a specific date).
Generally, a put option is "covered" if the Underlying Fund maintains in a
segregated account an amount of cash or liquid securities equal to the exercise
price of the option or if the Underlying Fund holds a put option on the same
underlying security with a similar or higher exercise price.
Each of the Underlying Funds will write put options (i) to receive the
premiums paid by purchasers; (ii) when MSAM or MAS wishes to purchase the
security underlying the option at a price lower than its current market price,
in which case it will write the covered put at an exercise price reflecting the
lower purchase price sought; and (iii) to close out a long put option position.
PURCHASE OF PUT AND CALL OPTIONS. Each of the Underlying Funds may purchase
listed or OTC put or call options on its portfolio securities. When each
Underlying Fund purchases a call option it acquires the right to purchase a
designated security at the exercise price, and when each Underlying Fund
purchases a put option it acquires the right to sell a designated security at
the exercise price, in each case on or before a specified date (the "termination
date"), usually not more than nine months from the date the option is issued.
Each Underlying Fund may purchase call options to close out a covered call
position or to protect against an increase in the price of a security it
anticipates purchasing. Each Underlying Fund may purchase put options on
securities which it holds in its portfolio only to protect itself against a
decline in the value of the security. If the value of the underlying security
were to fall below the exercise price of the put purchased in an amount greater
than the premium paid for the option, each Underlying Fund would incur no
additional loss. Each Underlying Fund may also purchase put options to close out
written put positions in a manner similar to call option closing purchase
transactions.
The amount each Underlying Fund pays to purchase an option is called a
"premium," and the risk assumed by the Underlying Fund when it purchases an
option is the loss of this premium. Because the price of an option tends to move
with that of its underlying security, if an Underlying Fund is to make a profit,
the price of the underlying security must change and the change must be
sufficient to cover the premium and commissions paid. A price change in the
security underlying the option does not assure a profit since prices in the
options market may not always reflect such a change.
STRUCTURED INVESTMENTS. The Underlying Funds may invest a portion of their
assets in interests in entities organized and operated solely for the purpose of
restructuring the investment characteristics of sovereign debt obligations. This
type of restructuring involves the deposit with or purchase by an entity, such
as a corporation or trust, of specified instruments (such as commercial bank
loans or Brady Bonds) and the issuance by that entity of one or more classes of
securities ("Structured Investments") backed by, or representing interests in,
the underlying instruments. The cash flow on the underlying instruments may be
apportioned among the newly issued Structured Investments to create securities
with different investment characteristics such as varying maturities, payment
priorities and interest rate provisions, and the extent of the payments made
with respect to Structured Investments is dependent on the extent of the cash
flow on the underlying instruments. Because Structured Investments of the type
in which each Underlying Fund anticipates it will invest typically involve no
credit enhancement, their credit risk generally will be equivalent to that of
the underlying instruments. Each Underlying Fund is permitted to invest in a
class of Structured Investments that is either subordinated or unsubordinated to
the right of payment of another class. Subordinated Structured Investments
typically have higher yields and present greater risks than unsubordinated
Structured Investments. Certain issuers of Structured Investments may be deemed
to be "investment companies" as defined in the 1940 Act. As a result, each
Underlying Fund's investment in these Structured Investments may be limited by
restrictions contained in the 1940 Act. Structured Investments are typically
sold in private placement transactions, and there currently is no active trading
market for Structured Investments.
SWAP CONTRACTS. The Underlying Funds may enter into swap contracts. A swap
is an agreement to exchange the return generated by one instrument for the
return generated by another instrument. The payment streams are calculated by
reference to a specified index and agreed upon notional amount. The term
"specified index" includes currencies, fixed interest rates, prices, total
return on interest rate indices, fixed income indices, stock indices and
commodity indices (as well as amounts derived from arithmetic operations on
these indices). For example, an Underlying Fund may agree to swap the return
generated by a fixed income index for the return generated by a second fixed
income index. The currency swaps in which the Underlying Funds may enter will
generally involve an agreement to pay interest streams in one currency based on
a specified index in exchange for receiving interest streams denominated in
another currency. Such swaps may involve initial and final exchanges that
correspond to the agreed upon notional amount.
Swaps do not involve the delivery of securities, other underlying assets, or
principal. Accordingly, the risk of loss with respect to swaps is limited to the
net amount of payments that an Underlying Fund is contractually obligated to
make. If the other party to a swap defaults, an Underlying Fund's risk of loss
consists of the net amount of payments that an Underlying Fund is contractually
entitled to receive. Currency swaps usually involve the delivery of the entire
principal value of one designated currency in exchange for the other designated
currency. Therefore, the entire principal value of a currency swap is subject to
the risk that the other party to the swap will default on its contractual
delivery obligations. If there is a default by the counterparty, the Underlying
Funds may have contractual remedies pursuant to the agreements related to the
transaction. The swap market has grown substantially in recent years with a
large number of banks and investment banking firms acting both as principals and
as agents utilizing standardized swap documentation. As a result, the swap
market has become relatively liquid. The swaps in
16
<PAGE>
which the Underlying Funds engage also may include caps, floors and collars on
the specified index under which one party pays a single or periodic fixed
amount(s) (or premium), and the other party pays periodic amounts based on the
movement of a specified index. Swaps that include caps, floors and collars are
more recent innovations for which standardized documentation has not yet been
fully developed and, accordingly, they are less liquid than "traditional" swaps.
An Underlying Fund's obligations under a swap agreement will be accrued
daily (offset against any amounts owing to the Underlying Fund) and any accrued
but unpaid net amounts owed to a swap counterparty will be covered by the
maintenance of a segregated account consisting of unencumbered liquid assets, to
avoid any potential leveraging of the Underlying Fund. To the extent that these
swaps (including any caps, floors, or collars) are entered into for hedging
purposes, MSAM and MAS believe such obligations do not constitute "senior
securities" under the 1940 Act and, accordingly, will not treat them as being
subject to an Underlying Fund's borrowing restrictions. The Underlying Funds may
enter into OTC Derivatives transactions (excluding foreign exchange contracts)
with counterparties that are approved by MSAM or MAS in accordance with
guidelines established by the Underlying Funds' Boards of Directors. These
guidelines provide for a minimum credit rating for each counterparty and various
credit enhancement techniques (for example, collateralization of amounts due
from counterparties) to limit exposure to counterparties that have a rating
below AA.
The use of Derivatives is a highly specialized activity which involves
investment techniques and risks different from those associated with ordinary
portfolio securities transactions. If MSAM or MAS is incorrect in its forecasts
of market values, interest rates, and currency exchange rates, the investment
performance of the Underlying Funds would be less favorable than it would have
been if this investment technique were not used.
OTHER SECURITIES
BORROWING AND OTHER FORMS OF LEVERAGE. Certain of the Underlying Funds are
permitted to borrow money for investment purposes. Borrowing for investment
purposes creates leverage which is a speculative characteristic. Although these
Underlying Funds are authorized to borrow, they will do so only when MSAM or MAS
believes that borrowing will benefit the Underlying Fund after taking into
account considerations such as the costs of borrowing and the likely investment
returns on securities purchased with borrowed monies.
MORGAN STANLEY CAPITAL INTERNATIONAL EAFE INDEX. The MSIF International
Magnum Portfolio uses the Morgan Stanley Capital International EAFE (Europe,
Australia and the Far East) Index (the "EAFE Index") as a tool for investment
decisions. The investment objective of the MSIF International Magnum Portfolio
is to provide long-term capital appreciation. The MSIF International Magnum
Portfolio seeks to achieve its objective by investing primarily in Equity
Securities of non-U.S. issuers domiciled in EAFE countries (defined below).
After establishing regional allocation strategies, MSAM selects Equity
Securities among issuers of a region. The MSIF International Magnum Portfolio
invests in countries comprising the EAFE Index (each, an "EAFE country").
The EAFE Index is one of seven international indices, twenty national
indices and thirty-eight international industry indices making up the Morgan
Stanley Capital International Indices. The EAFE Index is based on the share
prices of 1,066 companies listed on the stock exchanges of Europe, Australia,
New Zealand and the Far East. "Europe" includes Austria, Belgium, Denmark,
Finland, France, Germany, Italy, the Netherlands, Norway, Spain, Sweden,
Switzerland and the United Kingdom. "Far East" includes Japan, Hong Kong and
Singapore/Malaysia.
NON-PUBLICLY TRADED SECURITIES, PRIVATE PLACEMENTS AND RESTRICTED
SECURITIES. The Underlying Funds may invest in securities that are neither
listed on a stock exchange nor traded over-the-counter, including privately
placed securities. As a result of the absence of a public trading market for
these securities, they may be less liquid than publicly traded securities.
Although these securities may be resold in privately negotiated transactions,
the prices realized from these sales could be less than those originally paid by
the Underlying Fund or less than what may be considered the fair value of such
securities. Furthermore, companies whose securities are not publicly traded may
not be subject to the disclosure and other investor protection requirements
which might be applicable if their securities were publicly traded. If such
securities are required to be registered under the securities laws of one or
more jurisdictions before being resold, the Underlying Fund may be required to
bear the expenses of registration.
SECURITIES LENDING. Each Underlying Fund may lend its investment securities
to qualified institutional investors that need to borrow securities in order to
complete certain transactions, such as covering short sales, avoiding failures
to deliver securities or completing arbitrage operations. By lending its
investment securities, an Underlying Fund attempts to increase its net
investment income through the receipt of interest on the loan. Any gain or loss
in the market price of the securities loaned that might occur during the term of
the loan would be for the account of the Underlying Fund. Each Underlying Fund
may lend its investment securities to qualified brokers, dealers, domestic and
foreign banks or other financial institutions, so long as the terms, structure
and the aggregate amount of such loans are not inconsistent with the 1940 Act or
the Rules and Regulations or interpretations of the SEC thereunder, which
currently require that (i) the borrower pledge and maintain with the Underlying
Fund collateral consisting of liquid, unencumbered assets having a value at all
times not less than 100% of the value of the securities loaned; (ii) the
borrower add to such collateral whenever the price of the securities loaned
rises (i.e., the borrower "marks to the market" on a daily basis); (iii) the
loan be made subject to termination by the Underlying Fund at any time; and
17
<PAGE>
(iv) the Underlying Fund receive reasonable interest on the loan (which may
include the Underlying Fund investing any cash collateral in interest bearing
short-term investments), any distributions on the loaned securities and any
increase in their market value. There may be risks of delay in recovery of the
securities or even loss of rights in the collateral should the borrower of the
securities fail financially. However, loans will be made only to borrowers
deemed by MSAM or MAS to be of good standing and when, in the judgment of MSAM
or MAS, the consideration which can be earned currently from such securities
loans justifies the attendant risk. All relevant facts and circumstances,
including the creditworthiness of the broker, dealer or institution, will be
considered in making decisions with respect to the lending of securities,
subject to review by the Board of Directors of the Underlying Fund.
At the present time, the staff of the SEC does not object if an investment
company pays reasonable negotiated fees in connection with loaned securities, so
long as such fees are set forth in a written contract and approved by the
investment company's Board of Directors. In addition, voting rights may pass
with the loaned securities, but if a material event will occur affecting an
investment on loan, the loan must be called and the securities voted.
SHORT SALES. The Underlying Funds may from time to time sell securities
short consistent with applicable legal requirements. A short sale is a
transaction in which the Underlying Fund would sell securities it owns or has
the right to acquire at no added cost (i.e., "against the box") or does not own
(but has borrowed) in anticipation of a decline in the market price of the
securities. When the Underlying Fund makes a short sale of borrowed securities,
the proceeds it receives from the sale will be held on behalf of a broker until
the Underlying Fund replaces the borrowed securities. To deliver the securities
to the buyer, the Underlying Fund will need to arrange through a broker to
borrow the securities and, in so doing, the Underlying Fund will become
obligated to replace the securities borrowed at their market price at the time
of replacement, whatever that price may be. The Underlying Fund may have to pay
a premium to borrow the securities and must pay any dividends or interest
payable on the securities until they are replaced.
The Underlying Fund's obligation to replace the securities borrowed in
connection with a short sale will be secured by collateral deposited with the
broker that consists of liquid unencumbered assets. In addition, if the short
sale is not "against the box," the Underlying Fund will place in a segregated
account with its custodian, or designated sub-custodian, an amount of
unencumbered liquid assets equal to the difference, if any, between (i) the
market value of the securities sold at the time they were sold short, and (ii)
any unencumbered liquid assets deposited as collateral with the broker in
connection with the short sale (not including the proceeds of the short sale).
Until it replaces the borrowed securities, the Underlying Fund will maintain the
segregated account daily at a level so that (i) the amount deposited in the
account plus the amount deposited with the broker (not including the proceeds
from the short sale) will equal the current market value of the securities sold
short, and (ii) the amount deposited in the account plus the amount deposited
with the broker (not including the proceeds from the short sale) will not be
less than the market value of the securities at the time they were sold short.
Short sales by the Underlying Fund involve certain risks and special
considerations. Possible losses from short sales differ from losses that could
be incurred from a purchase of a security, because losses from short sales may
be unlimited, whereas losses from purchases can equal only the total amount
invested.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
The following discussion of certain federal income tax consequences is based
on the Internal Revenue Code of 1986, as amended (the "Code"), and the
regulations issued thereunder as in effect on the date of this Statement of
Additional Information. New legislation, as well as administrative changes or
court decisions, may significantly change the conclusions expressed herein, and
may have a retroactive effect with respect to the transactions contemplated
herein.
Each Portfolio within the Fund is generally treated as a separate
corporation for federal income tax purposes, and thus the provisions of the Code
generally will be applied to each Portfolio separately, rather than to the Fund
as a whole.
The Fund intends that each of its Portfolios qualify and elect to be treated
for each taxable year as a regulated investment company ("RIC") under Subchapter
M of the Code. Accordingly, each Portfolio must, among other things, (a) derive
at least 90% of its gross income each taxable year from dividends, interest,
payments with respect to securities loans, gains from the sale or other
disposition of stock, securities or foreign currencies, and certain other
related income, including, generally, certain gains from options, futures and
forward contracts; and (b) diversify its holdings so that, at the end of each
fiscal quarter of the Portfolio's taxable year, (i) at least 50% of the market
value of the Portfolio's total assets is represented by cash and cash items,
United States Government securities, securities of other RICs, and other
securities, with such other securities limited, in respect to any one issuer, to
an amount not greater than 5% of the value of the Portfolio's total assets or
10% of the outstanding voting securities of such issuer, and (ii) not more than
25% of the value of its total assets is invested in the securities (other than
United States Government securities or securities of other RICs) of any one
issuer or two or more issuers which the Portfolio controls and which are engaged
in the same, similar, or related trades or business. For purposes of the 90% of
gross income requirement described above, foreign currency gains which are not
directly related to a Portfolio's principal business of investing in stock or
securities (or options or futures with respect to stock or securities) may be
excluded from income that qualifies under the 90% requirement.
18
<PAGE>
In addition to the requirements described above, in order to qualify as a
RIC, each Portfolio must distribute at least 90% of each Portfolio's net
investment income (which generally includes dividends, taxable interest, and the
excess of net short-term capital gains over net long-term capital losses less
operating expenses) and at least 90% of its net tax-exempt interest income, if
any, to shareholders. If a Portfolio meets all of the RIC requirements, it will
not be subject to federal income tax on any of its net investment income or
capital gains that it distributes to shareholders.
If a Portfolio fails to qualify as a RIC for any year, all of its income
will be subject to tax at regular corporate rates without any deduction for
distributions to shareholders, and such distributions will be taxable to
shareholders as ordinary dividends to the extent of the Portfolio's accumulated
earnings and profits. Such distributions will be eligible for the corporate
dividends received deduction.
The Code imposes a non-deductible 4% excise tax on regulated investment
companies that do not distribute in each calendar year an amount equal to 98% of
their ordinary income for the calendar year plus 98% of their capital gain net
income for the one-year period ending on October 31 of such calendar year. The
excise tax is imposed on the undistributed part of this required distribution.
In addition, the balance of such income must be distributed during the next
calendar year to avoid liability for the excise tax in that year. For the
foregoing purposes, a company is treated as having distributed any amount on
which it is subject to income tax for any taxable year ending in such calendar
year. For purposes of the excise tax, a regulated investment company must reduce
its capital gain net income by the amount of any net ordinary loss for the
calendar year (but only to the extent the capital gain net income for the
one-year period ending on October 31 exceeds the net capital gains for such
period). Because each Portfolio intends to distribute all of its income
currently (or to retain, at most, its "net capital gains" and pay tax thereon),
no Portfolio anticipates incurring any liability for this excise tax. However, a
Portfolio may, in certain circumstances, be required to liquidate portfolio
investments in order to make sufficient distributions to avoid excise tax
liability.
Dividends declared by a Portfolio in October, November, or December of any
year and payable to shareholders of record on a date in such month will be
deemed to have been paid by the Portfolio and received by the shareholders on
December 31 of that year if paid by the Portfolio at any time during the
following January.
Short sales engaged in by a Portfolio may reduce the holding period of
property held by a Portfolio which is substantially identical to the property
sold short. This rule may have the effect of converting capital gains recognized
by the Portfolio from long-term to short-term as well as converting capital
losses recognized by the Underlying Fund from short-term to long- term.
STATE AND LOCAL
Rules of state and local taxation of dividends and capital gains
distributions from a RIC may be different from the rules of federal income
taxation described above. Shareholders are urged to consult their own tax
advisers as to the consequences of federal, state, local, and foreign tax rules
affecting an investment in a Portfolio.
FOREIGN INVESTMENTS
Gains or losses attributable to foreign currency contracts, or to
fluctuations in exchange rates that occur between the time an Underlying Fund
accrues interest or other receivables or accrues expenses or other liabilities
denominated in a foreign currency and the time the Underlying Fund actually
collects such receivables or pays such liabilities are treated as ordinary
income or ordinary loss to the Underlying Fund. Similarly, gains or losses on
disposition of debt securities denominated in a foreign currency attributable to
fluctuations in the value of the foreign currency between the date of
acquisition of the security and the date of disposition also are treated as
ordinary gain or loss to the Underlying Fund. These gains or losses increase or
decrease the amount of an Underlying Fund's net investment income available to
be distributed to its shareholders as ordinary income.
Each Underlying Fund that invests in foreign securities may be subject to
foreign withholding taxes with respect to its dividend and interest income from
foreign countries, and an Underlying Fund may be subject to foreign income taxes
with respect to other income. Because not more than 50% in value of an
Underlying Fund's total assets at the close of the taxable year consists of
stock or securities of foreign corporations, a Portfolio may not elect to treat
foreign income taxes imposed on an Underlying Fund for United States federal
income tax purposes as paid directly by its shareholders.
PURCHASE OF SHARES
The purchase price of each Portfolio of the Fund is the net asset value next
determined after the order is received. For each Portfolio of the Fund, an order
received prior to the regular close of the New York Stock Exchange (the "NYSE")
will be executed at the price computed on the date of receipt; and an order
received after the regular close of the NYSE will be executed at the price
computed on the next day the NYSE is open as long as the Fund's transfer agent
receives payment by check or in Federal Funds prior to the regular close of the
NYSE on such day. Shares of the Fund may be purchased on any day the NYSE is
open. The NYSE will be closed on the following days: New Year's Day, Martin
Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving Day and Christmas Day, and on the preceding Friday
or subsequent Monday when any of these holidays falls on a Saturday or Sunday,
respectively.
19
<PAGE>
Each Portfolio reserves the right in its sole discretion to suspend the
offering of its shares and to reject purchase orders when in the judgment of
management such rejection is in the best interest of the Portfolio.
REDEMPTION OF SHARES
REDEMPTIONS. Each Portfolio may suspend redemption privileges or postpone
the date of payment (i) during any period that the NYSE is closed, or trading on
the NYSE is restricted as determined by the SEC; (ii) during any period when an
emergency exists as defined by the rules of the SEC as a result of which it is
not reasonably practicable for a Portfolio to dispose of securities owned by it,
or fairly to determine the value of its assets; and (iii) for such other periods
as the Commission may permit.
DISTRIBUTIONS IN KIND. If the Board of Directors determines that it would
be detrimental to the best interests of the shareholders of a Portfolio to make
a redemption payment wholly in cash, and subject to applicable agreements with
entities qualified under qualified pension and profit sharing plans, the Fund
may pay any portion of a redemption by distribution in kind of portfolio
securities in lieu of cash. Securities issued in a distribution in kind will be
readily marketable, although shareholders receiving distributions in kind may
incur brokerage commissions when subsequently redeeming shares of those
securities.
INVESTMENT LIMITATIONS
FUNDAMENTAL LIMITATIONS
Each Portfolio has adopted the following restrictions, which are fundamental
policies and may not be changed without the approval of the lesser of: (i) at
least 67% of the voting securities of the Portfolio present at a meeting if the
holders of more than 50% of the outstanding voting securities of the Portfolio
are present or represented by proxy, or (ii) more than 50% of the outstanding
voting securities of the Portfolio. Each Portfolio of the Fund will not:
(1) purchase or sell physical commodities, unless acquired as a result of
ownership of securities or other instruments, except this shall not prevent a
Portfolio from purchasing or selling futures contracts or options thereon or
from investing in securities or other instruments backed by physical
commodities;
(2) purchase or sell real estate, although it may purchase or sell
securities of companies that deal in real estate and may purchase and sell
securities that are secured by interests in real estate;
(3) lend any security or make any other loan if, as a result, more than 33
1/3% of its total assets would be lent to other parties, but this limitation
does not apply to purchases of debt securities or repurchase agreements;
(4) except with respect to the shares of Underlying Funds, with respect to
75% of the Portfolio's assets (i) purchase more than 10% of the outstanding
voting securities of any issuer or (ii) purchase securities of an issuer (except
obligations of the U.S. Government and its agencies and instrumentalities) if as
a result more than 5% of the Portfolio's total assets, at market value, would be
invested in the securities of such issuer;
(5) issue senior securities or borrow money, except from banks in an amount
not in excess of 33 1/3% of its total assets (including the amount borrowed)
less liabilities;
(6) underwrite securities issued by others, except to the extent that a
Portfolio may be considered an underwriter within the meaning of the 1933 Act in
the disposition of restricted securities; or
(7) acquire any securities of companies within one industry if, as a result
of such acquisition, 25% or more of the value of the Portfolio's total assets
would be invested in securities of companies within such industry; provided,
that (i) each Portfolio will invest at least 25% of its assets in shares of
investment companies, and (ii) there shall be no limitation on the purchase of
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities.
NON-FUNDAMENTAL LIMITATIONS
In addition, each Portfolio of the Fund has adopted non-fundamental
investment limitations as stated below. Such limitations may be changed without
shareholder approval. Each Portfolio of the Fund will not:
(1) sell short (other than "against the box") unless the Portfolio's
obligation is covered by unencumbered liquid assets in a segregated account and
by collateral held by the lending broker; provided that transactions in futures
contracts and options are not deemed to constitute selling securities short;
(2) invest for the purpose of exercising control over management of any
company;
(3) invest its assets in securities of any investment company except for
shares of the Underlying Funds, and as otherwise may be permitted by the 1940
Act;
(4) invest more than an aggregate of 15% of the net assets of the Portfolio
in illiquid securities;
20
<PAGE>
(5) make loans except (i) by purchasing bonds, debentures or similar
obligations (including repurchase agreements) that are publicly distributed, and
(ii) by lending its portfolio securities to banks, brokers, dealers and other
financial institutions so long as such loans are not inconsistent with the 1940
Act or the Rules and Regulations or interpretations of the SEC thereunder;
(6) purchase on margin, except for use of short-term credit as may be
necessary for the clearance of purchases and sales of securities, but it may
make margin deposits in connection with transactions in options, futures, and
options on futures; or
(7) purchase additional securities while borrowings exceed 5% of total
assets.
The percentage limitations contained in these restrictions apply at the time
of purchase of securities. Future Portfolios of the Fund may adopt different
limitations.
Notwithstanding the foregoing fundamental and non-fundamental investment
restrictions, the Underlying Funds in which the Portfolios invest have adopted
certain investment limitations which may be more or less restrictive than those
listed above, thereby permitting a Portfolio to engage in investment strategies
indirectly that are prohibited under the fundamental and non-fundamental
investment limitations listed above. The investment limitations of an Underlying
Fund are located in the Statement of Additional Information for such Underlying
Fund.
MANAGEMENT OF THE FUND
OFFICERS AND DIRECTORS
The Fund's officers, under the supervision of the Board of Directors, manage
the day-to-day operations of the Fund. The Directors set broad policies for the
Fund and choose its officers. Directors and officers of the Fund are also
directors and officers of some or all of the other investment companies managed,
administered, advised or distributed by Morgan Stanley Asset Management Inc.,
Miller Anderson & Sherrerd, LLP or their affiliates. Two Directors and all of
the officers of the Fund are directors, officers or employees of the Fund's
advisers, distributor or administrators. The other Directors have no affiliation
with the Fund's advisers, distributor or administrators. A list of the Directors
and officers of the Fund and a brief statement of their present positions and
principal occupations during the past five years is set forth below:
<TABLE>
<CAPTION>
NAME, ADDRESS AND DATE OF
BIRTH POSITION WITH FUND PRINCIPAL OCCUPATION DURING PAST FIVE YEARS
- ------------------------------ ---------------------- --------------------------------------------------
<S> <C> <C>
Barton M. Biggs* Chairman and Director Chairman, Director and Managing Director of Morgan
1221 Avenue of the Americas Stanley Asset Management Inc. and Morgan Stanley
New York, NY 10020 Asset Management Limited; Managing Director of
11/26/32 Morgan Stanley & Co. Incorporated; Director of
the Rand McNally Company; Member of the Yale
Development Board; Chairman and Director of
various investment companies managed by Morgan
Stanley Asset Management Inc.
Michael F. Klein* Director and President Principal of Morgan Stanley & Co. Incorporated and
1221 Avenue of the Americas Morgan Stanley Asset Management Inc.; President
New York, NY 10020 and Director of three investment companies and
12/12/58 Officer of various other investment companies
managed by Morgan Stanley Asset Management Inc.
Previously practiced law with the New York law
firm of Rogers & Wells.
John D. Barrett, II Director Chairman and Director of Barrett Associates,
521 Fifth Avenue Inc.(investment counseling); Director of the
New York, NY 10135 Ashforth Company (real estate); Director of
8/21/35 Morgan Stanley Universal Funds, Inc. and Morgan
Stanley Institutional Fund, Inc.
Gerard E. Jones Director Partner in Richards & O'Neil LLP (law firm);
43 Arch Street Director of Morgan Stanley Universal Funds, Inc.
Greenwich, CT 06830 and Morgan Stanley Institutional Fund, Inc.
1/23/37
Andrew McNally IV Director Director of Allendale Insurance Co., Mercury
8255 North Central Finance (consumer finance); Zenith Electronics,
Park Avenue Hubbell, Inc. (industrial electronics); Director
Skokie, IL 60076 of Morgan Stanley Universal Funds, Inc. and
11/11/39 Morgan Stanley Institutional Fund, Inc. Formerly,
Chairman and Chief Executive Officer of Rand
McNally & Company (publication).
Samuel T. Reeves Director Chairman of the Board and CEO, Pinacle Trading
8211 North Fresno Street L.L.C. (investments); Director, Pacific Gas and
Fresno, CA 93720 Electric and PG&E Enterprises (utilities);
7/28/34 Director of Morgan Stanley Universal Funds, Inc.
and Morgan Stanley Institutional Fund, Inc.
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
NAME, ADDRESS AND DATE OF
BIRTH POSITION WITH FUND PRINCIPAL OCCUPATION DURING PAST FIVE YEARS
- ------------------------------ ---------------------- --------------------------------------------------
<S> <C> <C>
Fergus Reid Director Chairman and Chief Executive Officer of LumeLite
85 Charles Colman Blvd Corporation (injection molding); Trustee and
Pawling, NY 12564 Director of Vista Mutual Fund Group; Director of
8/12/32 Morgan Stanley Universal Funds, Inc. and Morgan
Stanley Institutional Fund, Inc.
Frederick O. Robertshaw Director Of Counsel, Copple, Chamberlin & Boehm, P.C.;
2800 North Central Avenue Formerly, Of Counsel, Bryan, Cave LLP (law
Phoenix, AZ 85004 firms); Director of Morgan Stanley Universal
1/24/34 Funds, Inc. and Morgan Stanley Institutional
Fund, Inc.
Harold J. Schaaff, Jr.* Vice President Principal of Morgan Stanley & Co. Incorporated and
1221 Avenue of the Americas Morgan Stanley Asset Management Inc.; General
New York, NY 10020 Counsel and Secretary of Morgan Stanley Asset
6/10/60 Management Inc.; Vice President of various
investment companies managed by Morgan Stanley
Asset Management Inc.
Joseph P. Stadler* Vice President Principal of Morgan Stanley & Co. Incorporated and
1221 Avenue of the Americas Morgan Stanley Asset Management Inc.; Previously
New York, NY 10020 with Price Waterhouse LLP (accounting); Vice
6/7/54 President of various investment companies managed
by Morgan Stanley Asset Management Inc.
Stefanie Chang* Vice President Vice President of Morgan Stanley & Co.
1221 Avenue of the Americas Incorporated and Morgan Stanley Asset Management
New York, NY 10020 Inc.; Vice President of various investment
11/30/66 companies managed by Morgan Stanley Asset
Management Inc. Previously practiced law with the
New York law firm of Rogers & Wells.
Valerie Y. Lewis* Secretary Vice President of Morgan Stanley & Co.
1221 Avenue of the Americas Incorporated and Morgan Stanley Asset Management
New York, NY 10020 Inc.; Previously with Citicorp (banking);
3/26/56 Secretary of various investment companies managed
by Morgan Stanley Asset Management Inc.
Joanna Haigney Treasurer Assistant Vice President, Senior Manager of Fund
73 Tremont Street Administration and Compliance Services, Chase
Boston, MA 02108-3913 Global Funds Services Company; Treasurer of
10/10/66 various investment companies managed by Morgan
Stanley Asset Management Inc. Previously with
Coopers & Lybrand LLP.
Rene J. Feuerman Assistant Treasurer Manager of Fund Administration and Compliance
73 Tremont Street Services, Chase Global Funds Services Company;
Boston, MA 02108-3913 Previously Fund Administrator and Senior Fund
1/25/67 Accountant, Chase Global Funds Services Company.
</TABLE>
- ------------------
* "Interested Person" within the meaning of the 1940 Act.
REMUNERATION OF DIRECTORS AND OFFICERS
Members of the Board of Directors of the Fund do not receive compensation
for serving as Directors of the Fund. However, members of the Board of Directors
who are not "interested persons" within the meaning of the 1940 Act
("Noninterested Directors") are also members of the boards of directors of
certain other investment companies advised by MSAM or MAS (or by affiliated
companies), including certain Underlying Funds (such other investment companies
are referred to as the "Fund Complex"), and receive compensation from such other
investment companies in the Fund Complex. Accordingly, as shareholders of the
Underlying Funds, the Portfolios will indirectly bear their proportionate share
of Directors' compensation paid by the Fund Complex. The open-end investment
companies in the Fund Complex pay each of the Noninterested Directors an annual
aggregate compensation of $65,000, plus out-of-pocket expenses, and pay each of
the Noninterested Directors on the Board Audit Committees additional annual
aggregate compensation of $10,000 for serving on such committees. The aggregate
of such compensation for each Noninterested Director is allocated among the
open-end investment companies in direct proportion to their respective average
annual net assets. Column (2) in the following table sets forth that no
compensation was paid by the Fund to any Director for serving as a Director of
the Fund. Column (5) in the table sets forth aggregate compensation paid by the
Fund Complex to each Director during the fiscal year ended December 31, 1996.
Compensation amounts do not include reimbursements of out-of-pocket expenses.
Directors who are officers or otherwise "interested persons" receive no
remuneration for their services as Directors. As of December 10, 1997, to Fund
management's knowledge, the Directors and officers of the Fund, as a group,
owned less than 1% of the outstanding common stock of each Portfolio of the
Fund.
22
<PAGE>
COMPENSATION TABLE
<TABLE>
<CAPTION>
(3) (4)
PENSION OR ESTIMATED
(2) RETIREMENT ANNUAL
AGGREGATE BENEFITS ACCRUED BENEFITS
(1) COMPENSATION AS PART OF FUND UPON
NAME OF DIRECTOR FROM FUND EXPENSES RETIREMENT
- -------------------------------------------------------------------- ----------------- --------------------- ---------------
<S> <C> <C> <C>
Barton M. Biggs..................................................... $ 0 $ 0 $ 0
Michael F. Klein.................................................... 0 0 0
John D. Barrett, II(b).............................................. 0 0 0
Gerard E. Jones(b).................................................. 0 0 0
Andrew McNally, IV.................................................. 0 0 0
Samuel T. Reeves.................................................... 0 0 0
Fergus Reid(b)...................................................... 0 0 0
Frederick O. Robertshaw............................................. 0 0 0
<CAPTION>
(5)
TOTAL COMPENSATION
FROM FUND AND FUND
(1) COMPLEX PAID TO
NAME OF DIRECTOR DIRECTORS(A)
- -------------------------------------------------------------------- --------------------
<S> <C>
Barton M. Biggs..................................................... $ 0
Michael F. Klein.................................................... 0
John D. Barrett, II(b).............................................. 68,777(c)
Gerard E. Jones(b).................................................. 75,877(c)(d)
Andrew McNally, IV.................................................. 63,195(c)
Samuel T. Reeves.................................................... 61,331(c)
Fergus Reid(b)...................................................... 77,220(c)(d)
Frederick O. Robertshaw............................................. 58,777(c)
</TABLE>
- ------------------
(a) Amounts include $24,657, $24,657 and $28,450 of deferred compensation for
Messrs. McNally, Reeves and Reid, respectively.
(b) Member of Audit Committee of the Board of Directors of the Fund.
(c) Number of other investment companies in Fund Complex from whom Director is
expected to receive compensation: Mr. Barrett -- 2; Mr. Jones -- 3; Mr.
McNally -- 2; Mr. Reeves -- 2; Mr. Reid -- 3; Mr. Robertshaw -- 2.
(d) Includes amounts paid for service as Director of a closed-end investment
company in the Fund Complex, in addition to amounts paid by the open-end
investment companies.
INVESTMENT ADVISORY AND ADMINISTRATIVE AGREEMENTS
MSAM is a wholly owned subsidiary of Morgan Stanley, Dean Witter, Discover &
Co. ("MSDWD"). The principal offices of MSAM are at 1221 Avenue of the Americas,
New York, New York 10020. MSAM receives no compensation for advisory services to
the Portfolios.
Pursuant to a separate Administration Agreement with the Fund, MSAM provides
administrative services, including accounting, transfer agency, dividend
disbursement, and other services, directly or through third parties to the
Portfolios. For its services under the Administration Agreement, the Fund pays
MSAM a monthly fee which on an annual basis equals 0.15% of the average daily
net assets of each Portfolio.
Under a Sub-Administration Agreement between MSAM and The Chase Manhattan
Bank ("Chase"), Chase Global Funds Services Company ("Chase Global," a corporate
affiliate of Chase) provides dividend disbursing, transfer agent and other fund
accounting services to the Fund. Chase Global's business address is 73 Tremont
Street, Boston, Massachusetts 02108-3913.
DISTRIBUTION OF FUND SHARES
Under a Distribution Agreement with the Fund, Morgan Stanley & Co.
Incorporated ("Morgan Stanley"), a wholly owned subsidiary of MSDWD, serves as
exclusive distributor of the Portfolios and sells shares of each Portfolio on
the terms described in the Fund's Prospectus.
CODE OF ETHICS
The Board of Directors of the Fund has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act which incorporates the Code of Ethics of MSAM (together,
the "Codes"). The Codes restrict the personal investing activities of all
employees of MSAM and, as described below, impose additional, more onerous,
restrictions on the Fund's investment personnel.
The Codes require that all employees of MSAM preclear any personal
securities investment (with limited exceptions, such as government securities).
The preclearance requirement and associated procedures are designed to identify
any substantive prohibition or limitation applicable to the proposed investment.
The substantive restrictions applicable to all employees of MSAM include a ban
on acquiring any securities in an initial public offering and a prohibition from
profiting on short-term trading in securities. In addition, no employee may
purchase or sell any security that at the time is being purchased or sold (as
the case may be), or to the knowledge of the employee is being considered for
purchase or sale, by any fund advised by MSAM. Furthermore, the Codes provide
for trading "blackout periods" that prohibit trading by investment personnel of
the Fund within periods of trading by the Fund in the same (or equivalent)
security.
23
<PAGE>
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
As of December 10, 1997, the following persons were record or beneficial
owners of 5% or more of the outstanding shares of the Portfolios:
<TABLE>
<CAPTION>
PORTFOLIO NAME OF BENEFICIAL OWNER
- -------------------------------------------------------------------- ---------------------------------------------------
<S> <C>
Strategic Adviser Conservative Portfolio............................ Morgan Stanley, Dean Witter, Discover & Co.
1221 Avenue of the Americas
New York, NY 10020
Strategic Adviser Moderate Portfolio................................ Morgan Stanley, Dean Witter, Discover & Co.
1221 Avenue of the Americas
New York, NY 10020
Strategic Adviser Aggressive Portfolio.............................. Morgan Stanley, Dean Witter, Discover & Co.
1221 Avenue of the Americas
New York, NY 10020
<CAPTION>
PERCENT OF
OUTSTANDING
PORTFOLIO SHARES
- -------------------------------------------------------------------- -------------
<S> <C>
Strategic Adviser Conservative Portfolio............................ 100%
Strategic Adviser Moderate Portfolio................................ 100%
Strategic Adviser Aggressive Portfolio.............................. 100%
</TABLE>
MSDWD has voting power with respect to the voting securities in its
ownership. Consequently, under the 1940 Act, MSDWD may be deemed to be a
controlling person of the Portfolio.
To the best knowledge of the Fund, MSDWD's ownership of such securities is
for investment only, not for the purposes of control, but may materially affect
the voting rights of other shareholders.
PORTFOLIO TRANSACTIONS
The Portfolios will invest primarily in shares of the Underlying Funds.
Orders for transactions in the Underlying Funds will be placed with Morgan
Stanley or MAS Fund Distribution, Inc., the distributors for MSIF and MAS Funds,
respectively. Morgan Stanley also acts as distributor for the Portfolios.
PORTFOLIO TURNOVER
Each Portfolio's turnover rate for a year is calculated by dividing the
lesser of the value of the purchases or sales for the year by the average
monthly market value of the Portfolio for the year. The rate of portfolio
turnover will not be a limiting factor when a Portfolio deems it appropriate to
purchase or sell shares of the Underlying Funds or other portfolio securities.
PERFORMANCE INFORMATION
The Fund may from time to time quote various performance figures to
illustrate a Portfolio's past performance.
Performance quotations by investment companies are subject to rules adopted
by the SEC, which require the use of standardized performance quotations. In the
case of total return, non-standardized performance quotations may be furnished
by the Fund but must be accompanied by certain standardized performance
information computed as required by the SEC. Current yield and average annual
compounded total return quotations used by the Fund are based on the
standardized methods of computing performance mandated by the SEC. An
explanation of those and other methods used by the Fund to compute or express
performance follows.
TOTAL RETURN
From time to time each Portfolio may advertise total return for the shares
of the Portfolio. Total return figures are based on historical earnings and are
not intended to indicate future performance. The average annual total return is
determined by finding the average annual compounded rates of return over 1-, 5-,
and 10-year periods (or over the life of the Portfolio) that would equate an
initial hypothetical $1,000 investment to its ending redeemable value. The
calculation assumes that all dividends and distributions are reinvested when
paid. The quotation assumes the amount was completely redeemed at the end of
each 1-, 5-, and 10-year period (or over the life of the Portfolio) and the
deduction of all applicable Fund expenses on an annual basis.
These total returns are calculated according to the following formula:
<TABLE>
<C> <C> <S>
P(1+T)n = ERV
</TABLE>
where:
<TABLE>
<C> <C> <S>
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of hypothetical $1,000 payment made at the beginning
of the 1-, 5-, or 10-year periods at the end of the 1-, 5-, or 10-year
periods (or fractional portion thereof).
</TABLE>
24
<PAGE>
CALCULATION OF YIELD
From time to time certain of the Portfolios may advertise yield.
Current yield reflects the income per share earned by a Portfolio's
investments.
Current yield is determined by dividing the net investment income per share
earned during a 30-day base period by the maximum offering price per share on
the last day of the period and annualizing the result. Expenses accrued for the
period include any fees charged to all shareholders during the base period.
Yield is obtained using the following formula:
<TABLE>
<S> <C> <C>
2[(a - b + 1)(6) -
1]
Yield = -----------
cd
</TABLE>
where:
<TABLE>
<C> <C> <S>
a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the period that were entitled
to receive income distributions
d = the maximum offering price per share on the last day of the period
</TABLE>
COMPARISONS
To help investors better evaluate how an investment in a Portfolio might
satisfy their investment objective, advertisements regarding the Fund may
discuss various measures of Fund performance as reported by various financial
publications. Advertisements may also compare performance (as calculated above)
to performance as reported by other investments, indices and averages. The
following publications may be used:
(a) CDA Mutual Fund Report, published by CDA Investment Technologies,
Inc. analyzes price, current yield, risk, total return and average rate of
return (average annual compounded growth rate) over specified time periods for
the mutual fund industry.
(b) Financial publications: Business Week, Changing Times, Financial
World, Forbes, Fortune, Money, Barron's, Consumer's Digest, Financial Times,
Global Investor, Investor's Daily, Lipper Analytical Services, Inc.,
Morningstar, Inc., New York Times, Personal Investor, Wall Street Journal and
Weisenberger Investment Companies Service -- publications that rate fund
performance over specified time periods.
(c) Financial Times Actuaries World Ex U.S. Index -- The FT-A World EX
U.S. Index is a capitalization-weighted price index, expressed in dollars, after
dividend withholding taxes, of foreign stock prices. This index is calculated
daily and reflects price changes in 24 major foreign equity markets. It is
jointly compiled by the Financial Times, Ltd., Goldman Sachs & Co., and Country
NatWest/Wood Mackenzie in conjunction with the Institute of Actuaries and the
Faculty of Actuaries.
(d) Historical data supplied by the research departments of First Boston
Corporation, the J.P. Morgan companies, Salomon Brothers, Merrill Lynch, Pierce,
Fenner & Smith, Lehman Brothers and Bloomberg L.P.
(e) Lipper Analytical Services -- Mutual Fund Performance Analysis and
Lipper -- Fixed Income Fund Performance Analysis -- measures total return and
average current yield for the mutual fund industry. Ranks individual mutual fund
performance over specified time periods, assuming reinvestment of all
distributions, exclusive of any applicable sales charges.
(f) Mutual Fund Source Book, published by Morningstar, Inc. -- analyzes
price, yield, risk and total return for equity funds.
(g) Savings and Loan Historical Interest Rates -- as published in the
U.S. Savings & Loan League Fact Book.
(h) Stocks, Bonds, Bills and Inflation, published by Hobson Associates --
historical measure of yield, price and total return for common and small company
stock, long-term government bonds, U.S. Treasury bills and inflation.
The following indices and averages may also be used:
(a) Composite Indices -- 70% Standard & Poor's 500 Stock Index and 30%
NASDAQ Industrial Index; 35% Standard & Poor's 500 Stock Index and 65% Salomon
Brothers High Grade Bond Index; and 65% Standard & Poor's 500 Stock Index and
35% Salomon Brothers High Grade Bond Index.
(b) Consumer Price Index (or Cost of Living Index), published by the U.S.
Bureau of Labor Statistics -- a statistical measure of change, over time, in the
price of goods and services in major expenditure groups.
(c) Donoghue's Money Fund Average -- an average of all major money market
fund yields, published weekly for 7 and 30-day yields.
25
<PAGE>
(d) Dow Jones Composite Average or its component averages -- an unmanaged
index composed of 30 blue-chip industrial corporation stocks (Dow Jones
Industrial Average), 15 utilities company stocks and 20 transportation stocks.
Comparisons of performance assume reinvestment of dividends.
(e) EMBI+ -- Expanding on the EMBI, which includes all Bradys, the EMBI+
includes a broader group of Brady Bonds, loans, Eurobonds and the U.S. Dollar
local markets instruments. A more comprehensive benchmark than the EMBI, the
EMBI+ is not, however, intended to replace the EMBI but rather to complement it.
The EMBI continues to represent the most liquid, most easily traded segment of
the market, including more of the assets that investors typically hold in their
portfolios. Both of these indices are published daily.
(f) CS First Boston High Yield Index -- generally includes over 180
issues with an average maturity range of seven to ten years with a minimum
capitalization of $100 million. All issues are individually trader-priced
monthly.
(g) CS First Boston Upper/Middle Tier High Yield Index -- an unmanaged
index of bonds rated B to BBB.
(h) Goldman Sachs 100 Convertible Bond Index -- currently includes 67
bonds and 33 preferred stocks. The original list of names was generated by
screening for convertible issues of $100 million or greater in market
capitalization. The index is priced monthly.
(i) IFC Global Total Return Composite Index -- an unmanaged index of
common stocks and includes 18 developing countries in Latin America, East and
South Asia, Europe, the Middle East and Africa (net of dividends reinvested).
(j) Indata Balanced-Median Index -- an unmanaged index and includes an
asset allocation of 2.5% cash, 38.2% bonds and 59.3% equity based on $52.6
billion in assets among 579 portfolios for the year ended December 31, 1996
(assumes dividends reinvested).
(k) Indata Equity-Median Stock Index -- an unmanaged index which includes
an average asset allocation of 7.4% cash and 92.6% equity based on $464.9
billion in assets among 1,277 portfolios for the year ended December 31, 1996.
(l) International Finance Corporation Emerging Markets Index -- an index
designed to measure the total return in either U.S. or local currency terms of
developing markets as defined by the World Bank. The selection of stocks is made
based on size, liquidity and industry. The weight given to any stock is
determined by its market capitalization.
(m) J.P. Morgan Emerging Markets Bond Index -- a market-weighted index
composed of all Brady bonds outstanding and includes Argentina, Brazil,
Bulgaria, Mexico, Nigeria, the Philippines, Poland and Venezuela.
(n) J.P. Morgan Emerging Markets Bond Index Plus -- The Emerging Markets
Bond Index Plus (EMBI+) reflects total returns for external debt instruments
which have been traded in the emerging markets. Brady bonds are included among
such instruments, as well as Eurobonds, loans, and US dollar denominated local
market instruments. Countries included in the index are Argentina, Brazil,
Bulgaria, Ecuador, Mexico, Morocco, Nigeria, Panama, Peru, the Philippines,
Poland, Russia, South Africa, and Venezuela. The EMBI+ is an expansion of the JP
Morgan EMBI, which only tracks Brady bonds.
(o) J.P. Morgan Traded Global Bond Index -- an unmanaged index of
securities which includes Australia, Belgium, Canada, Denmark, France, Germany,
Italy, Japan, The Netherlands, Spain, Sweden, United Kingdom and the United
States.
(p) J.P. Morgan Traded Government Bond Index -- designed to provide a
comprehensive measure of total return performance of the domestic Government
bond market of 13 countries. The index is maintained by J.P. Morgan Securities,
Inc. and includes only liquid assets.
(q) Lehman Brothers 5-Year Municipal Bond Index -- a total return
performance benchmark for the intermediate investment grade tax exempt bond
market. The Index includes general obligation bonds, revenue bonds, insured
bonds and prefunded bonds with maturities between 4 and 6 years.
(r) Lehman Brothers 7-Year Municipal Bond Index -- an unmanaged index
which consists of investment grade bonds with maturities between 6-8 years rated
Baa or better. All bonds have been taken from deals done within the last 5
years, with assets of $50 million or greater.
(s) Lehman Brothers 10-Year Municipal Bond Index -- a total return
performance benchmark for the long term, investment grade tax-exempt bond
market. The index includes general obligation bonds, revenue bonds, insured
bonds and prefunded bonds with maturities between 8 and 12 years.
(t) Lehman Brothers Aggregate Bond Index -- an unmanaged index made up of
the Government/Corporate Index, the Mortgage Backed Securities Index and the
Asset-Backed Securities Index.
(u) Lehman Brothers Government/Corporate Index -- a combination of the
Government and Corporate Bond Indices. The Government Index includes public
obligations of the U.S. Treasury, issues of Government agencies and corporate
debt backed by the U.S. Government. The Corporate Bond Index includes fixed rate
nonconvertible corporate debt. Also included are Yankee Bonds and nonconvertible
debt issued or guaranteed by foreign or international governments and agencies.
26
<PAGE>
All issues are investment grade (BBB) or higher, with maturities of at least one
year and an outstanding par value of at least $100 million for U.S. Government
issues and $25 million for others. Any security downgraded during the month is
held in the index until month-end and then removed. All returns are market value
weighted inclusive of accrued income.
(v) Lehman Brothers Intermediate Government/Corporate Index -- a
combination of the Government and Corporate Bond Indices. All issues are
investment grade (BBB) or higher, with maturities of one to ten years and an
outstanding par value of at least $100 million for U.S. Government issues and
$25 million for others. The Government Index includes public obligations of the
U.S. Treasury, issues of Government agencies, and corporate debt backed by the
U.S. Government. The Corporate Bond Index includes fixed rate nonconvertible
corporate debt. Also included are Yankee Bonds and nonconvertible debt issued or
guaranteed by foreign or international governments and agencies. Any security
downgraded during the month is held in the index until month-end and then
removed. All returns are market value weighted inclusive of accrued income.
(w) Lehman Brothers Long Municipal Bond Index -- a total return for the
long-term, investment-grade tax-exempt bond market for bonds. The index includes
municipal bonds with maturities of 22 years or more.
(x) Lehman Brothers LONG-TERM Treasury Bond Index -- composed of all
bonds covered by the Lehman Brothers Treasury Bond Index with maturities of 10
years or greater.
(y) Lehman Brothers Mortgage-Backed Securities Index -- includes fixed
rate mortgage securities backed by GNMA, FHLMC and FNMA. Graduated Payment
Mortgages (GPMs) are included. All issues are AAA, with maturities on at least
one year and outstanding par values of at least $100 million. Returns are market
value weighted inclusive of accrued income.
(z) Lipper Capital Appreciation Index -- a composite of mutual funds
managed for maximum capital gains.
(aa) Lipper Growth & Income Fund Index -- a net asset value weighted index
of the 30 largest Funds within the Growth & Income investment objective. It is
calculated daily with adjustments for income dividends and capital gains
distribution as of the ex-dividend dates.
(bb) Lipper High Current Yield Fund Average -- reports the average return
of all funds tracked by Lipper Analytical Services, Inc. classified as high
yield funds. The number of funds tracked varies. As a result, reported returns
for longer time periods do not always match the linked product of shorter period
returns.
(cc) Lipper Money Market Average -- reports the average return of all the
Funds tracked by Lipper Analytical Services, Inc., classified as money market
Funds for any given period. The number of Funds tracked varies. As a result,
reported returns for longer time periods do not always match the linked product
of shorter period returns.
(dd) Merrill Lynch Corporate & Government Bond Index -- includes over
4,500 U.S. Treasury, Agency and investment grade corporate bonds. The Index is
calculated daily and will be used from time to time in performance comparison
for partial month periods.
(ee) Morgan Stanley Capital International Combined Far East Free ex-Japan
Index -- a market-capitalization weighted index comprising stocks in Hong Kong,
Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand. Korea
is included in the MSCI Combined Far East Free ex-Japan Index at 20% of its
market capitalization.
(ff) Morgan Stanley Capital International EAFE Index -- an arithmetic,
market value-weighted average of the performance of over 900 securities on the
stock exchanges of countries in Europe, Australia and the Far East.
(gg) Morgan Stanley Capital International EAFE-GDP Weighted Index -- an
arithmetic average of the performance of over 900 securities listed on the stock
exchanges of countries in Europe, Australia and the Far East. The index is
weighted by the Gross Domestic Product of the various countries in the index.
(hh) Morgan Stanley Capital International Emerging Markets Free Index -- a
capitalization weighted index of over 800 stocks from 17 different emerging
market countries.
(ii) Morgan Stanley Capital International Emerging Markets Global Latin
American Index -- an unmanaged, arithmetic, market value-weighted average of the
performance of over 196 securities on the stock exchanges of Argentina, Brazil,
Chile, Colombia, Mexico, Peru and Venezuela (assumes reinvestment of dividends).
(jj) Morgan Stanley Capital International Europe Index -- an unmanaged
index of common stocks and includes 14 countries throughout Europe.
(kk) Morgan Stanley Capital International Japan Index -- an unmanaged
index of common stocks.
(ll) Morgan Stanley Capital International Latin America Index -- a
broad-based market capitalization-weighted composite index covering at least 60%
of markets in Mexico, Argentina, Brazil, Chile, Colombia, Peru and Venezuela
(assumes dividends reinvested).
(mm) Morgan Stanley Capital International World Index -- an arithmetic,
market value-weighted average of the performance of over 1,470 securities listed
on the stock exchanges of countries in Europe, Australia, the Far East, Canada
and the United States.
27
<PAGE>
(nn) Morgan Stanley Capital International World ex USA Index -- a
capitalization-weighted price index expressed in dollars. The index reflects the
performance of over 1,100 companies in 19 foreign countries in Europe, Australia
and the Far East.
(oo) NASDAQ Composite Index -- an unmanaged index of common stocks.
(pp) NASDAQ Industrial Index -- a capitalization-weighted index composed
of more than 3,000 domestic stocks taken from the following industry sectors:
agriculture, mining, construction, manufacturing, electronic components,
services and public administration enterprises. It is a value-weighted index
calculated on price change only and does not include income.
(qq) NASDAQ Industrials Index -- a measure of all NASDAQ National Market
System issues classified as industrial based on Standard Industrial
Classification codes relative to a company's major source of revenue. The index
is exclusive of warrants, and all domestic common stocks traded in the regular
NASDAQ market which are not part of the NASDAQ National Market System. The
NASDAQ Industrials Index is value weighted.
(rr) National Association of Real Estate Investment Trusts ("NAREIT")
Index -- an unmanaged market-weighted index of tax qualified REITs (excluding
healthcare REITs) listed on the New York Stock Exchange, American Stock Exchange
and the NASDAQ National Market System including dividends.
(ss) The New York Stock Exchange composite or component indices --
unmanaged indices of all industrial, utilities, transportation and finance
company stocks listed on the New York Stock Exchange.
(tt) Philadelphia Gold and Silver Index -- an unmanaged index comprised
of seven leading companies involved in the mining of gold and silver.
(uu) Russell 1000 Index -- consists of the 1,000 largest of the 3,000
largest stocks. Market capitalization is typically between $610 million and $85
billion. The list is rebalanced each year on June 30. If a stock is taken over
or goes bankrupt, it is not replaced until rebalancing. Therefore, there can be
fewer than 1,000 stocks in the Russell 1000 Index. The index is an equity market
capitalization weighted index available from Frank Russell & Co. on a monthly
basis.
(vv) Russell 1000 Growth Index -- contains the securities of the Russell
1000 which possess an above-average growth orientation. These securities tend to
exhibit higher price-to-book and price-earnings ratios, lower dividend yields
and higher forecasted growth.
(ww) Russell 2000 Index -- consists of the 2,000 smallest of the 3,000
largest stocks. Market capitalization is typically between $610 million and $57
billion. The list is rebalanced each year on June 30. If a stock is taken over
or goes bankrupt, it is not replaced until rebalancing. Therefore, there can be
fewer than 2,000 stocks in the Russell 2000 Index. The index is an equity market
capitalization weighted index available from Frank Russell & Co. on a monthly
basis.
(xx) Russell 2000 Growth Index -- comprised of those Russell 2000
Securities with an above-average growth orientation. Here, securities tend to
exhibit higher price-to-book and price-earnings ratios, lower dividend yields
and higher forecasted growth than the value universe.
(yy) Russell 2500 Index -- comprised of the bottom 500 stocks in the
Russell 1000 Index which represents the universe of stocks from which most
active money managers typically select; and all the stocks in the Russell 2000
Index. The largest security in the index has a market capitalization of
approximately $1.3 billion.
(zz) Russell 3000 Index -- a combination of the Russell 1000 Index and the
Russell 2000 Index.
(aaa) Salomon 1-3 Year Treasury / Government Sponsored Index -- includes
U.S. Treasury and agency securities with maturities one year or greater and less
than three years. Securities with amounts outstanding of at least $25 million
are included in the index.
(bbb) Salomon 1-3 Year Treasury / Government Sponsored/Corporate Index --
includes U.S. Treasury, agency and investment grade (BBB or better) securities
with maturities one year or greater and less than three years. Securities with
amounts outstanding of at least $25 million are included in the index.
(ccc) Salomon Broad Index -- also known as the Salomon Broad Investment
Grade (BIG) Index, is a fixed income market capitalization-weighted index,
including U.S. Treasury, agency, mortgage and investment grade (BBB or better)
corporate securities with maturities of one year or longer and with amounts
outstanding of at least $25 million. The government index includes traditional
agencies; the mortgage index includes agency pass-throughs and FHA and GNMA
project loans, the corporate index includes returns for 17 industry sub-sectors.
Securities excluded from the Broad Index are floating/variable rate bonds,
private placements and derivatives (e.g., U.S. Treasury zeros, CMOs, mortgage
strips). Every issue is trader-priced at month-end and the index is published
monthly.
(ddd) Salomon Brothers GNMA Index -- includes pools of mortgages originated
by private lenders and guaranteed by the mortgage pools of the Government
National Mortgage Association.
28
<PAGE>
(eee) Salomon Brothers High Grade Corporate Bond Index -- consists of
publicly issued, non-convertible corporate bonds rated AA or AAA. It is a
value-weighted, total return index, including approximately 800 issues with
maturities of 12 years or greater.
(fff) Salomon Brothers Broad Investment Grade Bond Index -- a
market-weighted index that contains approximately 4700 individually priced
investment grade corporate bonds rated BBB or better, U.S. Treasury/agency
issues and mortgage pass-through securities.
(ggg) Salomon High-Yield Market Index -- includes public, non-convertible
corporate bond issues with at least one year remaining to maturity and $50
million in par amount outstanding which carry a below investment-grade quality
rating from either Standard & Poor's or Moody's rating services.
(hhh) Salomon Mortgage Index -- includes agency pass-throughs (GNMA, FHLMC,
FNMA) and FHA and GNMA project loans. Pools with remaining terms shorter than 25
years are seasoned; pools with longer terms are classified as new. The index is
published monthly.
(iii) Salomon 1-3 Year Treasury Index -- includes only U.S. Treasury Notes
and Bonds with maturities one year or greater and less than three years.
(jjj) Salomon World Government Bond Index -- designed to provide a
comprehensive measure of total return performance of the domestic Government
bond market of thirteen countries. The index has been constructed with the aim
of choosing an "all inclusive" universe of institutionally traded fixed rate
bonds. The selection of security types to be included in the index is made with
the aim of being as comprehensive as possible, while satisfying the criterion of
reasonable availability to domestic and international institutions and the
existence of complete pricing and market profile data.
(kkk) Salomon World Government Bond Index ex U.S. -- designed to provide a
comprehensive measure of total return performance of the domestic government
bond markets of 12 countries outside the United States. The index has been
constructed with the aim of choosing "an inclusive" universe of institutionally
traded fixed rate bonds. The selection of security types to be included in the
index is made with the aim of being as comprehensive as possible, while
satisfying the criterion of reasonable availability to domestic and
international institutions and the existence of complete pricing and market
profile data.
(lll) S&P/BARRA Mid Cap 400 Growth Index -- constructed by dividing the
stocks in the S&P MidCap 400 Index according to a single attribute:
price-to-book ratios. The MidCap 400 Growth Index is composed of firms with
higher price-to-book ratios. Like the MidCap 400, the MidCap 400 Growth Index is
capitalization-weighted, meaning that each stock is weighted in the appropriate
index in proportion to its market value.
(mmm) S&P Ex South Africa Index -- the same as the S&P 500 Index excluding
companies that are on the Investor Responsibility Research Center (IRRC) list of
companies doing business in South Africa. This index is maintained by Wilshire
Associates.
(nnn) Standard & Poor's 500 Stock Index or its component indices --
unmanaged index composed of 400 industrial stocks, 40 financial stocks, 40
utilities company stocks and 20 transportation stocks. Comparisons of
performance assume reinvestment of dividends.
(ooo) Standard & Poor's MidCap 400 Index -- a market-value weighted index.
The companies chosen for the Index generally have market values between $800
million and $3 billion, depending upon current equity market valuations and
represent a broad range of industry segments within the U.S. economy.
(ppp) Standard & Poor's Small Cap 600 Index -- a capitalization-weighted
index of 600 domestic stocks having market capitalizations which reside within
the 50th and the 83rd percentiles of the market capitalization of the entire
stock market, chosen for certain liquidity characteristics and for industry
representation.
(qqq) Wilshire 5000 Equity Index or its component indices -- represents the
return on the market value of all common equity securities for which daily
pricing is available. Comparisons of performance assume reinvestment of
dividends.
In assessing such comparisons of performance an investor should keep in mind
that the composition of the investments in the reported indices and averages is
not identical to the composition of investments in the Fund's Portfolios, that
the averages are generally unmanaged, and that the items included in the
calculations of such averages may not be identical to the formula used by the
Fund to calculate its figures. In addition, there can be no assurance that the
Fund will continue this performance as compared to such other averages.
GENERAL PERFORMANCE INFORMATION
Each Portfolio's performance will fluctuate, unlike bank deposits or other
investments which pay a fixed yield for a stated period of time. Past
performance is not necessarily indicative of future return. Actual performance
will depend on such variables as portfolio quality, average portfolio maturity,
the type of portfolio instruments acquired, changes in interest rates, portfolio
expenses and other factors. Performance is one basis investors may use to
analyze a Portfolio as compared to other funds and
29
<PAGE>
other investment vehicles. However, performance of other funds and other
investment vehicles may not be comparable because of the foregoing variables,
and differences in the methods used in valuing their portfolio instruments,
computing net asset value and determining performance.
From time to time, a Portfolio's performance may be compared to other mutual
funds tracked by financial or business publications and periodicals. For
example, a Portfolio may quote Morningstar, Inc. in its advertising materials.
Morningstar, Inc. is a mutual fund rating service that rates mutual funds on the
basis of risk-adjusted performance. Rankings that compare the performance of the
Funds to one another in appropriate categories over specific periods of time may
also be quoted in advertising.
Portfolio advertising may include data on historical returns of the capital
markets in the United States compiled or published by Ibbotson Associates of
Chicago, Illinois ("Ibbotson"), including returns on common stocks, small
capitalization stocks, long-term corporate bonds, intermediate-term government
bonds, long-term government bonds, Treasury bills, the U.S. rate of inflation
(based on the Consumer Price Index), and combinations of various capital
markets. The performance of these capital markets is based on the returns of
different indices. The Portfolios may use the performance of these capital
markets in order to demonstrate general risk-versus-reward investment scenarios.
Performance comparisons may also include the value of a hypothetical investment
in any of these capital markets. The risks associated with the security types in
any capital market may or may not correspond directly to those of the
Portfolios. The Portfolios may also compare their performance to that of other
compilations or indices that may be developed and made available in the future.
The Portfolios may include in advertisements, charts, graphs or drawings
which illustrate the potential risks and rewards of investment in various
investment vehicles, including but not limited to, foreign securities, stocks,
bonds, treasury bills and shares of a Portfolio. In addition, advertisements may
include a discussion of certain attributes or benefits to be derived by an
investment in a Portfolio and/or other mutual funds, shareholder profiles and
hypothetical investor scenarios, timely information on financial management, tax
and retirement planning and various investment alternatives. Advertisements may
include lists of representative Morgan Stanley clients. The Portfolios may also
from time to time include discussions or illustrations of the effects of
compounding in advertisements. "Compounding" refers to the fact that, if
dividends or other distributions on a Portfolio investment are reinvested by
being paid in additional Portfolio shares, any future income or capital
appreciation of a Portfolio would increase the value, not only of the original
investment in the Portfolio, but also of the additional Portfolio shares
received through reinvestment.
The Portfolios may include in advertisements, discussions or illustrations
of the potential investment goals of a prospective investor (including materials
that describe general principles of investing, such as asset allocation,
diversification, risk tolerance, goal setting, questionnaires designed to help
create a personal financial profile, worksheets used to project savings needs
based on assumed rates of inflation and hypothetical rates of return and action
plans offering investment alternatives), investment management techniques,
policies or investment suitability of a Portfolio (such as value investing,
market timing, dollar cost averaging, asset allocation, constant ratio transfer,
automatic account rebalancing, the advantages and disadvantages of investing in
tax-deferred and taxable investments). Advertisements and sales materials
relating to a Portfolio may include information regarding the background and
experience of its portfolio managers; the resources, expertise and support made
available to the portfolio managers by Morgan Stanley; and the portfolio
manager's goals, strategies and investment techniques.
The Portfolios' advertisements may discuss economic and political conditions
of the United States and foreign countries, the relationship between sectors of
the U.S., a foreign, or the global economy and the U.S., a foreign, or the
global economy as a whole and the effects of inflation. The Portfolios may
include discussions and illustrations of the growth potential of various global
markets including, but not limited to, Africa, Asia, Europe, Latin America,
North America, South America, Emerging Markets and individual countries. These
discussions may include the past performance of the various markets or market
sectors; forecasts of population, gross national product and market performance;
and the underlying data which supports such forecasts. From time to time,
advertisements, sales literature, communications to shareholders or other
materials may summarize the substance of information contained in the
Portfolios' shareholder reports (including the investment composition of a
Portfolio), as well as the views of Morgan Stanley as to current market,
economic, trade and interest rate trends, legislative, regulatory and monetary
developments, investment strategies and related matters believed to be of
relevance to a Portfolio.
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The Portfolios may quote various measures of volatility and benchmark
correlation in advertising. The Portfolios may compare these measures to those
of other funds. Measures of volatility seek to compare the historical share
price fluctuations or total returns to those of a benchmark. Measures of
benchmark correlation indicate how valid a comparative benchmark may be.
Measures of volatility and correlation may be calculated using averages of
historical data. A Portfolio may also advertise its current interest rate
sensitivity, duration, weighted average maturity or similar maturity
characteristics.
The Portfolio may advertise examples of the effects of periodic investment
plans, including the principle of dollar cost averaging. In such a program, an
investor invests a fixed dollar amount in a Portfolio at periodic intervals,
thereby purchasing fewer shares when prices are high and more shares when prices
are low. While such a strategy does not assure a profit or guard against loss in
a declining market, the investor's average cost per share can be lower than if
fixed numbers of shares are purchased at the same intervals. In evaluating such
a plan, investors should consider their ability to continue purchasing shares
during periods of low price levels.
GENERAL INFORMATION
DESCRIPTION OF SHARES AND VOTING RIGHTS
The Fund's Articles of Incorporation currently permit the Directors to issue
three billion shares of common stock, par value $.001 per share, from an
unlimited number of classes ("Portfolios") of shares. Currently the Fund
consists of shares of three Portfolios.
When issued, the shares of each Portfolio of the Fund will be fully paid and
nonassessable, and have no preference as to conversion, exchange, dividends,
retirement or other features. The shares of each Portfolio of the Fund have no
pre-emptive rights. The shares of the Fund have non-cumulative voting rights,
which means that the holders of more than 50% of the shares voting for the
election of Directors can elect 100% of the Directors if they choose to do so. A
shareholder is entitled to one vote for each full share held (and a fractional
vote for each fractional share held), then standing in his name on the books of
the Fund.
DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
The Fund's policy is to distribute substantially all of each Portfolio's net
investment income, if any. The Fund may also distribute any net realized capital
gains in the amount and at the times that will avoid both income (including
taxable gains) taxes on it and the imposition of the federal excise tax on
income and capital gains (see discussion under "Taxes" in this Statement of
Additional Information). However, the Fund may also choose to retain net
realized capital gains and pay taxes on such gains. The amounts of any income
dividends or capital gains distributions cannot be predicted. Any dividend or
distribution paid by a Portfolio will have the effect of reducing the per share
net asset value of that Portfolio by the per share amount of the dividend or
distribution.
As set forth in the Prospectus, unless the shareholder elects otherwise in
writing, all dividends and capital gains distributions for a class of shares are
automatically received in additional shares of such class of that Portfolio of
the Fund at the net asset value as of the business day following the record
date. This automatic reinvestment of dividends and distributions will remain in
effect until the Fund is notified by the shareholder in writing at least three
days prior to the record date that either the Income Option (income dividends in
cash and capital gains distributions in additional shares at net asset value) or
the Cash Option (both income dividends and capital gains distributions in cash)
has been elected.
CUSTODY ARRANGEMENTS
Chase acts as the Fund's custodian. Chase is not affiliated with Morgan
Stanley.
DESCRIPTION OF CERTAIN SECURITIES RATINGS
DESCRIPTION OF COMMERCIAL PAPER -- RATINGS
DESCRIPTION OF MOODY'S RATINGS OF STATE AND MUNICIPAL NOTES: Moody's
ratings for state and municipal notes and other short-term obligations are
designated Moody's Investment Grade ("MIG"). Symbols used are as follows: MIG-1
- -- best quality, enjoying strong protection from established cash flows of funds
for their servicing or from established broad-based access to the market for
refinancing, or both; MIG-2 -- high quality with margins of protection ample
although not so large as in the preceding group; MIG-3 -- favorable quality,
with all security elements accounted for but lacking the undeniable strength of
the preceding grades.
DESCRIPTION OF MOODY'S HIGHEST COMMERCIAL PAPER RATING: Prime-1 ("P1") --
Judged to be of the best quality. Their short-term debt obligations carry the
smallest degree of investment risk.
EXCERPT FROM S&P'S RATING OF MUNICIPAL NOTE ISSUES: SP-1+ -- very strong
capacity to pay principal and interest; SP-2 -- strong capacity to pay principal
and interest.
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<PAGE>
DESCRIPTION OF S&P'S HIGHEST COMMERCIAL PAPER RATINGS: A-1+ -- this
designation indicates the degree of safety regarding timely payment is
overwhelming. A-1 -- this designation indicates the degree of safety regarding
timely payment is very strong.
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS:
Aaa -- Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt-edge."
Interest payments are protected by a large or by an exceptionally stable margin
and principal is secure. While the various protective elements are likely to
change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa -- Bonds rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as for Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risks appear somewhat larger than in Aaa securities.
A -- Bonds rated A possess many favorable investment attributes and are to
be considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
Baa -- Bonds rated Baa are considered as medium-grade obligations, i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba -- Bonds rated Ba are judged to have speculative elements. Their future
cannot be considered as well assured. Often the protection of interest and
principal payments may be very moderate and thereby not well safeguarded during
both good and bad times over the future. Uncertainty of position characterizes
bonds in this class.
B -- Bonds rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa -- Bonds rated Caa are of poor standing. Such issues may be in default
or there may be present elements of danger with respect to principal or
interest.
Ca -- Bonds rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked short-comings.
C -- Bonds rated C are the lowest-rated class of bonds and issues so rated
can be regarded as having extremely poor prospects of ever attaining any real
investment standing.
Moody's applies numerical modifiers 1, 2 and 3, in each generic rating
classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
DESCRIPTION OF S&P'S CORPORATE BOND RATINGS:
AAA -- Debt rated AAA has the highest rating assigned by S&P's to a debt
obligation. Capacity to pay interest and repay principal is extremely strong.
AA -- Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher-rated issues only in small degree.
A -- Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions.
BBB -- Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
BB -- Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions that could lead to
inadequate capacity to meet timely interest and principal payments.
B -- Debt rated B has greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The B rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied BB-rating.
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<PAGE>
CCC -- Debt rated CCC has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial, and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial, or economic conditions, it is not likely to have
the capacity to pay interest and repay principal.
CC -- Debt rated CC is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC debt rating.
C -- The rating C is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC- debt rating. The C rating may be
used to cover a situation where a bankruptcy petition has been filed but debt
service payments are continued.
CI -- The rating CI is reserved for income bonds on which no interest is
being paid.
D -- Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating will also be used upon the
filing of a bankruptcy petition if debt service payments are jeopardized.
FINANCIAL STATEMENTS
Because the Portfolios have only recently commenced operations, audited
financial statements for the Portfolios have not been included. The Fund's
Statements of Assets and Liabilities dated October 29, 1997 and the report
thereon of Price Waterhouse LLP, independent accountants, are included herein.
33
<PAGE>
APPENDIX A
The following is a list of the Underlying Funds which are investment
portfolios of MORGAN STANLEY INSTITUTIONAL FUND, INC., with their respective
investment objectives and a brief statement of their investment policies.
GLOBAL AND INTERNATIONAL EQUITY PORTFOLIOS:
The ACTIVE COUNTRY ALLOCATION PORTFOLIO seeks long-term capital appreciation
by investing in accordance with country weightings determined by MSAM in equity
securities of non-U.S. issuers which, in the aggregate, replicate broad country
indices.
The ASIAN EQUITY PORTFOLIO seeks long-term capital appreciation by investing
primarily in equity securities of Asian issuers.
The ASIAN REAL ESTATE PORTFOLIO seeks to provide long-term capital
appreciation by investing primarily in equity securities of companies in the
Asian real estate industry.
The CHINA GROWTH PORTFOLIO seeks to provide long-term capital appreciation
by investing primarily in equity securities of issuers in the People's Republic
of China, Hong Kong and Taiwan.
The EMERGING MARKETS PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of emerging country issuers.
The EUROPEAN EQUITY PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of European issuers.
The EUROPEAN REAL ESTATE PORTFOLIO seeks to provide current income and
long-term capital appreciation by investing primarily in equity securities of
companies in the European real estate industry.
The GLOBAL EQUITY PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of issuers throughout the world,
including U.S. issuers.
The GOLD PORTFOLIO seeks long-term capital appreciation by investing
primarily in equity securities of foreign and domestic issuers engaged in
gold-related activities.
The INTERNATIONAL EQUITY PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of non-U.S. issuers.
The INTERNATIONAL MAGNUM PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of non-U.S. issuers domiciled in EAFE
countries.
The INTERNATIONAL SMALL CAP PORTFOLIO seeks long-term capital appreciation
by investing primarily in equity securities of non-U.S. issuers with equity
market capitalizations of less than $1 billion.
The JAPANESE EQUITY PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of Japanese issuers.
The LATIN AMERICAN PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of Latin American issuers and, from
time to time, debt securities issued or guaranteed by Latin American governments
or governmental entities.
U.S. EQUITY PORTFOLIOS:
The AGGRESSIVE EQUITY PORTFOLIO seeks capital appreciation by investing
primarily in corporate equity and equity-linked securities.
The EMERGING GROWTH PORTFOLIO seeks long-term capital appreciation by
investing primarily in growth-oriented equity securities of small- to
medium-sized corporations.
The EQUITY GROWTH PORTFOLIO seeks long-term capital appreciation by
investing primarily in growth-oriented equity securities of medium and large
capitalization companies.
The MICROCAP PORTFOLIO seeks long-term capital appreciation by investing
primarily in growth-oriented equity securities of small corporations.
The SMALL CAP VALUE EQUITY PORTFOLIO seeks high long-term total return by
investing in undervalued equity securities of small- to medium-sized companies.
The TECHNOLOGY PORTFOLIO seeks long-term capital appreciation by investing
primarily in equity securities of companies that, in the opinion of MSAM, are
expected to benefit from their involvement in technology and technology-related
industries.
The U.S. EQUITY PLUS PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of issuers included in the S&P 500
Index.
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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 companies in the U.S. real estate industry, including substantial investment
in real estate investment trusts.
The VALUE EQUITY PORTFOLIO seeks high total return by investing in equity
securities which MSAM believes to be undervalued relative to the stock market in
general at the time of purchase.
EQUITY AND FIXED INCOME PORTFOLIOS:
The BALANCED PORTFOLIO seeks high total return while preserving capital by
investing in a combination of undervalued equity securities and fixed income
securities.
FIXED INCOME PORTFOLIOS:
The EMERGING MARKETS DEBT PORTFOLIO seeks high total return by investing
primarily in debt securities of government, government-related and corporate
issuers located in emerging countries.
The FIXED INCOME PORTFOLIO seeks to produce a high total return consistent
with the preservation of capital by investing in a diversified portfolio of
fixed income securities.
The GLOBAL FIXED INCOME PORTFOLIO seeks to produce an attractive real rate
of return while preserving capital by investing in fixed income securities of
issuers throughout the world, including U.S. issuers.
The HIGH YIELD PORTFOLIO seeks to maximize total return by investing in a
diversified portfolio of high yield fixed income securities that offer a yield
above that generally available on debt securities in the four highest rating
categories of the recognized rating services.
The MORTGAGE-BACKED SECURITIES PORTFOLIO seeks to produce as high a level of
current income as is consistent with the preservation of capital by investing
primarily in a variety of investment grade mortgage-backed securities.
The MUNICIPAL BOND PORTFOLIO seeks to produce a high level of current income
consistent with preservation of principal by investing in municipal obligations,
the interest on which is exempt from federal income tax.
MONEY MARKET PORTFOLIOS:
The MONEY MARKET PORTFOLIO seeks to maximize current income and preserve
capital while maintaining high levels of liquidity through investing in high
quality money market instruments with remaining maturities of one year or less.
The MUNICIPAL MONEY MARKET PORTFOLIO seeks to maximize current tax-exempt
income and preserve capital while maintaining high levels of liquidity through
investing in high quality money market instruments with remaining maturities of
one year or less which are exempt from federal income tax.
The following is a list of the Underlying Funds which are investment
portfolios of MAS FUNDS, INC., with their respective investment objectives and a
brief statement of their investment policies.
EQUITY PORTFOLIOS:
The EQUITY PORTFOLIO seeks to achieve above-average total return over a
market cycle of three to five years, consistent with reasonable risk, by
investing primarily in a diversified portfolio of common stocks of companies
which are deemed by MAS to have earnings growth potential greater than the
economy in general and greater than the expected rate of inflation.
The GROWTH PORTFOLIO seeks to achieve long-term capital growth by investing
primarily in a diversified portfolio of common stocks of larger size companies
that are deemed by MAS to offer long-term growth potential.
The INTERNATIONAL EQUITY PORTFOLIO seeks to achieve above-average total
return over a market cycle of three to five years, consistent with reasonable
risk, by investing primarily in a diversified portfolio of foreign equities.
The MID CAP GROWTH PORTFOLIO seeks to achieve long-term capital growth by
investing primarily in a diversified portfolio of common stocks of smaller and
medium size companies that are deemed by MAS to offer long-term growth
potential.
The MID CAP VALUE PORTFOLIO seeks to achieve above-average total return over
a market cycle of three to five years, consistent with reasonable risk, by
investing in common stocks with equity capitalizations in the range of the
companies represented in the S&P MidCap 400 Index which are deemed by MAS to be
relatively undervalued based on certain proprietary measures of value. The
portfolio will typically exhibit a lower price/earnings value ratio than the S&P
MidCap 400 Index.
The SMALL CAP VALUE PORTFOLIO (not currently offered to new investors) seeks
to achieve above-average total return over a market cycle of three to five
years, consistent with reasonable risk, by investing primarily in a diversified
portfolio of common stocks with equity capitalizations in the range of companies
represented in the Russell 2000 Index which are deemed by MAS to be relatively
undervalued based on certain proprietary measures of value. The portfolio will
typically exhibit lower price/earnings and price/book value ratios than the
Russell 2000.
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The VALUE PORTFOLIO seeks to achieve above-average total return over a
market cycle of three to five years, consistent with reasonable risk, by
investing primarily in a diversified portfolio of common stocks which are deemed
by MAS to be relatively undervalued based on various measures such as
price/earnings ratios and price/book ratios.
FIXED-INCOME PORTFOLIOS:
The CASH RESERVES PORTFOLIO seeks to realize maximum current income,
consistent with preservation of capital and liquidity, by investing in a
diversified portfolio of money market instruments, cash equivalents and other
short-term securities having expected maturities of thirteen months or less. THE
PORTFOLIOS SEEKS TO MAINTAIN, BUT DOES NOT GUARANTEE, A CONSTANT NET ASSET VALUE
OF $1.00 PER SHARE.
The DOMESTIC FIXED INCOME PORTFOLIO seeks to achieve above-average total
return over a market cycle of three to five years, consistent with reasonable
risk, by investing in a diversified portfolio of U.S. Governments and other
investment grade fixed income securities of domestic issuers.
The FIXED INCOME PORTFOLIO seeks to achieve above-average total return over
a market cycle of three to five years, consistent with reasonable risk, by
investing primarily in a diversified portfolio of U.S. Governments, corporate
fixed income securities, mortgage securities, foreign bonds and other fixed
income securities and derivatives. The portfolio's average-weighted maturity
will ordinarily exceed five years.
The FIXED INCOME II PORTFOLIO seeks to achieve above-average total return
over a market cycle of three to five years, consistent with reasonable risk, by
investing primarily in a diversified portfolio of U.S. Governments and other
investment grade fixed income securities.
The GLOBAL FIXED INCOME PORTFOLIO seeks to achieve above-average total
return over a market cycle of three to five years, consistent with reasonable
risk, by investing primarily in high-grade fixed income securities, foreign
bonds and derivatives representing securities of United States and foreign
issuers. The portfolio's average weighted maturity will ordinarily exceed five
years.
The HIGH YIELD PORTFOLIO seeks to achieve above-average total return over a
market cycle of three to five years, consistent with reasonable risk, by
investing primarily in a diversified portfolio of high yield securities,
corporate fixed income securities and other fixed income securities (including
bonds rated below investment grade) and derivatives. The portfolio's average
weighted maturity will ordinarily exceed five years.
The INTERMEDIATE DURATION PORTFOLIO seeks to achieve above-average total
return over a market cycle of three to five years, consistent with reasonable
risk, by investing primarily in a diversified portfolio of U.S. Governments and
investment-grade corporate fixed income securities, mortgage securities, foreign
bonds and other fixed income securities and derivatives. The portfolio with
maintain an average duration of between two and five years.
The INTERNATIONAL FIXED INCOME PORTFOLIO seeks to achieve above-average
total return over a market cycle of three to five years, consistent with
reasonable risk, by investing primarily in high-grade foreign bonds and
derivatives. The portfolio's average weighted maturity will ordinarily exceed
five years.
The LIMITED DURATION PORTFOLIO seeks to achieve above-average total return
over a market cycle of three to five years, consistent with reasonable risk, by
investing primarily in a diversified portfolio of U.S. Governments, mortgage
securities, investment-grade corporate fixed income securities and other fixed
income securities. The portfolio will maintain an average duration of between
one and three years.
The MORTGAGE-BACKED SECURITIES PORTFOLIO seeks to achieve above-average
total return over a market cycle of three to five years, consistent with
reasonable risk, by investing primarily in a diversified portfolio of mortgage
securities and other fixed income securities and derivatives. The portfolio's
average weighted maturity will ordinarily exceed seven years.
The MUNICIPAL PORTFOLIO seeks to realize above-average total return over a
market cycle of three to five years, consistent with conservation of capital and
the realization of current income which is exempt from federal income tax, by
investing primarily in a diversified portfolio of municipal and other fixed
income securities and derivatives, including a limited percentage of bonds rated
below investment grade. The portfolio's average weighted maturity will
ordinarily be between five and ten years.
The PA MUNICIPAL PORTFOLIO seeks to realize above-average total return over
a market cycle of three to five years, consistent with the conservation of
capital and the realization of current income which is exempt from federal
income tax and Pennsylvania personal income tax by investing in a diversified
portfolio of Pennsylvania municipal and other fixed income securities and
derivatives including a limited percentage of bonds rated below investment
grade. The portfolio's average weighted maturity will ordinarily be between five
and ten years.
The SPECIAL PURPOSE FIXED INCOME PORTFOLIO seeks to achieve above-average
total return over a market cycle of three to five years, consistent with
reasonable risk, by investing primarily in a diversified portfolio of U.S.
Governments, corporate fixed income securities, mortgage securities, foreign
bonds and other fixed income securities and derivatives. The portfolio's average
weighted maturity will ordinarily exceed five years.
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BALANCED PORTFOLIOS:
The BALANCED PORTFOLIO seeks to achieve above-average total return over a
market cycle of three to five years, consistent with reasonable risk, by
investing in a diversified portfolio of equity securities, fixed income
securities and derivatives. When MAS judges the relative outlook for the equity
and fixed-income markets to be neutral, the portfolio will be invested 60% in
equity securities and 40% in fixed-income securities. The asset mix is actively
managed by MAS, with equity securities ordinarily representing between 45% and
75% of the total investment. The average weighted maturity of the fixed-income
portion of the portfolio will ordinarily be greater than five years.
The MULTI-ASSET-CLASS PORTFOLIO seeks to achieve above-average total return
over a market cycle of three to five years, consistent with reasonable risk, by
investing primarily in a diversified portfolio of equity securities, fixed
income securities and high yield securities of United States and foreign issuers
and derivatives. The asset mix is actively managed by MAS.
The BALANCED PLUS PORTFOLIO seeks to achieve above-average total return over
a market cycle of three to five years, consistent with reasonable risk, by
investing in a diversified portfolio of common stocks of domestic and foreign
issuers and fixed income securities.
ADVISORY PORTFOLIOS:
The ADVISORY FOREIGN FIXED INCOME PORTFOLIO seeks to achieve above-average
total return over a market cycle of three to five years, consistent with
reasonable risk, by investing primarily in high-grade foreign bonds and
derivatives.
The ADVISORY MORTGAGE PORTFOLIO seeks to achieve returns consistent with
returns generated by the market for mortgage securities by investing primarily
(at least 65% of its assets under normal circumstances) in mortgage securities.
The portfolio's average weighted maturity will ordinarily be greater than seven
years.
The EMERGING MARKETS PORTFOLIO seeks to achieve long-term capital growth by
investing primarily in common stocks of emerging market issuers.
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REPORT OF INDEPENDENT ACCOUNTANTS
In our opinion, the accompanying statements of assets and liabilities
present fairly, in all material respects, the financial position of The
Conservative Portfolio, The Moderate Portfolio and The Aggressive Portfolio,
each a separate series of Morgan Stanley Strategic Adviser Fund, Inc. (the
"Fund"), at October 29, 1997, in conformity with generally accepted accounting
principles. These 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 provide a
reasonable basis for the opinion expressed above.
/s/ Price Waterhouse LLP
PRICE WATERHOUSE LLP
1177 Avenue of the Americas
New York, New York 10036
November 3, 1997
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MORGAN STANLEY STRATEGIC ADVISER FUND, INC.
STATEMENTS OF ASSETS AND LIABILITIES
OCTOBER 29, 1997
<TABLE>
<CAPTION>
CONSERVATIVE MODERATE
PORTFOLIO PORTFOLIO
------------ -----------
<S> <C> <C>
Assets:
Cash............................................................................................ $ 33,333 $ 33,333
Deferred organization costs..................................................................... 65,570 65,570
------------ -----------
Total Assets.................................................................................. 98,903 98,903
------------ -----------
Liabilities:
Organization costs payable...................................................................... 65,570 65,570
------------ -----------
Total Liabilities............................................................................. 65,570 65,570
------------ -----------
Net Assets:
Common Stock, $.001 par value, 3,000,000,000 authorized (Class A & B),
Paid in capital, Class A...................................................................... 16,667 16,667
Paid in capital, Class B...................................................................... 16,666 16,666
------------ -----------
Net Assets.................................................................................. $ 33,333 $ 33,333
------------ -----------
Net Asset Value per Share (Class A & B)........................................................... $ 10.00 $ 10.00
------------ -----------
Shares issued and outstanding
Class A shares issued and outstanding........................................................... 1,667 1,667
Class B shares issued and outstanding........................................................... 1,667 1,667
<CAPTION>
AGGRESSIVE
PORTFOLIO
-----------
<S> <C>
Assets:
Cash............................................................................................ $ 33,334
Deferred organization costs..................................................................... 65,570
-----------
Total Assets.................................................................................. 98,904
-----------
Liabilities:
Organization costs payable...................................................................... 65,570
-----------
Total Liabilities............................................................................. 65,570
-----------
Net Assets:
Common Stock, $.001 par value, 3,000,000,000 authorized (Class A & B),
Paid in capital, Class A...................................................................... 16,667
Paid in capital, Class B...................................................................... 16,667
-----------
Net Assets.................................................................................. $ 33,334
-----------
Net Asset Value per Share (Class A & B)........................................................... $ 10.00
-----------
Shares issued and outstanding
Class A shares issued and outstanding........................................................... 1,666
Class B shares issued and outstanding........................................................... 1,666
</TABLE>
NOTE 1 ORGANIZATION AND FINANCIAL STATEMENTS
Morgan Stanley Strategic Adviser Fund, Inc. (the "Fund") was organized as a
Maryland Corporation on May 20, 1997, and is registered with the Securities and
Exchange Commission under the Investment Company Act of 1940, as amended, as an
open-end management investment company with diversified series (the
"Portfolios") that invest in underlying portfolios of the Morgan Stanley
Institutional Fund, Inc. and the MAS Funds (the "Underlying Funds"). This type
of investment structure is commonly referred to as a Fund of Funds. The
investment objectives of the Portfolios are as follows: The Conservative
Portfolio -- to achieve the highest level of long-term total return consistent
with a relatively low level of risk; The Moderate Portfolio -- to achieve the
highest level of long-term total return consistent with a relatively moderate
level of risk; and The Aggressive Portfolio -- to achieve the highest level of
long-term total return consistent with a relatively high level of risk.
Generally accepted accounting principles may require management to make
estimates and assumptions that affect the reported amounts and disclosures in
the financial statement. Actual results may differ from those estimates.
The Fund has had no operations other than the issuance of shares of class A
and class B of its common stock of the Conservative, Moderate and Aggressive
Portfolios to Morgan Stanley, Dean Witter, Discover & Company on October 29,
1997. Class A and Class B shares of each Portfolio have identical voting,
dividend and other rights.
NOTE 2 AGREEMENTS
The Fund has entered into an investment Advisory Agreement with Morgan
Stanley Asset Management Inc. ("MSAM") pursuant to which MSAM will be
responsible for providing investment management services to the Fund with
respect to the allocation of each Portfolio's investments among the Underlying
Funds. MSAM does not receive a fee for its services as Adviser to the
Portfolios. In addition, MSAM has voluntarily agreed to waive its administration
fees, as described below, and/or reimburse each Portfolio, if necessary, if the
expenses of the Portfolios including the expenses of the Underlying Funds
attributable to the Portfolios would cause the total operating expenses of any
Portfolio to exceed the following Total Operating Expenses: Conservative, Class
A .80%, Class B 1.05%; Moderate, Class A .90%, Class B 1.15%; Aggressive, Class
A 1.10%, Class B 1.35%.
The Fund has also entered into an Administrative Agreement with MSAM whereby
MSAM provides administrative services to the Fund for a fee, paid monthly, at
the annual rate of 0.15% of the average daily net assets of each Portfolio of
the Fund. Under an agreement between MSAM and The Chase Manhattan Bank
("Chase"), through an affiliate Chase Global Funds Services Company ("CGFSC"),
Chase provides certain administrative services to the Fund. For such services,
MSAM pays Chase a portion of the fee MSAM receives from the Fund. In addition,
Chase serves as the custodian for the Portfolios and receives a fee for such
services.
39
<PAGE>
Morgan Stanley & Co. Incorporated ("Morgan Stanley") serves as the exclusive
Distributor of the shares of the Fund. The Fund has adopted a Plan of
Distribution with respect to the Class B shares for each Portfolio pursuant to
Rule 12b-1 under the 1940 Act. Under the Plans, the Distributor is entitled to
receive compensation from the Portfolios, which is accrued daily and paid
quarterly, equal to 0.25% of the Class B shares' average daily net assets on an
annualized basis.
NOTE 3 ORGANIZATION COSTS AND OFFERING COSTS
Organization costs estimated at $196,710 have been equally allocated to each
Portfolio and have been capitalized by the Fund. Such costs are being amortized
over a maximum period of sixty months on a straight-line basis from the date the
Fund commences operations. MSAM has agreed that in the event any of its initial
shares are redeemed during the period that the Fund is amortizing its
organizations costs, the redemption proceeds payable will be reduced by the
unamortized organization costs in the same ratio as the number of initial shares
being redeemed bears to the number of initial shares outstanding at the time of
the redemption.
NOTE 4 RELATED PARTIES
Morgan Stanley Institutional Fund, Inc., one of the underlying funds in
which the Fund may invest, has the same investment adviser as the Fund and also
has the same members constituting its Board of Directors. In addition, the
adviser to the MAS Funds is affiliated to the investment adviser of the Fund.
40
