<PAGE>
SUPPLEMENT DATED NOVEMBER 18, 1996
TO THE PROSPECTUS DATED MAY 1, 1996
EQUITY GROWTH PORTFOLIO
EMERGING GROWTH PORTFOLIO
MICROCAP PORTFOLIO
AGGRESSIVE EQUITY PORTFOLIO
PORTFOLIOS OF THE
MORGAN STANLEY INSTITUTIONAL FUND, INC.
P.O. BOX 2798
BOSTON, MASSACHUSETTS
02208-2798
-------------
The Prospectus is hereby amended and supplemented as follows: The third
sentence in the second paragraph under the heading "INVESTMENT OBJECTIVES AND
POLICIES -- THE EQUITY GROWTH PORTFOLIO" on page 13 is deleted and replaced by
the following:
The Adviser's universe of potential investments generally comprises
companies with market capitalizations of $500 million or more.
--------------
On page 19, the first sentence under the heading "FOREIGN INVESTMENT" is
deleted and replaced by the following:
The Portfolios may invest in U.S. dollar-denominated securities of foreign
issuers trading in U.S. markets and the Equity Growth, Emerging Growth and
Aggressive Equity Portfolios may invest in non-U.S. dollar-denominated
securities of foreign issuers.
--------------
On page 19, the last paragraph under the heading "FOREIGN INVESTMENT" is
deleted and replaced by the following:
Investments in securities of foreign issuers are frequently denominated in
foreign currencies and, since the Equity Growth, Emerging Growth and Aggressive
Equity Portfolios may also temporarily hold uninvested reserves in bank deposits
in foreign currencies, the value of the Portfolios' assets measured in U.S.
dollars may be affected favorably or unfavorably by changes in currency exchange
rates and in exchange control regulations, and the Portfolios may incur costs in
connection with conversions between various currencies.
--------------
On page 19 the first sentence under the heading "FORWARD FOREIGN CURRENCY
EXCHANGE CONTRACTS" is deleted and replaced by the following:
The Equity Growth, Emerging Growth and Aggressive Equity Portfolios may
enter into forward foreign currency exchange contracts ("forward contracts"),
that provide for the purchase or sale of an amount of a specified foreign
currency at a future date.
--------------
PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE
<PAGE>
SUPPLEMENT DATED NOVEMBER 18, 1996
TO THE PROSPECTUS DATED MAY 1, 1996
U.S. REAL ESTATE PORTFOLIO
PORTFOLIO OF THE
MORGAN STANLEY INSTITUTIONAL FUND, INC.
P.O. BOX 2798
BOSTON, MASSACHUSETTS
02208-2798
-------------
The Prospectus is hereby amended and supplemented as follows: The first
sentence of the third paragraph under the heading "INVESTMENT OBJECTIVE AND
POLICIES" on page 10 is deleted and replaced by the following to clarify that
the Portfolio can invest in non-U.S. issuers principally engaged in the U.S.
real estate industry:
Under normal circumstances, at least 65% of the Portfolio's total
assets will be invested in income producing equity securities of U.S.
and non-U.S. companies principally engaged in the U.S. real estate
industry.
--------------
PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE.
<PAGE>
SUPPLEMENT DATED NOVEMBER 18, 1996
TO THE PROSPECTUS DATED MAY 1, 1996
FIXED INCOME PORTFOLIO
GLOBAL FIXED INCOME PORTFOLIO
MUNICIPAL BOND PORTFOLIO
MORTGAGE-BACKED SECURITIES PORTFOLIO
HIGH YIELD PORTFOLIO
MONEY MARKET PORTFOLIO
MUNICIPAL MONEY MARKET PORTFOLIO
PORTFOLIOS OF THE
MORGAN STANLEY INSTITUTIONAL FUND, INC.
P.O. BOX 2798
BOSTON, MASSACHUSETTS
02208-2798
-------------
The Prospectus is hereby amended and supplemented by changing the following
investment policies:
Under the heading "ADDITIONAL INVESTMENT INFORMATION" on Page 27
under the subheading "FUTURES CONTRACTS AND OPTIONS ON FUTURES
CONTRACTS," the first two paragraphs are deleted and replaced with the
following:
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. In order to
remain fully invested and to reduce transaction costs, each Portfolio,
except the Global Fixed Income Portfolio, may utilize appropriate
futures contracts and options on futures contracts to a limited extent.
Because transaction costs associated with futures and options may be
lower than the costs of investing in stocks directly, it is expected
that the use of futures and options on futures contracts to facilitate
cash flows may reduce a Portfolio's overall transaction costs.
Each Portfolio may enter into futures contracts and options on
futures provided that not more than 5% of its total assets are required
as deposit to secure obligations under such contracts, and provided
further that not more than 20% of its total assets are invested, in the
aggregate, in futures contracts and options on futures.
--------------
Add the following investment policies with respect to the FIXED INCOME
PORTFOLIO under the heading "ADDITIONAL INVESTMENT INFORMATION" on page 28
before the sub-heading "ADDITIONAL INVESTMENT INFORMATION -- REPURCHASE
AGREEMENTS."
OPTIONS TRANSACTIONS. The Fixed Income Portfolio may write (i.e.,
sell) covered call options and covered put options on portfolio
securities. By selling a covered call option, the Portfolio 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
<PAGE>
call it has written, the Portfolio will receive from the purchaser (or
option holder) a premium which is the price of the option, less a
commission charged by a broker. The Portfolio will keep the premium
regardless of whether the option is exercised. By selling a covered put
option, the Portfolio 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 options written by the Portfolio will be exercisable
by the purchaser only on a specific date). A call option is "covered" if
the Portfolio owns the security underlying the option it has written or
has an absolute or immediate right to acquire the security by holding a
call option on such security, or maintains a sufficient amount of cash,
cash equivalents or liquid assets to purchase the underlying security.
Generally, a put option is "covered" if the Portfolio maintains cash,
U.S. Government securities or other liquid assets equal to the exercise
price of the option, or if the Portfolio holds a put option on the same
underlying security with a similar or higher exercise price.
When the Fixed Income Portfolio 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. The premiums received will offset a portion of
the potential loss incurred by the Portfolio if the securities
underlying the options are ultimately sold by the Portfolio at a loss.
However, during the option period, the Portfolio 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 Fixed Income Portfolio will write covered put options to receive
the premiums paid by purchasers (when the Adviser wishes to purchase the
security underlying the option at a price lower than its current market
price, in which case the Portfolio will write the covered put at an
exercise price reflecting the lower purchase price sought) and to close
out a long put option position. The writer of a covered put option
accepts the risk of a decline in the price of the underlying security.
The Fixed Income Portfolio may also purchase put or call options.
When the Portfolio purchases a call option it acquires the right to buy
a designated security at a designated price (the "exercise price"), and
when the Portfolio 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"), which is usually not more than
nine months from the date the option is issued. The Portfolio 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. The Portfolio may purchase put options on securities 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, the Portfolio would incur no additional loss. The Portfolio may
also purchase put options to close out written put positions in a manner
similar to call option closing purchase transactions. There are no other
limits on the Portfolio's ability to purchase call and put options.
Other risks associated with the use of options are (i) imperfect
correlation between the change in market value of the securities held by
the Portfolio and the price of options relating to the securities
purchased or sold by the Portfolio; and (ii) possible lack of a liquid
secondary market for an option. Options that are not traded on an
exchange (OTC options) are often considered illiquid and may be
difficult to value. In the opinion of the Adviser, the risk that the
Portfolio will be unable to close out an
<PAGE>
options contract will be minimized by only entering into options
transactions for which there appears to be a liquid secondary market.
For more detailed information about options transactions, see
"Investment Objectives and Policies" in the Statement of Additional
Information.
----------------
ADDITION OF PORTFOLIO MANAGERS. J. David Germany, Michael B. Kushma
and Paul F. O'Brien have joined Robert M. Smith as portfolio managers
with primary responsibility for managing the assets of the Global Fixed
Income Portfolio. Michael J. Smith no longer has responsibility for
managing the assets of the Global Fixed Income Portfolio. Accordingly, the
third paragraph on p. 31 of the Prospectus is deleted and replaced with
the following paragraph:
GLOBAL FIXED INCOME PORTFOLIO -- J. DAVID GERMANY, MICHAEL B.
KUSHMA, PAUL F. O'BRIEN AND ROBERT M. SMITH. J. David Germany shares
primary responsibility for managing the Portfolio's assets. He joined
the Adviser in 1996 and has been a portfolio manager with the Adviser's
affiliate, Miller Anderson & Sherrerd, LLP ("MAS") since 1991. He was
Vice President & Senior Economist for Morgan Stanley & Co. Incorporated
("Morgan Stanley") from 1989 to 1991. He assumed responsibility for the
Global Fixed Income and International Fixed Income Portfolios of the
MAS-advised MAS Funds in 1993 and the MAS Funds' Multi-Asset-Class
Portfolio in 1994. Mr. Germany was Senior Staff Economist (International
Finance and Macroeconomics) to the Council of Economic Advisors --
Executive Office of the President from 1986 through 1987 and an
Economist with the Board of Governors of the Federal Reserve System --
Division of International Finance from 1983 through 1987. He holds an
A.B. degree (Valedictorian) from Princeton University and a Ph.D. in
Economics from the Massachusetts Institute of Technology. Michael B.
Kushma, a Principal at Morgan Stanley, joined the firm in 1987. He
shares primary responsibility for managing the Portfolio's assets. He
was a member of Morgan Stanley's global fixed income strategy group in
the fixed income division from 1987-1995 where he became the division's
senior government bond strategist. He joined the Adviser in 1995 where
he took responsibility for the global fixed income portfolios. Mr.
Kushma received an A.B. in economics from Princeton University in 1979,
an M. Sc. in economics from the London School of Economics in 1981 and
an M.Phil. in economics from Columbia University in 1983. Paul F.
O'Brien shares primary responsibility for managing the Portfolio's
assets. He joined the Adviser and MAS in 1996. He was head of European
Economics from 1993 through 1995 for JP Morgan and as Principal
Administrator from 1991 through 1992 for the Organization for Economic
Cooperation and Development. He assumed responsibility for the
MAS-advised MAS Funds' Global Fixed Income and International Fixed
Income Portfolios in 1996. Mr. O'Brien holds a B.S. degree from the
Massachusetts Institute of Technology and a Ph.D. in Economics from the
University of Minnesota. Robert Smith, a Principal of Morgan Stanley,
joined the Adviser in June 1994 and has shared primary responsibility
for managing the Portfolio's assets since July 1994. Prior to joining
the Adviser he spent eight years as Senior Portfolio Manager -- Fixed
Income at the State of Florida Pension Fund. Mr. Smith's
responsibilities included active total-rate-of-return management of long
term portfolios and supervision of other fixed income managers. A
graduate of Florida State University with a B.S. in Business, Mr. Smith
also received an M.B.A. -- Finance from Florida State and holds a
Chartered Financial Analyst (CFA) designation.
--------------
ADDITION OF PORTFOLIO MANAGERS. Thomas L. Bennett and Stephen F.
Esser have joined Robert Angevine as portfolio managers with primary
responsibility for managing the assets of the High Yield Portfolio.
Accordingly, the last paragraph on p. 31 of the Prospectus is deleted
and replaced with the following paragraph:
<PAGE>
HIGH YIELD PORTFOLIO -- ROBERT ANGEVINE, THOMAS L. BENNETT AND
STEPHEN F. ESSER. Robert Angevine is a Principal of the Adviser and the
Portfolio Manager for high yield investments. He shares primary
responsibility for managing the Portfolio's assets. Prior to joining the
Adviser in October 1988, he spent over eight years at Prudential
Insurance where he was responsible for the largest open-end high yield
mutual fund in the country. Mr. Angevine also manages high yield assets
for one of the largest corporate pension funds in the country. His other
experience includes international treasury operations at a major
pharmaceutical company and commercial banking. Mr. Angevine received an
M.B.A. from Fairleigh Dickinson University and a B.A. in Economics from
Lafayette College. He served two years as a Lieutenant in the U.S. Army.
Thomas L. Bennett shares responsibility for managing the Portfolio's
assets. He joined the Adviser in 1996 and has been a portfolio manager
with MAS since 1984. Mr. Bennett assumed responsibility for the
MAS-advised MAS Funds' Fixed Income Portfolio in 1984, the Domestic
Fixed Income Portfolio in 1987, the High Yield Portfolio in 1985, the
Fixed Income Portfolio II in 1990, the Special Purpose Fixed Income and
Balanced Portfolios in 1992 and the Multi-Asset-Class Portfolio in 1994.
Mr. Bennett also is the Chairman of the MAS Funds and has a B.S. degree
(Chemistry) and an M.B.A. from the University of Cincinnati. Stephen F.
Esser shares primary responsibility for managing the Portfolio's assets.
He joined the Adviser in 1996 and has been a portfolio manager with MAS
since 1988. He assumed responsibility for the MAS-advised MAS Funds'
High Yield Portfolio in 1989. Mr. Esser is a member of the New York
Society of Security Analysts and has a B.S. degree (Summa Cum Laude; Phi
Beta Kappa) from the University of Delaware.
--------------
ADDITION OF PORTFOLIO MANAGERS. Ellen D. Harvey, Christian G. Roth
and Scott F. Richard have joined Abigail Jones Feder and Kenneth R.
Holley as portfolio managers with primary responsibility for managing
the assets of the Money Market Portfolio. Accordingly, the first
paragraph on p. 32 of the Prospectus is deleted and replaced with the
following paragraph:
MONEY MARKET PORTFOLIO -- ABIGAIL JONES FEDER, KENNETH R. HOLLEY,
ELLEN D. HARVEY, CHRISTIAN G. ROTH AND SCOTT F. RICHARD. Abigail Feder
is a Principal of Morgan Stanley and shares responsibility for managing
short-term taxable and tax-exempt portfolios. Ms. Feder joined Morgan
Stanley's Corporate Finance Department in 1985. In 1987 she joined the
Adviser as a Marketing Analyst and was promoted to a Marketing Director
in 1988. She joined the Fixed Income Group as a Portfolio Manager in
1989 and she became a Vice President in 1992. Ms. Feder holds a B.A.
from Vassar College. Kenneth R. Holley joined the Adviser as a
short-term fixed income portfolio manager in July, 1993. Prior thereto,
he worked for 2 1/2 years as a Finance Officer for the African
Development Bank implementing trading strategies for the bank's $1
billion short to intermediate U.S. dollar portfolio. Prior to joining
the ADB, Mr. Holley spent 1 1/2 years with Ward and Associates Asset
Management as a Vice President responsible for fixed income strategy.
Before Ward and Associates he worked in the fixed income department of
Salomon Brothers, Inc. Mr. Holley holds a B.S. degree in Engineering
from University of Pennsylvania and an M.B.A. from the Wharton School.
Mr. Barth and Ms. Feder have had primary responsibility for managing the
Portfolio's assets since inception. Mr. Holley has shared primary
responsibility for managing the Portfolio's assets since August, 1993.
Ellen D. Harvey shares primary responsibility for managing the
Portfolio's assets. She joined the Adviser in 1996 and has been a
portfolio manager with MAS since 1984. She assumed responsibility for
the MAS-advised Cash Reserves Portfolio in 1990, the Limited Duration
Portfolio in 1992 and the Intermediate Duration Portfolio in 1994. Ms.
Harvey holds an A.B. in economics from Princeton University and an M.A.
in economics from George Washington University. Christian G. Roth shares
primary responsibility for managing the Portfolio's assets. He joined
the Adviser in 1996 and has been a portfolio manager with
<PAGE>
MAS since 1991. He served as Senior Associate, Dean Witter Capital
Corporation from 1987 to 1991. He assumed responsibility for the
MAS-advised Limited Duration and Intermediate Duration Portfolios in
1994. Mr. Roth holds a B.S. from The Wharton School of the University of
Pennsylvania. Scott F. Richard shares primary responsibility for
managing the Portfolio's assets. He joined the Adviser in 1996 and has
been a portfolio manager with MAS since 1992. He served as Vice
President, Head of Fixed Income Research & Model Development for
Goldman, Sachs & Co. from 1987 to 1991 and as Head of Mortgage Research
in 1992. He assumed responsibility for the MAS-advised Mortgage-Backed
Securities Portfolio in 1992 and the Limited Duration, Intermediate
Duration, Municipal and PA Municipal Portfolios in 1994. Mr. Richard
holds a B.S. from Massachusetts Institute of Technology and a D.B.A.
from Harvard Graduate School of Business Administration.
PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE.
<PAGE>
SUPPLEMENT DATED NOVEMBER 18, 1996
TO PROSPECTUS DATED MAY 1, 1996
EMERGING MARKETS PORTFOLIO
EMERGING MARKETS DEBT PORTFOLIO
PORTFOLIOS OF THE
MORGAN STANLEY INSTITUTIONAL FUND, INC.
P.O. BOX 2798
BOSTON, MASSACHUSETTS
02208-2798
-------------
The Prospectus is hereby amended and supplemented to reflect the addition of
a Portfolio Manager to the Emerging Markets Portfolio.
ADDITION OF PORTFOLIO MANAGER. Marianne L. Hay has joined Madhav Dhar as a
portfolio manager with primary responsibility for managing the assets of the
Emerging Markets Portfolio. Accordingly, the second paragraph on p. 26 of the
Prospectus is deleted and replaced with the following paragraph:
EMERGING MARKETS PORTFOLIO -- MADHAV DHAR AND MARIANNE L. HAY. Madhav
Dhar is a Managing Director of Morgan Stanley. He joined the Adviser in
1984 to focus on global asset allocation and investment strategy and now
is a co-head of the Adviser's emerging markets group. Mr. Dhar has been
involved in the launching of the Adviser's country funds. He holds a
B.S. (honors) from St. Stephens College, Delhi University (India), and
an M.B.A. from Carnegie-Mellon University. Mr. Dhar has had primary
responsibility for managing the Portfolio's assets since its inception.
Marianne L. Hay, a Managing Director of Morgan Stanley & Co.
Incorporated, is a co-head of the Adviser's emerging markets group and
shares, with Mr. Dhar, primary responsibility for managing the
Portfolio's assets. She joined the Adviser in June 1993 to work with the
Adviser's senior management covering all emerging markets, asset
allocation, product development and client services. Ms. Hay has 17
years of investment experience. Prior to joining the Adviser, she was a
director of Martin Currie Investment Management, Ltd. where her
responsibilities included geographic asset allocation and portfolio
management for global and emerging markets funds, as well as being
director in charge of the company's North American clients. Prior to her
tenure at Martin Currie Investment Management, Ltd. she worked for the
Bank of Scotland and the investment management firm of Ivory and Sime
plc. She graduated with an honors degree in genetics from Edinburgh
University and holds a Diploma in Education and the qualification of the
Association of the Institute of Bankers in Scotland.
--------------
PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE.
<PAGE>
SUPPLEMENT DATED NOVEMBER 18, 1996
TO PROSPECTUS DATED MAY 1, 1996
SMALL CAP VALUE EQUITY PORTFOLIO
VALUE EQUITY PORTFOLIO
BALANCED PORTFOLIO
PORTFOLIOS OF THE
MORGAN STANLEY INSTITUTIONAL FUND, INC.
P.O. BOX 2798
BOSTON, MASSACHUSETTS
02208-2798
-------------
The Prospectus is hereby amended and supplemented to reflect a change in
Portfolio Managers for the Small Cap Value Equity Portfolio.
REPLACEMENT OF PORTFOLIO MANAGER. Christian K. Stadlinger, a Portfolio
Manager of the Small Cap Value Equity Portfolio of the Fund, has resigned from
Morgan Stanley Asset Management Inc. Gary D. Haubold and William B. Gerlach have
assumed primary responsibility for managing the assets of the Small Cap Value
Equity Portfolio. Accordingly, the third full paragraph on p. 18 is deleted and
replaced with the following paragraph:
PORTFOLIO MANAGERS
Stephen C. Sexauer and Alford E. Zick, Jr. have primary
responsibility for managing the Balanced Portfolio and the Value Equity
Portfolio and have had such responsibility since the Portfolios'
inception in February and January, 1990, respectively. Gary D. Haubold
and William B. Gerlach have begun sharing primary responsibility for
managing the Small Cap Value Equity Portfolio.
Additionally, the first full paragraph on p. 19 of the Prospectus is deleted
and replaced with the following paragraphs:
GARY D. HAUBOLD. Mr. Haubold joined the Adviser in July, 1996 and
has served as a portfolio manager with the Adviser's affiliate, Miller
Anderson & Sherrerd, LLP for the past three years. Prior thereto, Mr.
Haubold held several positions at Wood, Struthers & Winthrop including
Vice President and Director of Equity Research, Portfolio Manager and
Senior Vice President. Mr. Haubold has a B.S. degree (Magna Cum Laude)
in Civil Engineering from Rice University and an M.B.A. from the
University of Pennsylvania -- The Wharton School. In addition, Mr.
Haubold is a member of the New York Society of Security Analysts and is
a Certified Financial Analyst.
WILLIAM B. GERLACH. Mr. Gerlach joined the Adviser in July, 1996
and has worked with the Adviser's affiliate, Miller Anderson & Sherrerd,
LLP for the past five years. Previously, he was with Alphametrics
Corporation and Wharton Econometric Forecasting Associates. Mr. Gerlach
received a B.A. in Economics from Haverford College.
--------------
PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE.
<PAGE>
SUPPLEMENT DATED NOVEMBER 18, 1996
TO THE PROSPECTUS DATED MAY 1, 1996
ACTIVE COUNTRY ALLOCATION PORTFOLIO
PORTFOLIO OF THE
MORGAN STANLEY INSTITUTIONAL FUND, INC.
P.O. BOX 2798
BOSTON, MASSACHUSETTS
02208-2798
-------------
The Prospectus is hereby amended and supplemented as follows: Under the
heading "Management of the Fund," the third paragraph on Page 16 is deleted and
replaced with the following:
PORTFOLIO MANAGERS. BARTON M. BIGGS, MADHAV DHAR, FRANCINE J. BOVICH
AND ANN D. THIVIERGE. Barton M. Biggs has been Chairman and a director of the
Adviser since 1980 and a Managing Director of Morgan Stanley since 1975. He is
also a director of Morgan Stanley Group Inc. and a director and chairman of
various registered investment companies to which the Adviser and certain of its
affiliates provide investment advisory services. Mr. Biggs holds a B.A. from
Yale University and an M.B.A. from New York University. Madhav Dhar is a
Managing Director of Morgan Stanley. He joined the Adviser in 1984 to focus on
global asset allocation and investment strategy and now is a co-head of the
Adviser's emerging markets group. Mr. Dhar also has been involved in the
launching of the Adviser's country funds. He is a portfolio manager of the
Fund's Emerging Markets Portfolio, the Emerging Markets and Global Equity
Allocation Funds of the Morgan Stanley Fund, Inc., and the Morgan Stanley
Emerging Markets Fund, Inc. (a closed-end investment company listed on the New
York Stock Exchange). He holds a B.S. (honors) from St. Stephens College, Delhi
University (India), and an M.B.A. from Carnegie-Mellon University. Francine
Bovich joined the Adviser as a Principal in 1993. She is responsible for product
development, portfolio management and communication of the Adviser's asset
allocation strategy to institutional investor clients. Previously, Ms. Bovich
was a Principal and Executive Vice President of Westwood Management Corp.
("Westwood"), a registered investment adviser. Before joining Westwood, she was
a Managing Director of Citicorp Investment Management, Inc. (now Chancellor
Capital Management), where she was responsible for the Institutional Investment
Management Group. Ms. Bovich began her investment career with Banker's Trust
Company. She holds a B.A. in Economics from Connecticut College and an M.B.A. in
Finance from New York University. Ann Thivierge is a Principal of the Adviser.
She is a member of the Adviser's asset allocation committee, primarily
representing the Total Fund Management team since its inception in 1991. Prior
to joining the Adviser in 1986, she spent two years at Edgewood Management
Company, a privately held investment management firm. Ms. Thivierge holds a B.A.
in International Relations from James Madison College, Michigan State
University, and an M.B.A. in Finance from New York University.
--------------
PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE.
<PAGE>
MORGAN STANLEY INSTITUTIONAL FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
Morgan Stanley Institutional Fund, Inc. (the "Fund") is a no-load, open-end
management investment company with diversified and non-diversified series
("Portfolios"). The Fund currently consists of twenty-eight Portfolios offering
a broad range of investment choices. The Fund is designed to provide clients
with attractive alternatives for meeting their investment needs. Each
Portfolio, except the Money Market, Municipal Money Market, International Small
Cap and China Growth Portfolios, offers two classes of shares, the Class A
shares and the Class B shares (each, a "Multiclass Portfolio"). Each Multiclass
Portfolio, except the International Magnum Portfolio, offered one class of
shares until January 2, 1996, when all shares of such Portfolios owned prior to
January 2, 1996 were redesignated Class A shares. The Class A shares and the
Class B shares currently offered by each Multiclass Portfolio have different
minimum investment requirements and fund expenses. Shares of each Portfolio are
offered with no sales charge or exchange or redemption fee (with the exception
of the International Small Cap Portfolio). This Statement of Additional
Information addresses information of the Fund applicable to each of the twenty-
eight Portfolios.
This Statement is not a prospectus but should be read in conjunction with
the several prospectuses of the Fund's Portfolios (the "Prospectuses"). To
obtain any of the Prospectuses, please call the Morgan Stanley Institutional
Fund, Inc. Services Group at 1-800-548-7786.
TABLE OF CONTENTS
PAGE
----
Investment Objectives and Policies . . . . . . . . . . . . . . . . . . . . 2
Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Special Tax Considerations Relating to Municipal Bond and
Municipal Money Market Portfolios . . . . . . . . . . . . . . . . . . . 14
Special Tax Considerations Relating to Foreign Investments . . . . . . . . 15
Taxes and Foreign Shareholders . . . . . . . . . . . . . . . . . . . . . . 16
Purchase of Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Redemption of Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Shareholder Services . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Investment Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Determining Maturities of Certain Instruments. . . . . . . . . . . . . . . 19
Management of the Fund . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Net Asset Value for Money Market Portfolios. . . . . . . . . . . . . . . . 29
Performance Information. . . . . . . . . . . . . . . . . . . . . . . . . . 30
General Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
Description of Securities and Ratings. . . . . . . . . . . . . . . . . . . 37
Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
STATEMENT OF ADDITIONAL INFORMATION DATED MAY 1, 1996 AS AMENDED
AUGUST 30, 1996 AND NOVEMBER 18, 1996 RELATING TO:
Prospectus for the International Magnum Portfolio, dated May 1, 1996
Prospectus for the U.S. Real Estate Portfolio, dated May 1, 1996
Prospectus for the Fixed Income Portfolio, Global Fixed Income Portfolio,
Municipal Bond Portfolio, Mortgage-Backed Securities Portfolio, High Yield
Portfolio, Money Market Portfolio and Municipal Money Market Portfolio,
dated May 1, 1996
Prospectus for the Equity Growth Portfolio, Emerging Growth Portfolio,
MicroCap Portfolio and Aggressive Equity Portfolio, dated May 1, 1996
Prospectus for the Small Cap Value Equity Portfolio, Value Equity Portfolio
and Balanced Portfolio, dated May 1, 1996
Prospectus for the Global Equity Portfolio, International Equity Portfolio,
International Small Cap Portfolio, Asian Equity Portfolio, European Equity
Portfolio, Japanese Equity Portfolio and Latin American Portfolio, dated
May 1, 1996
Prospectus for the Emerging Markets Portfolio and Emerging Markets Debt
Portfolio, dated May 1, 1996
Prospectus for the Active Country Allocation Portfolio, dated May 1, 1996
Prospectus for the Gold Portfolio, dated May 1, 1996
Prospectus for the China Growth Portfolio, dated April 13, 1994
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INVESTMENT OBJECTIVES AND POLICIES
The following policies supplement the investment objectives and policies
set forth in the Fund's Prospectuses:
CURRENCY SWAPS
The China Growth Portfolio may enter into currency swaps for hedging
purposes and non-hedging purposes. Inasmuch as swaps are entered into for good
faith hedging purposes and are offset by a segregated account as described
below, the Portfolio believes that swaps do not constitute senior securities as
defined in the 1940 Act and, accordingly, will not treat them as being subject
to the Portfolio's borrowing restrictions. An amount of cash or liquid high
grade debt securities (i.e., securities rated in one of the top three ratings
categories by Moody's Investors Service, Inc. ("Moody's") or Standard & Poor's
Ratings Group ("S&P"), or, if unrated, deemed by the Adviser to be of comparable
credit quality) having an aggregate net asset value at least equal to the gross
payments which the Portfolio is obligated to make under the currency swap will
be maintained in a segregated account by the Fund's Custodian. The Portfolio
will not enter into any currency swap unless the credit quality of the unsecured
senior debt or the claims-paying ability of the other party thereto is
considered to be investment grade by the Adviser. If there is a default by the
other party to such a transaction, the Portfolio will 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
in comparison with the markets for other similar instruments which are traded in
the interbank market.
EMERGING COUNTRY EQUITY AND DEBT SECURITIES
GENERAL. Each of the Emerging Markets and Emerging Markets Debt Portfolio's
definition of emerging country equity or debt securities includes securities of
companies that may have characteristics and business relationships common to
companies in a country or countries other than an emerging 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 country. Morgan
Stanley Asset Management Inc. (the "Adviser") believes, however, that investment
in such companies will be appropriate because the Portfolio will invest only in
those companies which, in its view, have sufficiently strong exposure to
economic and market forces in an emerging country such that their value will
tend to reflect developments in such emerging country to a greater extent than
developments in another country or countries. For example, the Portfolio may
invest in companies organized and located in countries other than an emerging
country, including companies having their entire production facilities outside
of an emerging country, when securities of such companies meet one or more
elements of the Portfolio's definition of an emerging country equity or debt
security and so long as the Adviser believes at the time of investment that the
value of the company's securities will reflect principally conditions in such
emerging country.
The Emerging Markets Debt Portfolio is subject to no restrictions on the
maturities of the emerging country debt securities it holds; those maturities
may range from overnight to 30 years. The value of debt securities held by the
Portfolio generally will vary inversely to changes in prevailing interest rates.
The Portfolio's investments in fixed-rated debt securities with longer terms to
maturity are subject to greater volatility than the Portfolio'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.
Investments in emerging country government debt securities involve special
risks. Certain emerging 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 country's debt may not be
able or willing 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 Portfolio 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 debt 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.
BRADY BONDS. The Emerging Markets Debt Portfolio may invest in certain debt
obligations 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 (the "Brady Plan").
Brady Bonds have been issued only recently, 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-
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the-counter secondary market. The Portfolio 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, the Portfolio
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.
U.S. dollar-denominated, collateralized Brady Bonds, which may be fixed
rate par bonds or floating rate discount bonds, 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. In addition, in light of the residual
risk of the Brady Bonds and, among other factors, the history of defaults with
respect to commercial bank loans by public and private entities of countries
issuing Brady Bonds, investments in Brady Bonds should be viewed as speculative.
Brady Plan debt restructuring totalling approximately $73 billion have been
implemented to date in Argentina, Bulgaria, Costa Rica, Ecuador, Mexico,
Nigeria, the Philippines, Uruguay and Venezuela, with the largest proportion of
Brady Bonds having been issued to date by Mexico and Venezuela. Brazil and
Poland have announced plans to issue Brady Bonds aggregating approximately $52
billion, based on current estimates. There can be no assurance that the
circumstances regarding the issuance of Brady Bonds by these countries will not
change.
STRUCTURED SECURITIES. The Emerging Markets Debt Portfolio may also invest a
portion of its 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 Securities") backed by, or representing
interests in, the underlying instruments. The cash flow on the underlying
instruments may be apportioned among the newly issued Structured Securities 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 Securities is dependent on the
extent of the cash flow on the underlying instruments. Because Structured
Securities of the type in which the Portfolio anticipates it will invest
typically involve no credit enhancement, their credit risk generally will be
equivalent to that of the underlying instruments. The Portfolio is permitted to
invest in a class of Structured Securities that is either subordinated or
unsubordinated to the right of payment of another class. Subordinated
Structured Securities typically have higher yields and present greater risks
than unsubordinated Structured Securities. Certain issuers of Structured
Securities may be deemed to be "investment companies" as defined in the 1940
Act. As a result, the Portfolio's investment in these Structured Securities
may be limited by restrictions contained in the 1940 Act. Structured Securities
are typically sold in private placement transactions, and there currently is no
active trading market for Structured Securities.
LOAN PARTICIPATIONS AND ASSIGNMENTS. The Emerging Markets Debt Portfolio may
also invest in fixed and floating rate loans ("Loans") arranged through private
negotiations between an issuer of sovereign debt obligations and one or more
financial institutions ("Lenders"). The Portfolio's investments in Loans are
expected in most instances to be in the form of participations in Loans
("Participations") and assignments of all or a portion of Loans ("Assignments")
from third parties. The Portfolio's investment in Participations typically will
result in the Portfolio having a contractual relationship only with the Lender
and not with the borrower. The Portfolio 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, the
Portfolio 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 the Portfolio may not directly benefit from
any collateral supporting the Loan in which it has purchased the Participation.
As a result, the Portfolio 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, the Portfolio may be treated
as a general creditor of the Lender and may not benefit from any set-off between
the Lender and the
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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. The Portfolio will
acquire Participations only if the Lender interpositioned between the Portfolio
and the borrower is determined by the Adviser to be creditworthy.
When the Portfolio 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 the Portfolio 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 the Portfolio may acquire an interest
in a loan is through a Participation and not an Assignment. The Portfolio may
have difficulty disposing of Assignments and Participations because to do so it
will have to assign such securities to a third party. Because there is no
liquid market for such securities, the Portfolio anticipates 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 the Portfolio's ability to dispose of particular Assignments
or Participations when necessary to meet the Portfolio's liquidity needs or in
response to a specific economic event such as a deterioration in the
creditworthiness of the borrower. The lack of a liquid secondary market for
Assignments and Participations also may make it more difficult for the Portfolio
to assign a value to these securities for purposes of valuing the Portfolio's
securities and calculating its net asset value.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The U.S. dollar value of the assets of the Global Equity, International
Equity, International Small Cap, Asian Equity, European Equity, Japanese Equity,
Latin American, International Magnum, Global Fixed Income, Active Country
Allocation, China Growth, Emerging Markets, Emerging Markets Debt and Gold
Portfolios and, to the extent they invest in securities denominated in foreign
currencies, the assets of the Emerging Growth, MicroCap, Aggressive Equity,
Small Cap Value Equity, Value Equity, Balanced, Fixed Income and High Yield
Portfolios may be affected favorably or unfavorably by changes in foreign
currency exchange rates and exchange control regulations, and the Portfolios may
incur costs in connection with conversions between various currencies. The
Portfolios 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. A forward currency exchange 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. A forward contract generally has no
deposit requirement, and no commissions are charged at any stage for such
trades. The Gold Portfolio may also enter into precious metals forward
contracts. See "Precious Metals Forward and Futures Contracts and Options"
below.
The Portfolios may enter into forward foreign currency exchange contracts
in several circumstances. When a Portfolio enters into a contract for the
purchase or sale of a security denominated in a foreign currency, or when a
Portfolio anticipates the receipt in a foreign currency of dividends or interest
payments on a security which it holds, the Portfolio 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, the Portfolio 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 these Portfolios 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 Portfolio's securities denominated in such foreign currency. The precise
matching of the forward contract amounts and the value of the securities
involved will not generally 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 Portfolios intend to enter
into such forward contracts to protect the value of portfolio securities on a
continuous basis. The Portfolios will not enter into such forward contracts or
maintain a net exposure to such contracts where the consummation of the
contracts would obligate such Portfolio to deliver an amount of foreign
currency in excess of the value of such Portfolio's securities or other assets
denominated in that currency.
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, the management of the
Fund believes that it
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is important to have the flexibility to enter into such forward contracts when
it determines that the best interests of the performance of each Portfolio will
thereby be served. Except under circumstances where a segregated account is not
required under the 1940 Act or the rules adopted thereunder, the Fund's
Custodian will place cash, U.S. government securities, or high-grade debt
securities into a segregated account of a Portfolio in an amount equal to the
value of such Portfolio's total assets committed to the consummation of forward
currency exchange 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 Portfolio's commitments with respect to such contracts.
The Portfolios generally will not enter into a forward contract with a term
of greater than one year. At the maturity of a forward contract, a Portfolio
may either sell the portfolio security and make delivery of the foreign
currency, or it may retain the security and terminate its contractual obligation
to deliver the foreign currency by purchasing an "offsetting" contract with the
same currency trader obligating it to purchase, on the same maturity date, the
same amount of the foreign currency.
It is impossible to forecast with absolute precision the market value of a
particular portfolio security at the expiration of the contract. Accordingly,
it may be necessary for a Portfolio 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 Portfolio is
obligated to deliver and if a decision is made to sell the security and make
delivery of the foreign currency.
If a Portfolio retains the portfolio security and engages in an offsetting
transaction, such Portfolio 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 a Portfolio 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 Portfolio
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 Portfolio 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 Portfolios 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 such
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.
FUTURES CONTRACTS
The Equity Growth, Aggressive Equity, Value Equity, Balanced, Small Cap
Value Equity, Active Country Allocation, Gold, Latin American, U.S. Real Estate,
Emerging Markets, Emerging Markets Debt, International Magnum, Fixed Income and
China Growth Portfolios may enter into futures contracts and options on futures
contracts for the purpose of remaining fully invested and reducing transactions
costs. The Fixed Income, Municipal Bond, Mortgage-Backed Securities, High
Yield, Money Market, Municipal Money Market, Active Country Allocation, Equity
Growth, Aggressive Equity, Gold, Latin American, U.S. Real Estate, Emerging
Markets, Emerging Markets Debt, International Magnum and China Growth Portfolios
may also enter into futures contracts for hedging purposes. No Portfolio will
enter into futures contracts or options thereon for speculative purposes. The
Gold Portfolio may also enter into futures contracts and options thereon on
precious metals. See "Precious Metals Forward and Futures Contracts and
Options" below. The China Growth and Latin American Portfolios may also enter
into futures and options thereon on stock and other securities indices and
currencies. 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 national futures exchanges. Futures exchanges and trading are regulated under
the Commodity Exchange Act by the Commodity Futures Trading Commission ("CFTC"),
a U.S. government agency.
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
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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
Portfolios 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.
The Portfolios may purchase and write call and put options on futures
contracts which are traded on a U.S. Exchange (and in the case of the China
Growth and Latin American Portfolios, on any recognized securities or futures
exchange to the extent permitted by the CFTC) and 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 delivery of the accumulated balance in the writer's futures margin
account, 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 Portfolios 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 underlying securities with futures contracts which they trade, and use
futures contracts with the expectation of realizing profits from market
fluctuations. The Portfolios intend to use futures contracts only for hedging
purposes.
Regulations of the CFTC applicable to the Portfolios require that all
futures transactions constitute bona fide hedging transactions except that a
Portfolio may engage in futures transactions that do not constitute bona fide
hedging to the extent that not more than 5% of the liquidation value of a
Portfolio's total assets are required as margin deposits or premiums for such
transactions. The Portfolios will only sell futures contracts to protect
securities owned against declines in price or purchase contracts to protect
against an increase in the price of securities intended for purchase. As
evidence of this hedging interest, the Portfolios expect that approximately 75%
of their futures contracts will be "completed"; that is, equivalent amounts of
related securities will have been purchased or are being purchased by the
Portfolios upon sale of open futures contracts.
Although techniques other than the sale and purchase of futures contracts
could be used to control the Portfolios' exposure to market fluctuations, the
use of futures contracts may be a more effective means of hedging this exposure.
While the Portfolios 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. None of the Portfolios will enter
into futures contract transactions to the extent that, immediately thereafter,
the sum of its initial margin deposits on open contracts exceeds 5% of the
market value of its total assets. In addition, none of the Portfolios will
enter into futures contracts to the extent that its outstanding obligations to
purchase securities under futures contracts and options on futures contracts
(and in the case of the Active Country Allocation, Equity Growth, Gold, Latin
American and China Growth Portfolios, under options, futures contracts and
options on futures contracts) would exceed 20% of its respective total assets.
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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 contracts at any specific time. Thus, it may
not be possible to close a futures position. In the event of adverse price
movements, the Portfolios would continue to be required to make daily cash
payments to maintain their required margin. In such situations, if a Portfolio
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, a Portfolio 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 the Portfolio's ability
to effectively hedge.
The Portfolios will minimize the risk that they will be unable to close out
a futures contract by only entering into futures which are traded on national
futures exchanges and for which there appears to be a liquid secondary market.
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
Portfolios engage in futures strategies only for hedging purposes, the Adviser
does not believe that the Portfolios are subject to the risks of loss frequently
associated with futures transactions. A Portfolio 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.
Utilization of futures transactions by the Portfolios 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 a Portfolio 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 a Portfolio of margin deposits in the event of
bankruptcy of a broker with whom the Portfolio 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.
MORGAN STANLEY CAPITAL INTERNATIONAL EAFE INDEX
The investment objective of the Active Country Allocation Portfolio and the
International Magnum Portfolio is to provide long-term capital appreciation.
The Active Country Allocation Portfolio seeks to achieve its objective by
investing in equity securities of non-U.S. issuers which, in the aggregate,
replicate broad country indices, in accordance with country weightings
determined by the Adviser. The Adviser utilizes a top-down approach in
selecting investments for the Active Country Allocation Portfolio that
emphasizes country selection and weighting rather than individual stock
selection. The Active Country Allocation Portfolio invests, INTER ALIA, in
industrialized countries throughout the world that comprise the Morgan Stanley
Capital International EAFE (Europe, Australia and the Far East) Index (the "EAFE
Index"). The International Magnum Portfolio seeks to achieve its objective by
investing primarily in equity securities of non-U.S. issuers in accordance with
the EAFE country (defined below) weightings determined by the Adviser. After
establishing regional allocation strategies, the Adviser then selects equity
securities among issuers of a region. The 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 Morgan Stanley Capital
International 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.
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OPTIONS TRANSACTIONS
GENERAL INFORMATION. As stated in the applicable Prospectus, the Active Country
Allocation, Emerging Markets, Emerging Markets Debt, Equity Growth, Aggressive
Equity, Gold, Small Cap Value Equity, Value Equity, Balanced, Latin American,
U.S. Real Estate, International Magnum, Fixed Income and China Growth Portfolios
may purchase and sell options on portfolio securities and the China Growth and
Latin American Portfolios also may purchase and sell options on securities
indices. 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 Options").
Listed options are issued or guaranteed by the exchange on which they trade
or by a clearing corporation, such as Options Clearing Corporation ("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 state exercise price (the price per unit of the
underlying security or currency) 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 the current market price. Ownership of
listed put option would give the Portfolio the right to sell the underlying
security or currency to the clearing corporation or exchange at the state
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 of financial
institutions which have entered into direct agreements with the Portfolio. With
OTC options, such variables as expiration date, exercise price and premium will
be agreed upon between the Portfolio 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, the Portfolio would lose the premium paid for the option as well as any
anticipated benefit of the transaction.
COVERED CALL WRITING. Each of the Portfolios may write (i.e., sell) covered
call options on portfolio securities. By doing so, the Portfolio would become
obligated during the terms 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, the Portfolio
will receive from the purchaser (or option holder) a premium which is the price
of the option, less a commission charged by a broker. The Portfolio will keep
the premium regardless of whether the option is exercised. A call option is
"covered" if the Portfolio owns the security underlying the option it has
written or has an absolute or immediate right to acquire the security by holding
a call option on such security, or maintains a sufficient amount of cash, cash
equivalents or liquid securities to purchase the underlying security. When the
Portfolio 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 Portfolio if the securities
underlying the options are ultimately sold by the Portfolio at a loss. However,
during the option period, the Portfolio 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 Portfolios may write covered put options on
portfolio securities. By doing so, the Portfolio 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 Portfolio will be exercisable by
the purchaser only on a specific date). Generally, a put option is "covered" if
the Portfolio maintains cash, U.S. Government securities or other high grade
debt obligations equal to the exercise price of the option or if the Portfolio
holds a put option on the same underlying security with a similar or higher
exercise price.
Each of the Portfolios will write put options to receive the premiums paid
by purchasers; when the Adviser (and also the Sub-Adviser with respect to the
Gold Portfolio) 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 to close
out long put option positions.
PURCHASE OF PUT AND CALL OPTIONS. Each of the Portfolios may purchase listed or
OTC put or call options on its portfolio securities in amounts exceeding no more
than 5% of its total assets. When the Portfolio purchases a call option it
acquires the right to purchase a designated security at a designated price (the
"exercise price"), and when the Portfolio 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.
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The Portfolio 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. The Portfolio 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, the Portfolio would incur no additional loss. The
Portfolio may also purchase put options to close out written put positions in a
manner similar to call option closing purchase transactions.
The amount the Portfolio pays to purchase an option is called a "premium",
and the risk assumed by the Portfolio 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 the Portfolio 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.
OPTIONS ON SECURITIES INDICES. The China Growth and Latin American Portfolios
may purchase and write put and call options on securities indices and enter into
related closing transactions in order to hedge against the risk of market
price fluctuations or to increase income to the Portfolio.
Call and put options on indices are similar to options on securities except
that, rather than the right to purchase or sell particular securities at a
specified price, options on an index give the holder the right to receive, upon
exercise of the option, an amount of cash if the closing level of the underlying
index is greater than (or less than, in the case of puts) the exercise price of
the option. This amount of cash is equal to the difference between the closing
price of the index and the exercise price of the option, expressed in dollars
multiplied by a specified number. Thus, unlike options on individual
securities, all settlements are in cash, and gain or loss depends on price
movements in the particular market represented by the index generally (or in a
particular industry or segment of the market) rather than the price movements in
individual securities.
All options written on indices must be covered. When the Portfolio writes
an option on an index, it will establish a segregated account containing cash,
U.S. government securities or other high quality liquid debt securities with its
custodian in an amount at least equal to the market value of the option and will
maintain the account while the option is open or will otherwise cover the
transaction.
The Portfolio may choose to terminate an option position by entering into a
closing transaction. The ability of the Portfolio to enter into closing
transactions depends upon the existence of a liquid secondary market for such
transactions.
OPTIONS ON CURRENCIES. The China Growth and Latin American Portfolios may
purchase and write put and call options on foreign currencies (traded on U.S.
and foreign exchanges or over-the-counter markets) to manage the Portfolio's
exposure to changes in dollar exchange rates. Call options on foreign currency
written by the Portfolio will be "covered," which means that the Portfolio will
own an equal amount of the underlying foreign currency. With respect to put
options on foreign currency written by the Portfolio, the Portfolio will
establish a segregated account with the Fund's Custodian consisting of cash,
U.S. government securities or other high quality liquid debt securities in an
amount equal to the amount the Portfolio would be required to pay upon exercise
of the put.
PORTFOLIO TURNOVER
The portfolio turnover rate for a year is the lesser of the value of the
purchases or sales for the year divided by the average monthly market value of
the Portfolio for the year, excluding U.S. Government securities and securities
with maturities of one year or less. The portfolio turnover rate for a year is
calculated by dividing the lesser of sales or the average monthly value of the
Portfolio's portfolio purchases of portfolio securities during that year by
securities, excluding money market instruments. The rate of portfolio turnover
will not be a limiting factor when the Portfolio deems it appropriate to
purchase or sell securities for the Portfolio. However, the U.S. federal tax
requirement that the Portfolio derive less than 30% of its gross income from the
sale or disposition of securities held less than three months may limit the
Portfolio's ability to dispose of its securities. See "Taxes."
PRECIOUS METALS FORWARD AND FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
The Gold Portfolio may enter into futures contacts on precious ("precious
metals futures") metals as a hedge against changes in the prices of precious
metals held or intended to be acquired by the Portfolio, but not for speculation
or for achieving leverage. The Portfolio's hedging activities may include
purchases of futures contracts as an offset against the effect of anticipated
increases in the price of a precious metal which the Portfolio intends to
acquire ("anticipatory hedge") or sales of futures contracts as an offset
against the effect of anticipated declines in the price of precious metal which
the Portfolio owns ("hedge against an existing position").
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The Portfolio will enter into precious metals forward contracts which are
similar to precious metals futures contracts, in that they provide for the
purchase or sale of precious metals at an agreed price with delivery to take
place at an agreed future time. However, unlike futures contracts, forward
contracts are negotiated contracts which are primarily used in the dealer
market. Unlike the futures contract market, which is regulated by the CFTC and
by the regulations of the commodity exchanges, the forward contract market is
unregulated. The Portfolio will use forward contracts for the same hedging
purposes as those applicable to futures contracts, as described above. When the
Portfolio enters into a forward contract it will establish with the custodian a
segregated account consisting of cash, cash equivalents or bullion equal to the
market value of the forward contract purchased.
Precious metals futures and forward contract prices can be volatile and are
influenced principally by changes in spot market prices, which in turn are
affected by a variety of political and economic factors. In addition,
expectations of changing market conditions may at times influence the prices of
such futures and forward contracts, and changes in the cost of holding physical
precious metals, including storage, insurance and interest expense, will also
affect the relationship between spot and futures or forward prices. While the
correlation between changes in prices of futures and forward contracts and
prices of the precious metals being hedged by such contracts has historically
been very strong, the correlation may at times be imperfect and even a well
conceived hedge may be unsuccessful to some degree because of market behavior or
unexpected precious metals price trends. To the extent that interest rates move
in a direction opposite to that anticipated, the Portfolio may realize a loss on
a futures transaction not offset by an increase in the value of portfolio
securities. Moreover there is a possibility of a lack of a liquid secondary
market for closing out a futures position or futures option. The success of any
hedging technique depends upon the Adviser's and Sub-Adviser's accuracy in
predicting the direction of a market. If these predictions are incorrect, the
Portfolio may realize a loss.
The Portfolio may also purchase (buy) and write (sell) covered call or put
options on precious metals futures contracts. Such options would be purchased
solely for hedging purposes similar to those applicable to the purchase and sale
of futures contracts. Call options might be purchased to hedge against an
increase in the price of precious metals the Portfolio intends to acquire, and
put options may be purchased to hedge against a decline in the price of precious
metals owned by the Portfolio. As is the case with futures contracts, options
on precious metals futures may facilitate the Portfolio's acquisition of
precious metals or permit the Portfolio to defer disposition of precious metals
for tax or other purposes. The Portfolio may not purchase options on precious
metals and precious metals futures contracts if the premiums paid for all such
options, together with margin deposits on precious metals future contracts,
would exceed 5% of the Portfolio's total assets at the time the option is
purchased.
One of the risks which may arise in employing futures contracts to protect
against the price volatility of the Portfolio's assets is that the price of
precious metals subject to futures contracts (and thereby the futures contracts
prices) may correlate imperfectly with the prices of such assets. A correlation
may also be distorted by the fact that the futures market is dominated by short-
term traders seeking to profit from the difference between a contract or
security price objective and their cost of borrowed funds. Such distortions are
generally minor and would diminish as the contract approached maturity.
SECURITIES LENDING
Each Portfolio may lend its investment securities to qualified
institutional investors who 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, a Portfolio 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 Portfolio. Each Portfolio 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 Investment Company Act of 1940, as amended
(the "1940 Act"), or the Rules and Regulations or interpretations of the
Securities and Exchange Commission (the "Commission") thereunder, which
currently require that (a) the borrower pledge and maintain with the portfolio
collateral consisting of cash, an irrevocable letter of credit issued by a
domestic U.S. bank, or securities issued or guaranteed by the United States
Government having a value at all times not less than 100% of the value of the
securities loaned, (b) 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), (c) the loan be made subject to termination by the Portfolio at any
time, and (d) the Portfolio receive reasonable interest on the loan (which may
include the Portfolio 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 only be made to borrowers
deemed by the Advisor to be of good standing and when, in the judgment of the
Advisor, 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 Fund.
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At the present time, the staff of the Commission 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 Emerging Markets Debt, Latin American and Aggressive Equity Portfolios
may from time to time sell securities short without limitation but consistent
with applicable legal requirements, although initially the Portfolio does not
intend to sell securities short. A short sale is a transaction in which the
Portfolio 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
Portfolio makes a short sale of borrowed securities, the proceeds it receives
from the sale will be held on behalf of a broker until the Portfolio replaces
the borrowed securities. To deliver the securities to the buyer, the Portfolio
will need to arrange through a broker to borrow the securities and, in so doing,
the Portfolio will become obligated to replace the securities borrowed at their
market price at the time of replacement, whatever that price may be. The
Portfolio 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 Portfolio'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 cash, U.S. Government Securities or other liquid, high grade debt
obligations. In addition, if the short sale is not "against the box," the
Portfolio will place in a segregated account with its custodian, or designated
sub-custodian, an amount of cash, U.S. Government Securities or other liquid
high grade debt obligations equal to the difference, if any, between (1) the
market value of the securities sold at the time they were sold short and (2) any
cash, U.S. Government Securities or other liquid high grade debt obligations
deposited as collateral with the broker in connection with the short sale (not
including the proceeds of the short sale). Until it replaces the borrowed
securities, the Portfolio will maintain the segregated account daily at a level
so that (1) 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 (2) 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 Portfolio involve certain risks and special
considerations. Possible losses from short sales differ from losses that could
be incurred from a purchase of a security, because losses from short sales may
be unlimited, whereas losses from purchases can equal only the total amount
invested.
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 futures and options on
foreign currencies, 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 the Portfolios 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 a Portfolio's trading systems will be
based may not be as complete as the comparable data on which such Portfolio
makes investment and trading decisions in connection with securities and other
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 a Portfolio from responding to such events in a timely
manner.
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 United States 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 CFTC or (with the exception of certain foreign currency
options) the Commission. In an over-the-counter trading environment, many of
the protections associated with transactions on exchanges will not be available.
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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 a Portfolio is a party.
In addition, over-the-counter transactions can only be entered into with a
financial institution willing to take the opposite side, as principal, of a
Portfolio's position unless the institution acts as broker and is able to find
another counterparty willing to enter into the transaction with such Portfolio.
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 a Portfolio 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 a Portfolio'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. A Portfolio 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 a Portfolio's ability to enter into desired hedging transactions. A
Portfolio will enter into over-the-counter transactions only with parties whose
creditworthiness has been reviewed and found satisfactory by the Adviser.
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. The China Growth and
Latin American Portfolios are not able to determine at this time whether or to
what extent the CFTC may impose additional restrictions on the trading of over-
the-counter options on foreign currencies at some point in the future, or the
effect that any restrictions may have on the hedging strategies to be
implemented by the Portfolio. 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, a
Portfolio's ability to utilize forward contracts and currency swaps in the
manner set forth above and in the applicable Prospectus could be restricted.
Options on foreign currencies traded on a national securities exchange are
within the jurisdiction of the Commission, 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 a Portfolio 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 the OCC, which has established banking relationships in applicable
foreign countries for this purpose. As a result, the 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 the 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.
TAXES
The following is only a summary of certain additional federal tax
considerations generally affecting the Fund and its shareholders that are not
described in the Prospectuses. No attempt is made to present a detailed
explanation of the federal, state or local tax treatment of the Fund or its
shareholders, and the discussion here and in the Fund's Prospectuses is not
intended as a substitute for careful tax planning.
The following discussion of 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
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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.
Each Portfolio intends to 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; (b) derive
less than 30% of its gross income each taxable year from the sale or other
disposition of the following items if held less than three months (A) stock or
securities, (B) options, futures or forward contracts (other than options,
futures or forward contracts on foreign currencies), and (C) foreign currencies
(or options, futures, or forward contracts on foreign currencies) that are not
directly related to the Portfolio's principal business of investing in stocks or
securities (or options or futures with respect to stock or securities) (the
"short-short test") and (c) 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.
In addition to the requirements described above, in order to qualify as a
RIC, a Portfolio must distribute at least 90% of its 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 corporate rates, and its distributions (including
capital gains distributions) will be taxable as ordinary income dividends to its
shareholders to the extent of the Portfolio's current and accumulated earnings
and profits, and will be eligible for the corporate dividends received deduction
for corporate shareholders.
Each Portfolio will decide whether to distribute or to retain all or part
of any net capital gains (the excess of net long-term capital gains over net
short-term capital losses) in any year for reinvestment. If any such gains are
retained, the Portfolio will pay federal income tax thereon, and, if the
Portfolio makes an election, the shareholders will include such undistributed
gains in their income, will increase their basis in Portfolio shares by 65% of
the amount included in their income and will be able to claim their share of the
tax paid by the Portfolio as a refundable credit against their federal income
tax liability.
A gain or loss realized by a shareholder on the sale, exchange or
redemption of shares of a Portfolio held as a capital asset will be capital
gain or loss, and such gain or loss will be long-term if the holding period
for the shares exceeds one year, and otherwise will be short-term. Any loss
realized on a sale, exchange or redemption of shares of a Portfolio will be
disallowed to the extent the shares disposed of are replaced within the
61-day period beginning 30 days before and ending 30 days after the shares
are disposed of. Any loss realized by a shareholder on the disposition of
shares held 6 months or less is treated as a long-term capital loss to the
extent of any distributions of net long-term capital gains received by the
shareholder with respect to such shares or any inclusion of undistributed
capital gain with respect to such shares.
The conversion of Class A shares to Class B shares should not be a taxable
event to the shareholder.
Each Portfolio will generally be subject to a nondeductible 4% federal
excise tax to the extent it fails to distribute by the end of any calendar year
at least 98% of its ordinary income for that year and 98% of its capital gain
net income (the excess of short- and long-term capital gains over short- and
long-term capital losses) for the one-year period ending on October 31 of that
year, plus certain other amounts.
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Each Portfolio is required by federal law to withhold 31% of reportable
payments (which may include dividends, capital gains distributions, and
redemptions) paid to shareholders who have not certified on the Account
Registration Form or on a separate form supplied by the Portfolio, that the
Social Security or Taxpayer Identification Number provided is correct and that
the shareholder is exempt from backup withholding or is not currently subject to
backup withholding.
For certain transactions, each Portfolio is required for federal income tax
purposes to recognize as gain or loss its net unrealized gains and losses on
forward currency and futures contracts as of the end of each taxable year, as
well as those actually realized during the year. In most cases, any such gain
or loss recognized with respect to a regulated futures contract is considered to
be 60% long-term capital gain or loss and 40% short-term capital gain or loss,
without regard to the holding period of the contract. Realized gain or loss
attributable to a foreign currency forward contract is treated as 100% ordinary
income. Furthermore, foreign currency futures contracts which are intended to
hedge against a change in the value of securities held by a Portfolio may affect
the holding period of such securities and, consequently, the nature of the gain
or loss on such securities upon disposition.
As discussed above, in order for each Portfolio to continue to qualify for
federal income tax treatment as a RIC, at least 90% of its gross income for a
taxable year must be derived from certain qualifying income, including
dividends, interest, income derived from loans of securities, and gains from the
sale or other disposition of stock, securities or foreign currencies, or other
related income, including gains from options, futures and forward contracts,
derived with respect to its business of investing in stock, securities or
currencies. Any net gain realized from the closing out of futures contracts
will therefore generally be qualifying income for purposes of the 90%
requirement. Qualification as a RIC also requires that less than 30% of a
Portfolio's gross income be derived from the sale or other disposition of stock,
securities, options, futures or forward contracts (including certain foreign
currencies not directly related to the Fund's business of investing in stock or
securities) held less than three months. In order to avoid realizing excessive
gains on futures contracts held less than three months, the Portfolio may be
required to defer the closing out of futures contracts beyond the time when it
would otherwise be advantageous to do so.
Short sales engaged in by a Portfolio may reduce the holding property held
by a Portfolio which is substantially identical to the property sold short.
This rule may make it more difficult for the Portfolio to satisfy the short-
short test. This rule may also 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 Portfolio from short-term to long-term.
SPECIAL RULES FOR CERTAIN FOREIGN CURRENCY TRANSACTIONS. In general,
gains from foreign currencies and from foreign currency options, foreign
currency futures and forward foreign exchange contracts relating to
investments in stock, securities or foreign currencies are currently
considered to be qualifying income for purposes of determining whether the
Fund qualifies as a regulated investment company. It is currently unclear,
however, who will be treated as the issuer of certain foreign currency
instruments or how foreign currency options, futures, or forward foreign
currency contracts will be valued for purposes of the regulated investment
company diversification requirements applicable to the Fund. The Fund may
request a private letter ruling from the Internal Revenue Service on some or
all of these issues.
Under Code Section 988, special rules are provided for certain
transactions in a foreign currency other than the taxpayer's functional
currency (i.e., unless certain special rules apply, currencies other than the
U.S. dollar). In general, foreign currency gains or losses from forward
contracts, from futures contracts that are not "regulated futures contracts",
and from unlisted options will be treated as ordinary income or loss under
Code Section 988. Also, certain foreign exchange gains or losses derived with
respect to foreign fixed-income securities are also subject to Section 988
treatment. In general, therefore, Code Section 988 gains or losses will
increase or decrease the amount of the Fund's investment company taxable
income available to be distributed to shareholders as ordinary income, rather
than increasing or decreasing the amount of the Fund's net capital gain.
If the Fund invests in an entity which is classified as a "passive
foreign investment company" ("PFIC") for U.S. tax purposes, the application
of certain technical tax provisions applying to such companies could result
in the imposition of federal income tax with respect to such investments at
the Fund level which could not be eliminated by distributions to
shareholders. The U.S. Treasury issued proposed regulation section 1.1291-8
which establishes a mark-to-market regime which allows investment companies
investing in PFIC's to avoid most, if not all, of the difficulties posed by
the PFIC rules. In any event, it is not anticipated that any taxes on the
Fund with respect to investments in PFIC's would be significant.
A Fund's investment in options, swaps and related transactions, futures
contracts and forward contracts, options on futures contracts and stock
indices and certain other securities, including transactions involving actual
or deemed short sales or foreign exchange gains or losses are subject to many
complex and special tax rules. For example, over-the-counter options on debt
securities and equity options, including options on stock and on narrow-based
stock indexes, will be subject to tax under Section 1234 of the Code,
generally producing a long-term or short-term capital gain or loss upon
exercise, lapse or closing out of the option or sale of the underlying stock
or security. By contrast, a Fund's treatment of certain other options,
futures and forward contracts entered into by a Fund is generally governed by
Section 1256 of the Code. These "Section 1256" positions generally include
listed options on debt securities, options on broad-based stock indexes,
options on securities indexes, options on futures contracts, regulated
futures contracts and certain foreign currency contracts and options thereon.
A Section 1256 position held by a Fund will generally be marked-to-market
(i.e. treated as if it were sold for fair market value) on the last business
day of a Fund's fiscal year, and all gain or loss associated with fiscal year
transactions and mark-to-market positions at fiscal year end (except certain
currency gain or loss covered by Section 988 of the Code) will generally be
treated as 60% long-term capital gain or loss and 40% short-term capital gain
or loss. The effect of Section 1256 mark-to-market rules may be to accelerate
income or to convert what otherwise would have been long-term capital gains
into short-term capital gains or short-term capital losses into long-term
capital losses within a Fund. The acceleration of income on Section 1256
positions may require a Fund to accrue taxable income without the
corresponding receipt of cash. In order to generate cash to satisfy the
distribution requirements of the Code, a Fund may be required to dispose of
portfolio securities that they otherwise would have continued to hold or to
use cash flows from other sources such as the sale of Fund shares. In these
ways, any or all of these rules may affect the amount, character and timing
of income earned and in turn distributed to shareholders by a Fund.
When a Fund holds options or contracts which substantially diminish
their risk of loss with respect to other positions (as might occur in some
hedging transactions), this combination of positions could be treated as a
"straddle" for tax purposes, resulting in possible deferral of losses,
adjustments in the holding periods of Fund securities and conversion of
short-term capital losses into long-term capital losses. Certain tax
elections exist for mixed straddles i.e., straddles comprised of at least one
Section 1256 position and at least one non-Section 1256 position which may
reduce or eliminate the operation of these straddle rules.
SPECIAL TAX CONSIDERATIONS RELATING TO
MUNICIPAL BOND AND
MUNICIPAL MONEY MARKET PORTFOLIOS
Each of the Municipal Bond Portfolio and the Municipal Money Market
Portfolio will qualify to pay "exempt interest dividends" to its shareholders
provided that, at the close of each quarter of its taxable year at least 50% of
the value of its total assets consists of obligations the interest on which is
exempt from federal income tax. Current federal tax law limits the types and
volume of bonds qualifying for federal income tax exemption of interest, which
may have an effect on the ability of these Portfolios to purchase sufficient
amounts of tax-exempt securities to satisfy this requirement. Any loss on the
sale or exchange of shares of the Municipal Bond Portfolio or the Municipal
Money Market Portfolio held for six months or less will be disallowed to the
extent of any exempt-interest dividends received by the selling shareholder with
respect to such shares.
As noted in the Prospectus for the Municipal Bond Portfolio and the
Municipal Money Market Portfolio, exempt-interest dividends are excludable from
a shareholder's gross income for regular Federal income tax purposes. Exempt-
interest dividends may nevertheless be subject to the alternative minimum tax
(the "Alternative Minimum Tax") imposed by Section 55 of the Code or the
environmental tax (the "Environmental Tax") imposed by Section 59A of the Code.
The Alternative Minimum Tax is imposed at the rate of up to 28% in the case of
non-corporate taxpayers and at the rate of 20% in the case of corporate
taxpayers, to the extent it exceeds the taxpayer's regular tax liability. The
Environmental Tax is imposed at the rate of 0.12% and applies only to corporate
taxpayers. The Alternative Minimum Tax and the Environmental Tax may be
affected by the receipt of exempt-interest dividends in two circumstances.
First, exempt-interest dividends derived from certain "private activity bonds"
issued after August 7, 1986, will generally be an item of tax preference and
therefore potentially subject to the Alternative Minimum Tax and the
Environmental Tax. The Portfolios intend, when possible, to avoid investing in
private activity bonds. Second, in the case of exempt-interest dividends
received by corporate shareholders, all exempt-interest dividends, regardless of
when the bonds from which they are derived were issued or whether they are
derived from private activity bonds, will be included in the corporation's
"adjusted current earnings," as defined in Section 56(g) of the Code, in
calculating the corporation's alternative minimum taxable income for purposes of
determining the Alternative Minimum Tax and the Environmental Tax.
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The percentage of income that constitutes "exempt-interest dividends" will
be determined for each year for the Municipal Bond Portfolio and the Municipal
Money Market Portfolio and will be applied uniformly to all dividends declared
with respect to the Portfolios during that year. This percentage may differ
from the actual percentage for any particular day.
Interest on indebtedness incurred or continued by shareholders to purchase
or carry shares of the Municipal Bond Portfolio or the Municipal Money Market
Portfolio will not be deductible for federal income tax purposes. The deduction
otherwise allowable to property and casualty insurance companies for "losses
incurred" will be reduced by an amount equal to a portion of exempt-interest
dividends received or accrued during any taxable year. Foreign corporations
engaged in a trade or business in the United States will be subject to a "branch
profits tax" on their "dividend equivalent amount" for the taxable year, which
will include exempt-interest dividends. Certain Subchapter S corporations may
also be subject to taxes on their "passive investment income," which could
include exempt-interest dividends. Up to 85% of the Social Security benefits or
railroad retirement benefits received by an individual during any taxable year
will be included in the gross income of such individual if the individual's
"modified adjusted gross income" (which includes exempt-interest dividends) plus
one-half of the Social Security benefits or railroad retirement benefits
received by such individual during that taxable year exceeds the base amount
described in Section 86 of the Code.
Entities or persons who are "substantial users" (or persons related to
"substantial users") of facilities financed by industrial development bonds or
private activity bonds should consult their tax advisors before purchasing
shares of the Municipal Bond Portfolio or the Municipal Money Market Portfolio.
"Substantial user" is defined generally for these purposes as including a "non-
exempt person" who regularly uses in trade or business a part of a facility
financed from the proceeds of such bonds.
Issuers of bonds purchased by the Municipal Bond Portfolio (or the
beneficiary of such bonds) may have made certain representations or covenants in
connection with the issuance of such bonds to satisfy certain requirements of
the Code that must be satisfied subsequent to the issuance of such bonds.
Investors should be aware that exempt-interest dividends derived from such bonds
may become subject to federal income taxation retroactively to the date thereof
if such representations are determined to have been inaccurate or if the issuer
of such bonds (or the beneficiary of such bonds) fails to comply with such
covenants.
SPECIAL TAX CONSIDERATIONS RELATING TO FOREIGN INVESTMENTS
Gains or losses attributable to foreign currency contracts, or to
fluctuations in exchange rates that occur between the time a Portfolio accrues
interest or other receivables or accrues expenses or other liabilities
denominated in a foreign currency and the time the Portfolio actually collects
such receivables or pays such liabilities are treated as ordinary income or
ordinary loss to the Portfolio. 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 Portfolio. These gains or losses increase or decrease the amount of a
Portfolio's net investment income available to be distributed to its
shareholders as ordinary income.
It is expected that each Portfolio will be subject to foreign withholding
taxes with respect to its dividend and interest income from foreign countries,
and a Portfolio may be subject to foreign income taxes with respect to other
income. So long as more than 50% in value of a Portfolio's total assets at the
close of the taxable year consists of stock or securities of foreign
corporations, the Portfolio may elect to treat certain foreign income taxes
imposed on it for United States federal income tax purposes as paid directly by
its shareholders. A Portfolio will make such an election only if it deems it to
be in the best interest of its shareholders and will notify shareholders in
writing each year if it makes an election and of the amount of foreign income
taxes, if any, to be treated as paid by the shareholders. If a Portfolio makes
the election, shareholders will be required to include in income their
proportionate shares of the amount of foreign income taxes treated as imposed on
the Portfolio and will be entitled to claim either a credit (subject to the
limitations discussed below) or, if they itemize deductions, a deduction, for
their shares of the foreign income taxes in computing their federal income tax
liability.
Shareholders who choose to utilize a credit (rather than a deduction) for
foreign taxes will be subject to a number of complex limitations regarding the
availability and utilization of the credit. Because of these limitations,
shareholders may be unable to claim a credit for the full amount of their
proportionate shares of the foreign income taxes paid by a Portfolio.
Shareholders are urged to consult their tax advisors regarding the application
of these rules to their particular circumstances.
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TAXES AND FOREIGN SHAREHOLDERS
Taxation of a shareholder who, as to the United States, is a nonresident
alien individual, a foreign trust or estate, a foreign corporation, or a foreign
partnership ("Foreign Shareholder") depends on whether the income from the
Portfolio is "effectively connected" with a U.S. trade or business carried on by
such shareholder.
If the income from the Portfolio is not effectively connected with a U.S.
trade or business carried on by a Foreign Shareholder, distributions of net
investment income plus the excess of net short-term capital gains over net
long-term capital losses will be subject to U.S. withholding tax at the rate of
30% (or such lower treaty rate as may be applicable) upon the gross amount of
the dividend. Furthermore, Foreign Shareholders will generally be exempt from
U.S. federal income tax on gains realized on the sale of shares of the
Portfolio, distributions of net long-term capital gains, and amounts retained by
the Fund which are designated as undistributed capital gains.
If the income from the Portfolio is effectively connected with a U.S. trade
or business carried on by a Foreign Shareholder, then distributions from the
Portfolio and any gains realized upon the sale of shares of the Portfolio, will
be subject to U.S. federal income tax at the rates applicable to U.S. citizens
and residents or domestic corporations.
The Portfolio may be required to withhold U.S. federal income tax on
distributions that are otherwise exempt from withholding tax (or taxable at a
reduced treaty rate) unless the Foreign Shareholder complies with Internal
Revenue Service certification requirements.
The tax consequences to a Foreign Shareholder entitled to claim the
benefits of an applicable tax treaty may differ from those described here.
Furthermore, Foreign Shareholders are strongly urged to consult their own tax
advisors with respect to the particular tax consequences to them of an
investment in a Portfolio, including the potential application of the provisions
of the Foreign Investment in Real Estate Property Tax Act of 1980, as amended.
PURCHASE OF SHARES
The purchase price of the Class A shares of each Portfolio of the Fund,
except the Money Market and Municipal Money Market Portfolios, and the Class B
shares of each Multiclass Portfolio of the Fund is the net asset value next
determined after the order is received. For each Portfolio of the Fund other
then the Money Market or Municipal Market Portfolios, 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 Money Market and Municipal Money Market Portfolios may be purchased at
the net asset value per share at the price next determined after Federal Funds
are available to such Portfolios. 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, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day and Christmas Day.
Each Portfolio reserves the right in its sole discretion (i) to suspend the
offering of its shares, (ii) to reject purchase orders when in the judgment of
management such rejection is in the best interest of the Fund, and (iii) to
reduce or waive the minimum for initial and subsequent investments for certain
fiduciary accounts such as employee benefit plans or under circumstances where
certain economies can be achieved in sales of a Portfolio's shares. The
International Equity Portfolio is currently limiting investments in the
Portfolio to: (i) reinvested dividends and distributions by existing
shareholders of the Portfolio; (ii) additional investments by existing
shareholders of the Portfolio; (iii) investments by employees of Morgan Stanley;
and (iv) investors who were in the process of becoming shareholders of the
Portfolio at the time the Portfolio limited further investments.
REDEMPTION OF SHARES
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 Commission, (ii) during any period when an
emergency exists as defined by the rules of the Commission 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.
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No charge is made by any Portfolio for redemptions except for the 1%
transaction fee assessed upon redemption of the International Small Cap
Portfolio. Any redemption may be more or less than the shareholder's cost
depending on the market value of the securities held by the Portfolio.
To protect your account and the Fund from fraud, signature guarantees are
required for certain redemptions. Signature guarantees enable the Fund to
verify the identity of the person who has authorized a redemption from your
account. Signature guarantees are required in connection with: (1) all
redemptions, regardless of the amount involved, when the proceeds are to be paid
to someone other than the registered owner(s) and/or registered address; and
(2) share transfer requests.
A guarantor must be a bank, a trust company, a member firm of a domestic
stock exchange, or a foreign branch of any of the foregoing. Notaries public
are not acceptable guarantors.
The signature guarantees must appear either: (1) on the written request
for redemption; (2) on a separate instrument for assignment ("stock power")
which should specify the total number of shares to be redeemed; or (3) on all
stock certificates tendered for redemption and, if shares held by the Fund are
also being redeemed, on the letter or stock power.
SHAREHOLDER SERVICES
EXCHANGE FEATURES
Shares of each Portfolio of the Fund may be exchanged for shares of any
other available Portfolio (other than the International Equity Portfolio, which
is closed to new investors). In exchanging for shares of a Portfolio with more
than one class, the class of shares a shareholder receives in exchange will be
determined in the same manner as any other purchase of shares and will not be
based on the class of shares surrendered for the exchange. Consequently, the
same minimum initial investment and minimum account size for determining the
class of shares received in the exchange will apply.
Any such exchange will be based on the respective net asset values of the
shares involved. There is no sales commission or charge of any kind. Before
making an exchange, a shareholder should consider the investment objectives of
the Portfolio to be purchased.
Exchange requests may be made either by mail or telephone. Exchange
requests by mail should be sent to Morgan Stanley Institutional Fund, Inc., P.O.
Box 2798, Boston, Massachusetts 02208-2798. Telephone exchanges will be accepted
only if the certificates for the shares to be exchanged are held by the Fund for
the account of the shareholder and the registration of the two accounts will be
identical. Requests for exchanges received prior to 10:00 a.m. (Eastern Time)
for the Municipal Money Market Portfolio, 11:00 a.m. (Eastern Time) for the
Money Market Portfolio, and 4:00 p.m. (Eastern Time) for the remaining
Portfolios will be processed as of the close of business on the same day.
Requests received after these times will be processed on the next business day.
Exchanges may be subject to limitations as to amounts or frequency, and to other
restrictions established by the Board of Directors to assure that such exchanges
do not disadvantage the Fund and its shareholders.
For federal income tax purposes an exchange between Portfolios is a taxable
event for shareholders subject to tax, and, accordingly, a gain or loss may be
realized. The exchange privilege may be modified or terminated by the Fund at
any time upon 60-days' notice to shareholders.
TRANSFER OF SHARES
Shareholders may transfer shares of the Fund's Portfolios to another person
by making a written request to the Fund. The request should clearly identify
the account and number of shares to be transferred, and include the signature of
all registered owners and all stock certificates, if any, which are subject to
the transfer. The signature on the letter of request, the stock certificate or
any stock power must be guaranteed in the same manner as described under
"Redemption of Shares." As in the case of redemptions, the written request must
be received in good order before any transfer can be made. Transferring shares
may affect the eligibility of an account for a given class of the Portfolio's
shares and may result in involuntary conversion or redemption of such shares.
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INVESTMENT LIMITATIONS
Each current Portfolio has adopted the following restrictions which are
fundamental policies and may not be changed without the approval of the lesser
of: (1) 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 (2) 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 the
Portfolio from purchasing or selling options or futures contracts or from
investing in securities or other instruments backed by physical commodities),
and except that the Gold Portfolio may invest in gold bullion in accordance with
its investment objectives and policies;
(2) purchase or sell real estate, although it may purchase and 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 Global Fixed Income, Emerging Markets,
Emerging Markets Debt, China Growth, Latin American, MicroCap, Aggressive
Equity, U.S. Real Estate Portfolios (i) purchase more than 10% of any class of
the outstanding voting securities of any issuer and (ii) purchase securities of
an issuer (except obligations of the U.S. Government and its agencies and
instrumentalities) if as a result, with respect to 75% of its total assets, 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 and will not borrow, except from banks and as
a temporary measure for extraordinary or emergency purposes and then, in no
event, in excess of 33 1/3% of its total assets (including the amount borrowed)
less liabilities (other than borrowings), except that each of the Emerging
Markets Debt and Latin American Portfolios may borrow from banks and other
entities in amount not in excess of 33 1/3% of its total assets (including the
amount borrowed) less liabilities in accordance with its investment objectives
and policies;
(6) underwrite securities issued by others, except to the extent that the
Portfolio may be considered an underwriter within the meaning of the 1933 Act in
the disposition of restricted securities;
(7) acquire any securities of companies within one industry if, as a
result of such acquisition, more than 25% of the value of the Portfolio's
total assets would be invested in securities of companies within such
industry; provided, however, that there shall be no limitation on the
purchase of obligations issued or guaranteed by the U.S. Government, its
agencies or instrumentalities, or (in the case of the Money Market Portfolio
or the Municipal Money Market Portfolio) instruments issued by U.S. Banks,
except that (i) the Latin American Portfolio may invest more than 25% of its
total assets in companies involved in the telecommunications industry or
financial services industry, (ii) the Gold Portfolio may invest more than 25%
of its total assets in securities of companies in the group of industries
involved in gold-related or precious-metals-related activities, as described
in the prospectus, and may invest more than 25% of its total assets in one or
more of the industries, such as mining, that are part of such group of
industries, as described in the prospectus, and (iii) the U.S. Real Estate
Portfolio may invest more than 25% of its total assets in the U.S. real
estate industry, respectively, as provided in their respective Prospectuses;
and
(8) write or acquire options or interests in oil, gas or other mineral
exploration or development programs.
In addition, each current Portfolio of the Fund has adopted non-fundamental
investment limitations as stated below and in their respective Prospectuses.
Such limitations may be changed without shareholder approval. Each current
Portfolio of the Fund will not:
(1) purchase on margin or sell short, except (i) that the Emerging Markets
Debt, Latin American and Aggressive Equity Portfolios may from time to time sell
securities short without limitation but consistent with applicable legal
requirements as stated in its Prospectus, (ii) that each of the Active Country
Allocation, Equity Growth, Gold, China Growth and Aggressive Equity Portfolios
may enter into option transactions to the extent that not more than 5% of the
Portfolio's total assets are required as deposits to secure obligations under
options and not more than 20% of its total assets are invested in options,
futures contracts and options on futures contracts at any time, and (iii) as
specified above in Fundamental Restriction No. (1);
(2) purchase or retain securities of an issuer if those Officers and
Directors of the Fund or its investment adviser owning more than 1/2 of 1% of
such securities together own more than 5% of such securities;
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(3) pledge, mortgage, or hypothecate any of its assets to an extent
greater than 10% of its total assets at fair market value;
(4) invest for the purpose of exercising control over management of any
company;
(5) invest its assets in securities of any investment company, except by
purchase in the open market involving only customary brokers' commissions or in
connection with mergers, acquisitions of assets or consolidations and except as
may otherwise be permitted by the 1940 Act;
(6) invest more than 5% of its total assets in securities of companies
which have (with predecessors) a record of less than three years' continuous
operation;
(7) purchase warrants if, by reason of such purchase, more than 5% of the
value of the Portfolio's net assets (taken at market value) would be invested in
warrants, valued at the lower of cost or market. Included within this amount,
but not to exceed 2% of the value of the Portfolio's net assets, may be warrants
that are not listed on a recognized stock exchange;
(8) except for the U.S. Real Estate Portfolio, invest in real estate
limited partnership interests, and the U.S. Real Estate Portfolio may not invest
in such interests that are not publicly traded;
(9) make loans except (i) by purchasing bonds, debentures or similar
obligations (including repurchase agreements, subject to the limitations as
described in the respective Prospectuses) 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 Commission
thereunder;
(10) invest in oil, gas or other mineral leases; and
(11) purchase puts, calls, straddles, spreads and any combination thereof
if for any reason thereof the value of its aggregate investment in such classes
of securities will exceed 5% of their respective total assets, except that: (a)
each of the Active Country Allocation, Equity Growth, Gold, China Growth and
Aggressive Equity Portfolios may enter into option transactions to the extent
that not more than 5% of the Portfolio's total assets are required as deposits
to secure obligations under options and not more than 20% of its total assets
are invested in options, futures contracts and options on futures contracts at
any time; and (b) the Fixed Income Portfolio is not subject to this limitation
number (11).
The Balanced, Fixed Income and Value Equity Portfolios will only issue
shares for securities or assets other than cash in a bona fide reorganization,
statutory merger, or in other acquisitions of portfolio securities (except for
municipal debt securities issued by state political subdivisions or their
agencies or instrumentalities) which (i) meet their respective investment
objectives; (ii) are acquired for investment and not for resale.
Each of the Global Fixed Income, Emerging Markets, Emerging Markets Debt,
China Growth, Latin American, Aggressive Equity and U.S. Real Estate Portfolios
will diversify its holdings so that, at the close of each quarter of its taxable
year, (i) at least 50% of the market value of the Portfolio's total assets is
represented by cash (including cash items and receivables), U.S. Government
securities, and other securities, with such other securities limited, in respect
of any one issuer, for purposes of this calculation to an amount not greater
than 5% of the value of the Portfolio's total assets and 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 of any one issuer (other than U.S.
Government securities).
The percentage limitations contained in these restrictions apply at the
time of purchase of securities. Future Portfolios of the Fund may adopt
different limitations.
DETERMINING MATURITIES OF CERTAIN INSTRUMENTS
Generally, the maturity of a portfolio instrument shall be deemed to be the
period remaining until the date noted on the face of the instrument as the date
on which the principal amount must be paid, or in the case of an instrument
called for redemption, the date on which the redemption payment must be made.
However, instruments having variable or floating interest rates or demand
features may be deemed to have remaining maturities as follows: (1) a
Government Obligation with a variable rate of interest readjusted no less
frequently than annually may be deemed to have a maturity equal to the period
remaining until the next readjustment of the interest rate; (b) an instrument
with a variable rate of interest, the principal amount of which is scheduled on
the face of the
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instrument to be paid in one year or less, may be deemed to have a maturity
equal to the period remaining until the next readjustment of the interest rate;
(c) an instrument with a variable rate of interest that is subject to a demand
feature may be deemed to have a maturity equal to the longer of the period
remaining until the next readjustment of the interest rate or the period
remaining until the principal amount can be recovered through demand; (d) an
instrument with a floating rate of interest that is subject to a demand feature
may be deemed to have a maturity equal to the period remaining until the
principal amount can be recovered through demand; and (e) a repurchase agreement
may be deemed to have a maturity equal to the period remaining until the date on
which the repurchase of the underlying securities is scheduled to occur, or
where no date is specified, but the agreement is subject to demand, the notice
period applicable to a demand for the repurchase of the securities.
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. Three Directors and all of the officers
of the Fund are directors, officers or employees of the Fund's adviser,
distributor or administrative services provider. 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. or its affiliates. The other Directors have no affiliation with
the Fund's adviser, distributor or administrative services provider. 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:
Name, Address Position Principal Occupation During
and Age with Fund Past Five Years
- ------------------- --------- ---------------------------
Barton M. Biggs* Chairman and Chairman and Director of Morgan
1221 Avenue of the Director Stanley Asset Management Inc. and
Americas Morgan Stanley Asset Management
New York, NY 10020 Limited; Managing Director of Morgan
(63) Stanley & Co., Inc.; Director of
Morgan Stanley Group Inc.; Member of
International Advisory Counsel of
the Thailand Fund; Chairman and
Director of The Brazilian Investment
Fund, Inc., The Latin American
Discovery Fund, Inc., The Malaysia
Fund, Inc., Morgan Stanley Africa
Investment Fund, Inc., Morgan Stanley
Asia-Pacific Fund, Inc., Morgan
Stanley Emerging Markets Debt Fund,
Inc., Morgan Stanley Emerging Markets
Fund, Inc., Morgan Stanley Fund Inc.,
Morgan Stanley Global Opportunity
Bond Fund, Inc., Morgan Stanley High
Yield Fund, Inc., Morgan Stanley
India Investment Fund, Inc., Morgan
Stanley Institutional Fund, Inc., The
Pakistan Investment Fund, Inc., PCS
Cash Fund, Inc., The Thai Fund, Inc.
and The Turkish Investment Fund, Inc.
20
<PAGE>
Name, Address Position Principal Occupation During
and Age with Fund Past Five Years
- ------------------- --------- ---------------------------
Warren J. Olsen* Director and Principal of Morgan Stanley & Co.,
1221 Avenue of the President Inc.; Principal of Morgan Stanley
Americas Asset Management Inc.; President and
New York, NY 10020 Director of The Brazilian Investment
(39) Fund, Inc., The Latin American
Discovery Fund, Inc., The Malaysia
Fund, Inc., Morgan Stanley Africa
Investment Fund, Inc., Morgan Stanley
Asia-Pacific Fund, Inc., Morgan
Stanley Emerging Markets Debt Fund,
Inc., Morgan Stanley Emerging Markets
Fund, Inc., Morgan Stanley Fund,
Inc., Morgan Stanley Global
Opportunity Bond Fund, Inc., Morgan
Stanley High Yield Fund, Inc., Morgan
Stanley India Investment Fund, Inc.,
Morgan Stanley Institutional Fund,
Inc., The Pakistan Investment Fund,
Inc., PCS Cash Fund, Inc., The Thai
Fund, Inc., and The Turkish
Investment Fund, Inc.
John D. Barrett, II Director Chairman and Director of Barrett
521 Fifth Avenue Associates, Inc. (investment
New York, NY 10135 counseling); Director of the Ashforth
(60) Company (real estate); Director of
the Morgan Stanley Fund, Inc., Morgan
Stanley Institutional Fund, Inc. and
PCS Cash Fund, Inc.
Gerard E. Jones Director Partner in Richards & O'Neil LLP (law
43 Arch Street firm); Director of the Morgan Stanley
Greenwich, CT 06830 Fund, Inc., Morgan Stanley
(59) Institutional Fund, Inc. and PCS Cash
Fund, Inc.
Andrew McNally IV Director Chairman and Chief Executive Officer
8255 North Central of Rand McNally (publication);
Park Avenue Director of Allendale Insurance Co.,
Skokie, IL 60076 Mercury Finance (consumer finance);
(56) Zenith Electronics, Hubbell, Inc.
(industrial electronics); Director of
the Morgan Stanley Fund, Inc., Morgan
Stanley Institutional Fund, Inc. and
PCS Cash Fund, Inc.
Samuel T. Reeves Director Chairman of the Board and CEO,
8211 North Pinacle L.L.C. (investment firm);
Fresno Street Director, Pacific Gas and Electric
Fresno, CA 93720 and PG&E Enterprises (utilities);
(61) Director of the Morgan Stanley Fund,
Inc., Morgan Stanley Institutional
Fund, Inc. and PCS Cash Fund, Inc.
21
<PAGE>
Name, Address Position Principal Occupation During
and Age with Fund Past Five Years
- ------------------- --------- ---------------------------
Fergus Reid Director Chairman and Chief Executive Officer
85 Charles Colman Blvd of LumeLite Corporation (injection
Pawling, NY 12564 molding firm); Trustee and Director
(63) of Vista Mutual Fund Group; Director
of the Morgan Stanley Fund, Inc.,
Morgan Stanley Institutional Fund,
Inc. and PCS Cash Fund, Inc.
Frederick O. Robertshaw Director Of Counsel, Bryan, Cave (law firm);
2800 North Central Avenue Previously associated with Copple,
Phoenix, AZ 85004 Chamberlin & Boehm, P.C. and Rake,
(62) Copple, Downey & Black, P.C. (law
firms); Director of the Morgan
Stanley Fund, Inc., Morgan Stanley
Institutional Fund, Inc. and PCS Cash
Fund, Inc.
Frederick B. Whittemore* Director Advisory Director of Morgan Stanley &
1251 Avenue of the Co., Inc.; Vice-Chairman and Director
Americas, 30th Flr. of The Brazilian Investment Fund,
New York, NY 10020 Inc., The Latin American Discovery
(65) Fund, Inc., The Malaysia Fund, Inc.,
Morgan Stanley Africa Investment
Fund, Inc., Morgan Stanley
Asia-Pacific Fund, Inc., Morgan
Stanley Emerging Markets Debt Fund,
Inc., Morgan Stanley Emerging Markets
Fund, Inc., Morgan Stanley Fund,
Inc., Morgan Stanley Global
Opportunity Bond Fund, Inc., Morgan
Stanley High Yield Fund,Inc., Morgan
Stanley India Investment Fund, Inc.,
Morgan Stanley Institutional Fund,
Inc., The Pakistan Investment Fund,
Inc., PCS Cash Fund, Inc., The Thai
Fund, Inc. and The Turkish Investment
Fund, Inc.
James W. Grisham* Vice President Principal of Morgan Stanley & Co.,
1221 Avenue of the Inc.; Principal of Morgan Stanley
Americas Asset Management Inc.; Vice President
New York, NY 10020 of The Brazilian Investment Fund,
(54) Inc., The Latin American Discovery
Fund, Inc., The Malaysia Fund, Inc.,
Morgan Stanley Africa Investment
Fund, Inc., Morgan Stanley
Asia-Pacific Fund, Inc., Morgan
Stanley Emerging Markets Debt Fund,
Inc., Morgan Stanley Emerging Markets
Fund, Inc., Morgan Stanley Fund,
Inc., Morgan Stanley Global
Opportunity Bond Fund, Inc., Morgan
Stanley High Yield Fund, Inc., Morgan
Stanley India Investment Fund, Inc.,
Morgan Stanley Institutional Fund,
Inc., The Pakistan Investment Fund,
Inc., PCS Cash Fund, Inc., The Thai
Fund, Inc. and The Turkish Investment
Fund, Inc.
22
<PAGE>
Name, Address Position Principal Occupation During
and Age with Fund Past Five Years
- ------------------- --------- ---------------------------
Harold J. Schaaff, Jr.* Vice President Principal of Morgan Stanley & Co.;
1221 Avenue of the General Counsel and Secretary of
Americas Morgan Stanley Asset Management Inc.;
New York, NY 10020 Vice President of The Brazilian
(35) Investment Fund, Inc., The Latin
American Discovery Fund, Inc., The
Malaysia Fund, Inc., Morgan Stanley
Africa Investment Fund, Inc., Morgan
Stanley Asia-Pacific Fund, Inc.,
Morgan Stanley Emerging Markets Debt
Fund, Inc., Morgan Stanley Emerging
Markets Fund, Inc., Morgan Stanley
Fund, Inc., Morgan Stanley Global
Opportunity Bond Fund, Inc., Morgan
Stanley High Yield Fund, Inc., Morgan
Stanley India Investment Fund, Inc.,
Morgan Stanley Institutional Fund,
Inc., The Pakistan Investment Fund,
Inc., PCS Cash Fund, Inc., The Thai
Fund, Inc. and The Turkish Investment
Fund, Inc.
Joseph P. Stadler* Vice President Vice President of Morgan Stanley
1221 Avenue of the Asset Management Inc.; Previously
Americas with Price Waterhouse LLP
New York, NY 10020 (accounting); Vice President of The
(41) Brazilian Investment Fund, Inc., The
Latin American Discovery Fund, Inc.,
The Malaysia Fund, Inc., Morgan
Stanley Africa Investment Fund, Inc.,
Morgan Stanley Asia-Pacific Fund,
Inc., Morgan Stanley Emerging Markets
Debt Fund, Inc., Morgan Stanley
Emerging Markets Fund, Inc., Morgan
Stanley Fund, Inc., Morgan Stanley
Global Opportunity Bond Fund, Inc.,
Morgan Stanley High Yield Fund, Inc.,
Morgan Stanley India Investment Fund,
Inc., Morgan Stanley Institutional
Fund, Inc., The Pakistan Investment
Fund, Inc., PCS Cash Fund, Inc., The
Thai Fund, Inc. and The Turkish
Investment Fund, Inc.
23
<PAGE>
Name, Address Position Principal Occupation During
and Age with Fund Past Five Years
- ------------------- --------- ---------------------------
Valerie Y. Lewis* Secretary Vice President of Morgan Stanley
1221 Avenue of the Asset Management Inc.; Previously
Americas with Citicorp (banking); Secretary of
New York, NY 10020 The Brazilian Investment Fund, Inc.,
(40) The Latin American Discovery Fund,
Inc., The Malaysia Fund, Inc., Morgan
Stanley Africa Investment Fund, Inc.,
Morgan Stanley Asia-Pacific Fund,
Inc., Morgan Stanley Emerging Markets
Debt Fund, Inc., Morgan Stanley
Emerging Markets Fund, Inc., Morgan
Stanley Fund, Inc., Morgan Stanley
Global Opportunity Bond Fund, Inc.,
Morgan Stanley High Yield Fund, Inc.,
Morgan Stanley India Investment Fund,
Inc., Morgan Stanley Institutional
Fund, Inc., The Pakistan Investment
Fund, Inc., PCS Cash Fund, Inc., The
Thai Fund, Inc. and The Turkish
Investment Fund, Inc.
Karl O. Hartmann Assistant Senior Vice President, Secretary and
73 Tremont Street Secretary General Counsel of Chase Global Funds
Boston, MA 02108-3913 Services Company; Previously, Leland,
(41) O'Brien, Rubinstein Associates, Inc.
(investments).
James R. Rooney Treasurer Vice President, Chase Global Funds
73 Tremont Street Services Company; Director of Fund
Boston, MA 02108-3913 Administration; Officer of various
(37) investment companies managed by
Morgan Stanley Asset Management Inc.;
Previously with Scudder, Stevens &
Clark, Inc. (investments) and Ernst &
Young LLP (accounting); Treasurer of
The Brazilian Investment Fund, Inc.,
The Latin American Discovery Fund,
Inc., The Malaysia Fund, Inc., Morgan
Stanley Africa Investment Fund, Inc.,
Morgan Stanley Asia-Pacific Fund,
Inc., Morgan Stanley Emerging Markets
Debt Fund, Inc., Morgan Stanley
Emerging Markets Fund, Inc., Morgan
Stanley Fund, Inc., Morgan Stanley
Global Opportunity Bond Fund, Inc.,
Morgan Stanley High Yield Fund, Inc.,
Morgan Stanley India Investment Fund,
Inc., Morgan Stanley Institutional
Fund, Inc., The Pakistan Investment
Fund, Inc., The Thai Fund, Inc. and
The Turkish Investment Fund, Inc.
24
<PAGE>
Name, Address Position Principal Occupation During
and Age with Fund Past Five Years
- ------------------- --------- ---------------------------
Joanna Haigney Assistant Supervisor of Fund Administration and
73 Tremont Street Treasurer Compliance, Chase Global Funds
Boston, MA 02108-3913 Services Company; Previously with
(29) Coopers & Lybrand LLP; Assistant
Treasurer of The Brazilian Investment
Fund, Inc., The Latin American
Discovery Fund, Inc., The Malaysia
Fund, Inc., Morgan Stanley Africa
Investment Fund, Inc., Morgan Stanley
Asia-Pacific Fund, Inc., Morgan
Stanley Emerging Markets Debt Fund,
Inc., Morgan Stanley Emerging Markets
Fund, Inc., Morgan Stanley Fund,
Inc., Morgan Stanley Global
Opportunity Bond Fund, Inc., Morgan
Stanley High Yield Fund, Inc., Morgan
Stanley India Investment Fund, Inc.,
Morgan Stanley Institutional Fund,
Inc., The Pakistan Investment Fund,
Inc., The Thai Fund, Inc. and The
Turkish Investment Fund, Inc.
- --------------
* "Interested Person" within the meaning of the 1940 Act.
REMUNERATION OF DIRECTORS AND OFFICERS
Effective June 28, 1995, the Open-end Fund Complex will pay each of
the nine Directors who is not an "interested person" an annual aggregate fee
of $55,000, plus out-of-pocket expenses. The Open-end Fund Complex will pay
each of the members of the Fund's Audit Committee, which consists of the
Fund's Directors who are not "interested persons," an additional annual
aggregate fee of $10,000 for serving on such a committee. The allocation of
such fees will be among the three funds in the Open-end Fund Complex in
direct proportion to their respective average net assets. For the fiscal
year December 31, 1995, the Fund paid approximately $244,000 in Directors'
fees and expenses. Directors who are also officers or affiliated persons
receive no remuneration for their services as Directors. The Fund's officers
and employees are paid by the Adviser or its agents. As of August 16, 1996,
to Fund management's knowledge, the Directors and officers of the Fund, as a
group, owned more than 1% of the outstanding common stock of the following
Portfolios of the Fund: 2.4% Active Country Allocation Portfolio - Class B
shares; 2.3% Aggressive Equity Portfolio - Class A shares; 1.0% Aggressive
Equity Portfolio - Class B shares; 1.7% Asian Equity Portfolio - Class A
shares; 2.0% Emerging Growth Portfolio - Class B shares; 1.4% Emerging
Markets Debt Portfolio - Class A shares; 1.2% Emerging Markets Debt Portfolio
- - Class B shares; 1.3% Emerging Markets Portfolio - Class B shares; 1.8%
Equity Growth Portfolio - Class B shares; 6.2% Fixed Income Portfolio - Class
B shares; 2.2% Global Fixed Income Portfolio - Class B shares; 1.2%
International Equity Portfolio - Class B shares; 4.2% Latin American
Portfolio - Class A shares; and 23.9% Municipal Bond Portfolio - Class B
shares. The following table shows aggregate compensation paid to each of
the Fund's Directors by the Fund and the Fund Complex, respectively, in the
fiscal year ended December 31, 1995.
25
<PAGE>
COMPENSATION TABLE
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------------
(1) (2) (3) (4) (5)
NAME OF AGGREGATE PENSION OR ESTIMATED TOTAL
PERSON, COMPENSATION RETIREMENT ANNUAL COMPENSATION
POSITION FROM BENEFITS ACCRUED BENEFITS FROM REGISTRANT
REGISTRANT AS PART OF FUND UPON AND FUND COMPLEX
EXPENSES RETIREMENT PAID TO DIRECTORS
- ----------------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Barton M. Biggs, N/A N/A
Director and Chairman
of the Board
Warren J. Olsen, N/A N/A
Director and President
John D. Barrett, II 14,085 26,405
Director
Gerard E. Jones, 25,335 79,655
Director
Andrew McNally, IV 11,916 32,834
Director
Samuel T. Reeves, 11,916 14,303
Director
Fergus Reid, 14,085 48,517
Director
Frederick O. Robertshaw, 11,916 36,055
Director
Frederick B. Whittemore, 12,150 41,429
Director
John P. Britton*, 11,250 11,250
Director
George R. Bunn*, 12,900 12,900
Director
Peter E. deSvastich*, 11,250 25,225
Director
</TABLE>
- --------------
* As of June 30, 1995, Mssrs. Britton, Bunn and deSvastich resigned from the
Board of Directors.
26
<PAGE>
INVESTMENT ADVISORY AND ADMINISTRATIVE AGREEMENTS
Morgan Stanley Asset Management Inc. ("MSAM" or the "Adviser") is a
wholly-owned subsidiary of Morgan Stanley Group Inc. The principal offices of
Morgan Stanley Group Inc. are located at 1221 Avenue of the Americas, New York,
NY 10020. As compensation for advisory services for the fiscal years ended
December 31, 1993, December 31, 1994 and December 31, 1995, the Adviser earned
fees of approximately $17,539,000, $34,338,000 and $40,534,000, respectively,
and from such fees voluntarily waived fees of $3,037,000, $2,640,000 and
$3,526,000, respectively. For the fiscal years ended December 31, 1993,
December 31, 1994 and December 31, 1995, the Fund paid brokerage commissions of
approximately $5,827,000, $7,287,293 and $10,317,515, respectively. For the
fiscal years ended December 31, 1993, December 31, 1994 and December 31, 1995,
the Fund paid in the aggregate $797,000, $796,000 and $377,000, respectively, as
brokerage commissions to Morgan Stanley & Co. Incorporated, an affiliated
broker-dealer, which represented 13%, 11% and 4% of the total amount of
brokerage commissions paid in each respective period. For the fiscal years
ended December 31, 1993 , December 31, 1994 and December 31, 1995, the Fund paid
administrative fees to MSAM of approximately $4,662,000, $4,458,000 and
$5,238,000, respectively.
The Sub-Adviser, Sun Valley Gold Company, with principal offices at 620
Sun Valley Road, Sun Valley, Idaho, serves as the investment sub-adviser of the
Gold Portfolio, pursuant to a sub-advisory agreement among the Fund, the Adviser
and the Sub-Adviser (the "Sub-Advisory Agreement"). The Adviser and the Sub-
Adviser have entered into an indemnification agreement under which, generally,
the Sub-Adviser has agreed to indemnify the Adviser and the Fund for claims or
losses in connection with any failure by the Sub-Adviser to comply with its
obligations under the Sub-Advisory Agreement or related agreements or any act or
omission that amounts to negligence, misfeasance or bad faith, and the Adviser
has agreed to indemnify the Sub-Adviser for claims or losses in connection with
any failure by the Adviser to comply with its obligations under the Sub-Advisory
Agreement or related agreements. As compensation for sub-advisory services for
the fiscal years ended December 31, 1994 and December 31, 1995, the Sub-Adviser
earned fees of approximately $76,000 and $73,000, respectively, and from such
fees voluntarily waived fees of $36,000 and $37,000, respectively. For the
fiscal years ended December 31, 1994 and December 31, 1995, the Fund paid $8,000
and $450, respectively, as brokerage commissions to Sun Valley.
Pursuant to the MSAM Administration Agreement between the Adviser and
the Fund, the Adviser provides Administrative Services. For its services under
the Administration Agreement, the Fund pays the Adviser a monthly fee which on
an annual basis equals 0.15 of 1% of the average daily net assets of each
Portfolio.
Under the Agreement between the Adviser and The Chase Manhattan Bank,
N.A. ("Chase," successor in interest to United States Trust Company of New
York), Chase Global Funds Services Company ("CGFSC," formerly Mutual Funds
Service Company and now a Chase subsidiary) provides certain administrative
services to the Fund. CGFSC provides operational and administrative services to
investment companies with approximately $62 billion in assets and having
approximately 187,286 shareholder accounts as of March 31, 1996. CGFSC's
business address is 73 Tremont Street, Boston, Massachusetts 02108-3913.
DISTRIBUTION OF FUND SHARES
Morgan Stanley & Co. Incorporated (the "Distributor"), a wholly-owned
subsidiary of Morgan Stanley Group Inc., serves as the Distributor of the Fund's
shares pursuant to a Distribution Agreement for the Fund and a Plan of
Distribution for the Class B shares of the Portfolios (except the International
Small Cap Portfolio which does not have Class B shares) pursuant to Rule 12b-1
under the 1940 Act (each, a "Plan" and collectively, the "Plans"). Under each
Plan the Distributor is entitled to receive from these Portfolios a distribution
fee, which is accrued daily and paid quarterly, at an annual rate of up to 0.25%
of the average daily net assets of the Class B shares of these Portfolios. The
Distributor expects to allocate most of its fee to its investment representative
and investment dealers, banks or financial service firms that provide
distribution services ("Participating Dealer"). The actual amount of such
compensation is agreed upon by the Fund's Board of Directors and by the
Distributor. The Distributor may, in its discretion, voluntarily waive from
time to time all or any portion of its distribution fee and the Distributor is
free to make additional payments out of its own assets to promote the sale of
Fund shares.
The Plans obligate the Portfolios to accrue and pay to the Distributor
the fee agreed to under its Distribution Agreement. The Plans do not obligate
the Portfolios to reimburse the Distributor for the actual expenses the
Distributor may incur in fulfilling its obligations under the Plans. Thus,
under each Plan, even if the Distributor's actual expenses exceed the fee
payable to it thereunder at any given time, the Portfolios will not be obligated
to pay more than that fee. If the Distributor's actual expenses are less than
the fee it receives, the Distributor will retain the full amount of the fee. The
Plans for the Class B shares were most recently approved by the Fund's Board of
Directors, including those directors who are not "interested persons" of the
Fund as that term is defined in the 1940 Act and who have no direct or indirect
financial interest in the operation of a Plan or in any agreements related
thereto, on September 20, 1995.
27
<PAGE>
The Class B shares commenced operations on January 2, 1996. Therefore,
no Rule 12b-1 fees were paid to the Distributor for the fiscal year ended
December 31, 1995. The Mortgage-Backed Securities, China Growth, MicroCap and
International Magnum Portfolios were not in operation in the fiscal year ended
December 31, 1995.
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 the Adviser
(together, the "Codes"). The Codes significantly restrict the personal
investing activities of all employees of the Adviser and, as described below,
impose additional, more onerous, restrictions on the Fund's investment
personnel.
The Codes require that all employees of the Adviser 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 the Adviser include a ban on acquiring any securities in a "hot" 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
the Adviser. 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.
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
The names and addresses of the holders of 5% or more of the outstanding
shares of any class of the Fund as of August 16, 1996 and the percentage of
outstanding shares of such classes owned beneficially or of record by such
shareholders as of such date are, to Fund management's knowledge, as follows:
ACTIVE COUNTRY ALLOCATION PORTFOLIO: City of New York Deferred Compensation
Plan, 40 Rector Street, 3rd Floor, New York, NY 10006, owned 21% of such
Portfolio's total outstanding Class A shares.
The Trustees of Columbia University in the City of New York, 475 Riverside
Drive, Suite 401, New York, NY 10115, owned 15% of such Portfolio's total
outstanding Class A shares.
Oglebay Norton Company, 1100 Superior Avenue, Cleveland, OH 44114-2598, owned
11% of such Portfolio's total outstanding Class A shares.
The Flinn Foundation, Northern Trust Co., Master Trust Dept., P.O. Box 92984,
Chicago, IL 60675, owned 7% of such Portfolio's total outstanding Class A
shares.
Sahara Enterprises, Inc., 3 First National Plaza, Suite 2000, Chicago,
IL 60602-4260, owned 6% of such Portfolio's total outstanding Class A shares.
The Chase Manhattan Bank, N.A., Trustee Chubb Capital Accumulation Plan, 770
Broadway, New York, NY 10003, owned 6% of such Portfolio's total outstanding
Class A shares.
Lewis W. Bernard, 7 West 81st Street, New York, NY 10024, owned 15% of such
Portfolio's total outstanding Class B shares.
Jeffrey R. Holzschuh, 21 Kenilworth Terrace, Greenwich, CT 06830-4046, owned 14%
of such Portfolio's total outstanding Class B shares.
Benefit Administrators of America Inc., Attn: John Stephens, 626 Grand Avenue,
Des Moines, IA 50309, owned 14% of such Portfolio's total outstanding Class B
shares.
John P. and Janet K. Hanlon, 7 Stafford Place, Towaco, NJ 07082, owned 7% of
such Portfolio's total outstanding Class B shares.
28
<PAGE>
Michael and Maureen Cassedy, 1221 Jones Street, Apt. D1, San Francisco, CA
94109-4228, owned 7% of such Portfolio's total outstanding Class B shares.
Guarantee & Trust Company, IRA R/O, 101 S. Spring Street, La Grange, IL 60525,
owned 6% of such Portfolio's total outstanding Class B shares.
AGGRESSIVE EQUITY PORTFOLIO: Valassis Enterprises - Equity C/O Franklin
Enterprises, 520 Lake Cook Road, Suite 380, Deerfield, IL 60015, owned 14% of
such Portfolio's total outstanding Class A shares.
Kinghugh S.A., C/O Morgan Stanley Asset Management, 1221 Avenue of the
Americas, New York, NY 10020, owned 10% of such Portfolio's total outstanding
Class A shares.
Hullbridge Investement Limited, P.O. Box 719, Sufat, Kuwait 13008, owned 7%
of such Portfolio's total outstanding Class A shares.
Guy L. Chazal, Morgan Stanley & Company, 1221 Avenue of the Americas - 33rd
floor, New York, NY 10020, owned 5% of such Portfolio's total outstanding Class
B shares.
ASIAN EQUITY PORTFOLIO: Association De Bienfaisance Et De Retraite Des
Policiers De La Communaute Urbaine De Montreal, 480 Gilford Street, Montreal,
Quebec H2J1N3, owned 7% of such Portfolio's total outstanding Class A shares.
BALANCED PORTFOLIO: Kinney Printing Co-Employees, 4801 S. Lawndale, Chicago,
IL 60632-3018, owned 12% of such Portfolio's total outstanding Class A shares.
H. Conrad & Sarah Meyer, One Woodland Avenue, Bronxville, NY 10708, owned 8%
of such Portfolio's total outstanding Class A shares.
Joan M. Hunt Trust, 8627 Madison Drive, Niles, IL 60648, owned 7% of such
Portfolio's total outstanding Class A shares.
Laverne M. Brownsey Trust, 135 S. LaSalle Street, Chicago, IL 60602-4274,
owned 6% of such Portfolio's total outstanding Class A shares.
Cascino Investment Company, 820 Burgess Hill, Naperville, IL 60565, owned 5%
of such Portfolio's total outstanding Class A shares.
Guarantee & Trust Company, IRA Rollover, One Woodland Avenue, Bronxville, NY
10708, owned 5% of such Portfolio's total outstanding Class A shares.
William Guthrie, IRA Rollover, 435 Sheridan Road, Winnetka, IL 60093-2626,
owned 18% of such Portfolio's total outstanding Class B shares.
Laverne M. Brownsey Trust, 135 S. LaSalle Street, Chicago, IL 60602-4274,
owned 6% of such Portfolio's total outstanding Class B shares.
EMERGING GROWTH PORTFOLIO: Northern Trust Company Trustee, FBO Morgan Stanley
Profit Sharing Plan, P.O. Box 92956, Chicago, IL 60675-2956, owned 30% of such
Portfolio's total outstanding Class A shares.
Allendale Mutual Insurance Co., P.O. Box 7500, Johnston, RI 02919-0750, owned
12% of such Portfolio's total outstanding Class A shares.
Mac & Co. A/C Benf 0741602, P.O. Box 3198, Pittsburgh, PA 15230, owned 10% of
such Portfolio's total outstanding Class A shares.
NOAM/A/EC, C/O Philip Winters, Morgan Stanley Asset Management, 1221 6th
Avenue, New York, NY 10020, owned 5% of such Portfolio's total outstanding
Class A shares.
Worcester Polytechnical Institute, 100 Institute Road, Worcester, MA 01545,
owned 5% of such Portfolio's total outstanding Class A shares.
EMERGING MARKETS DEBT PORTFOLIO: Northwestern University, 633 Clark Street,
Evanston, IL 60208-1122, owned 13% of such Portfolio's total outstanding Class A
shares.
Swarthmore College, 500 College Avenue, Swarthmore, PA 19081-1110, owned 7% of
such Portfolio's total outstanding Class A shares.
29
<PAGE>
Barlett and Company, Profit Sharing Plan and Trust, 4800 Main Street, Kansas
City, MO 64112, owned 13% of such Portfolio's total outstanding Class B
shares.
Alice H. and Paul D. Bartlett Trustee, 4800 Main Street, Kansas City, MO 64112,
owned 6% of such Portfolio's total outstanding Class B shares.
Michael S. Virgil Trustee, FBO Mary Ann Young Brownsey Trust, 135 S. LaSalle
Street, Chicago, IL 60602, owned 5% of such Portfolio's total outstanding
Class B shares.
EMERGING MARKETS PORTFOLIO: Ministers & Missionaries Benefit Board of the
American Baptist Churches, 475 Riverside Drive, New York, NY 10115, owned 8% of
such Portfolio's total outstanding Class A shares.
Ewing Marion Kauffman Foundation, 4900 Oak Street, Kansas City, MO 64112, owned
7% of such Portfolio's total outstanding Class A shares.
EQUITY GROWTH PORTFOLIO: Northern Trust Company Trustee, FBO Morgan Stanley
Profit Sharing Plan, P.O. Box 92956, Chicago, IL 60675, owned 31% of such
Portfolio's total outstanding Class A shares.
St. Raymonds Cemetery Reserve Fund, 1201 Balcom Avenue, Bronx, NY 10465,
owned 10% of such Portfolio's total outstanding Class A shares.
Donald A. Moore Jr., 160 E. 72 Street, New York, NY 10021, owned 8% of such
Portfolio's total outstanding Class B shares.
Chicago Methodist Episcopal Church Aid Society, C/O Gordon Worley, 1407
Clinton Place, River Forest, IL 60305, owned 7% of such Portfolio's total
outstanding Class B shares.
EUROPEAN EQUITY PORTFOLIO: Alan Gerry, C/O Granite Associates LP, 1
Cablevision Center, Liberty, NY 12754, owned 7% of such Portfolio's total
outstanding Class A shares.
KPMG - Harvey Armstrong, FAO Volker Dolch Family Trust, 50 W. San Fernando
Street, San Jose, CA 95113-2413, owned 10% of such Portfolio's total
outstanding Class B shares.
Marc Andreessen Trustees, FBO Marc Andreessen, 16615 Lark Avenue, Los Gatos,
CA 95030, owned 7% of such Portfolio's total outstanding Class B shares.
Benedikt Von Schroder & Kristin Von Schroder, Burnitz str. 67, 6000 Frankfurt
70, West Germany, owned 6% of such Portfolio's total outstanding Class B shares.
James P. Smith Jr., 552 Ponte Vedra Boulevard, Ponte Vedra, FL 32082-2316,
owned 5% of such Portfolio's total outstanding Class B shares.
Beatrice Synder, Trustee FBO Jay Synder 21484, 300 Winston Drive Apt. 1711,
Cliff Side Park, NJ 07010-3222, owned 5% of such Portfolio's total outstanding
Class B shares.
Deborah Meredith, 1386 Pritchett Court, Los Altos, CA 94024-5713, owned 5% of
such Portfolio's total outstanding Class B shares.
Frank E. Hunt Trust, 8627 Madison Drive, Niles, IL 60648-2321, owned 5% of
such Portfolio's total outstanding Class B shares.
Christopher E. O'Donnell Trust, 1147 W. George Street, Chicago, IL
60657-4313, owned 5% of such Portfolio's total outstanding Class B shares.
FIXED INCOME PORTFOLIO: Northern Trust Company Trustee, FBO Morgan Stanley
Profit Sharing Plan, P.O. Box 92956, Chicago, IL 60675-2956, owned 23% of such
Portfolio's total outstanding Class A shares.
Morgan Stanley Foundation, 1221 Avenue of the Americas, New York, NY 10020,
owned 6% of such Portfolio's total outstanding Class A shares.
Brooks School, c/o Mr. Frank Marino, North Andover, MA 01845, owned 5% of such
Portfolio's total outstanding Class A shares.
Trust for Descendents of David R. Jaffe, C/O David Jaffe, 45 Hemlock Ridge,
Weston, CT 06883, owned 8% of such Portfolio's total outstanding Class B
shares.
Duncan Darrow Esq IRA, Orrick Herrington & Sutcliffe, 666 Fifth Avenue, New
York, NY 10103, owned 8% of such Portfolio's total outstanding Class B shares.
William M. Manger, Jr., 8 E. 81 Street, New York, NY 10028-0201, owned 6% of
such Portfolio's total outstanding Class B shares.
Harold J. Schaaff, IRA, 49 Old Orchard Lane, Ocean TWP, NJ 07712, owned 6% of
such Portfolio's total outstanding Class B shares.
Michael J. and Patricia L. Berchtold Trust, C/O Morgan Stanley Asia, 3
Exchange Square, Hong Kong, owned 5% of such Portfolio's total outstanding
Class B shares.
Richard B. Lonoff and Jacqueline M. Carr, 43 Mamanasco Road, Ridgefield, CT
06877-2402, owned 5% of such Portfolio's total outstanding Class B shares.
30
<PAGE>
GLOBAL EQUITY PORTFOLIO: Robert College of Istanbul Turkey C/O Morgan Stanley
Asset Management, 25 Cabot Square, London, England E144QA, owned 46% of such
Portfolio's total outstanding Class A shares.
Gaz Metropolitan and Company Limited Partnership, 1717 Du Havre, Montreal,
Canada H2K-2X3, owned 15% of such Portfolio's total outstanding Class A shares.
JM Kaplan Fund, Inc., 880 Third Avenue 3rd floor, New York, NY 10022, owned 13%
of such Portfolio's total outstanding Class A shares.
Divtex and Company FBO, Pritchard Hubble and Herr C/O Texas Commerce Bank, P.O.
Box 951405, Dallas, TX 75395, owned 8% of such Portfolio's total outstanding
Class A shares.
Kaplan, Choate Value Partners, L.P., 880 Third Avenue, New York, NY
10022-4730, owned 7% of such Portfolio's total outstanding Class A shares.
Edward J. Prostic, 2225 Stratford Road, Mission Hills, KS 66208, owned 13% of
such Portfolio's total outstanding Class B shares.
North American Trust Company, FBO Heller/Robert S. Venning, P.O. Box 84419, San
Diego, CA 92138, owned 9% of such Portfolio's total outstanding Class B
shares.
Janet Snyder IRA, MSTC Custodian, 3677 Sunsey Way, Sanford, MI 48657,
owned 6% of such Portfolio's total outstanding Class B shares.
Douglas E. Ebert Trust, Douglas E. Ebert, Trustee and Successor in Trust, 3470
Twin Oaks Court, W. Bloomfield, MI 48324-3249, owned 5% of such Portfolio's
total outstanding Class B shares.
GLOBAL FIXED INCOME PORTFOLIO: Farm Credit Bank Retirement Plan, Columbia
District American Industries Trust Company Trustee, 5700 NW Central Drive, 4th
Floor, Houston, TX 77092, owned 14% of such Portfolio's total outstanding Class
A shares.
Northern Trust Company as Custodian FBO The Lund Foundation, P.O. Box 92956,
Chicago, IL 60675, owned 10% of such Portfolio's total outstanding Class A
shares.
The Northern Trust Customer FBO Resort Condominiums International, P.O. Box
92956, Chicago, IL 60675-2956, owned 6% of such Portfolio's total outstanding
Class A shares.
David Brooks Gendron, C/O CS First Boston - London, 55 East 52nd Street, New
York, NY 10055, owned 14% of such Portfolio's total outstanding Class B shares.
Marjorie S. Burggraf, FBO The Robert V. Burgraff Family Trust UTA DTD 11-5-86,
2378 E. Oakmont Drive, Idaho Falls, ID 83404-7720, owned 7% of such Portfolio's
total outstanding Class B shares.
Laverne M. Brownsey Trust, 135 S. LaSalle Street, Chicago, IL 60603,
owned 7% of such Portfolio's total outstanding Class B shares.
Spencer and Caroline Fleischer, 15 Kensington Park Gardens, London W11 3HD,
England, owned 6% of such Portfolio's total outstanding Class B shares.
31
<PAGE>
GOLD PORTFOLIO: Marshall & Ilsley Trust Company, 1000 N. Water Street,
Milwaukee, WI 53202, owned 31% of such Portfolio's total outstanding Class B
shares.
Jerome Reed Schusterman, P.O. Box 699, Tulsa OK 74101, owned 19%
of such Portfolio's total outstanding Class B shares.
Chicago Methodist Episcopal Church Aid Society, C/O Gordon Worley, 1407
Clinton Place, River Forest, IL 60305, owned 16% of such Portfolio's total
outstanding Class B shares.
Steve C. Olson, 505 Knollwood Road, Ridgewood, NJ 07450, owned 14% of such
Portfolio's total outstanding Class B shares.
Priscilla and John Privat, 8852 N.E. 24th Street, Bellevue, WA 98004,
owned 7% of such Portfolio's total outstanding Class B shares.
HIGH YIELD PORTFOLIO: Northern Trust Company Trustee, FBO Morgan Stanley Profit
Sharing Plan, P.O. Box 92956, Chicago, IL 60675-2956, owned 20% of such
Portfolio's total outstanding Class A shares.
Valassis Enterprises - Equity, c/o Franklin Enterprises, 520 Lake Cook Road,
Suite 380, Deerfield, IL 60015, owned 13% of such Portfolio's total outstanding
Class A shares.
Greenwich Academy, 200 North Maple Avenue, Greenwich, CT 06830, owned 6% of
such Portfolio's total outstanding Class B shares.
Jerome Reed Schusterman, P.O. Box 699, Tulsa, OK 74101, owned 6%
of such Portfolio's total outstanding Class B shares.
INTERNATIONAL EQUITY PORTFOLIO: Steven M. Benardete, 120 East 75th Street,
New York, NY 10021, owned 5% of such Portfolio's total outstanding Class B
shares.
INTERNATIONAL MAGNUM PORTFOLIO: Bankers Trust Trustee, Harris Corporation
Retirement Plan & Harris Corporation Union Retirement Plan, 1025 W. Nasa
Boulevard, Melbourne, FL 32919, owned 70% of such Portfolio's total
outstanding Class A shares.
Hampden-Sydney College, P. O. Box 127, Hampden-Sydney, VA 23943, owned 7% of
such Portfolio's total outstanding Class A shares.
Infirmary Health Systems Inc., C/O Paul Freeman Executive Vice President of
Finance, P.O. Box 2226, Mobile, AL 36652 owned 6% of such Portfolio's total
outstanding Class A shares.
Ameritas Life Insurance Corporation, P.O. Box 81889, Lincoln, NE 68501,
owned 6% of such Portfolio's total outstanding Class A shares.
Sinclair Community College Foundation, 444 W. Third Street, Dayton, OH 45402,
owned 16% of such Portfolio's total outstanding Class B shares.
Ronald E. Altier, 11716 98th Place S.W., Vashon Island, WA 98070, owned 12%
of such Portfolio's total outstanding Class B shares.
Warren R. Appleton, SEP IRA, P.O. Box 3415, Redmond, WA 98073, owned 11% of
such Portfolio's total outstanding Class B shares.
Larry Fowler and The Philip and Betsy Templeton Charitable Remainder Trust,
777 108th Avenue N.E., Bellevue, WA 98004, owned 9% of such Portfolio's total
outstanding Class B shares.
Mike and Rose Crowe, 8840 SE 74th Place, Mercer Island, WA 98040-5700, owned
7% of such Portfolio's total outstanding Class B shares.
Steve E. Trautman III and Sonja K. Gustafson, 4232 Meridian Avenue, Seattle,
WA 98103, owned 6% of such Portfolio's total outstanding Class B shares.
William W. McCaughey, 15519 SE 27th Street, Bellevue, WA 98007, owned 5% of
such Portfolio's total outstanding Class B shares.
INTERNATIONAL SMALL CAP PORTFOLIO: The Short Brothers Pension Fund, P.O. Box
241, Airport Road, Belfast, N. Ireland, owned 11% of such Portfolio's total
outstanding Class A shares.
32
<PAGE>
Trustees of Boston College Attn: Paul Haran Associates Treasurer, St. Thomas
More Hall 310, Chestnut Hill, MA 02167, owned 7% of such Portfolio's total
outstanding Class A shares.
General Mills, Inc. Master Trust: Pooled International Fund, One General Mills
Blvd., Minneapolis, MN 55426, owned 7% of such Portfolio's total outstanding
Class A shares.
The Casey Family Program, 1300 Dexter Avenue, Suite 400, Seattle, WA 98109-3547,
owned 7% of such Portfolio's total outstanding Class A shares.
JAPANESE EQUITY PORTFOLIO: Avanse Forvaltning As, 1904 Vika, Olso, Norway,
owned 6% of such Portfolio's total outstanding Class A shares.
Marc Andreessen Trustees, FBO Marc Andreessen, 16615 Lark Avenue, Los Gatos,
CA 95030, owned 6% of such Portfolio's total outstanding Class B shares.
Barlett and Company, Profit Sharing Plan and Trust, 4800 Main Street, Kansas,
MO 64112, owned 6% of such Portfolio's total outstanding Class B shares.
Ryco & Company, C/O State Street Bank and Trust Company, Boston, MA 02107,
owned 5% of such Portfolio's total outstanding Class B shares.
LATIN AMERICAN PORTFOLIO: Chicago Methodist Episcopal Church Aid Society, C/O
Gordon Worley, 1407 Clinton Place, River Forest, IL 60305, owned 19% of such
Portfolio's total outstanding Class B shares.
Henri Dyner, 232 Truman Drive, Cresskill, NJ 07626, owned 19% of such
Portfolio's total outstanding Class B shares.
Marc Andreessen Trustees, FBO Marc Andreessen, 16615 Lark Avenue, Los Gatos,
CA 95030, owned 13% of such Portfolio's total outstanding Class B shares.
Walter Graves Jr. and Evelyn Myers Graves Revocable Trust, 5301 Bryant Irvin
Road, Fort Worth, TX 76132, owned 11% of such Portfolio's total outstanding
Class B shares.
John P. Hanlon and Janet K. Hanlon, 7 Stafford Place, Towaco, NJ 07082, owned
6% of such Portfolio's total outstanding Class B shares.
MUNICIPAL BOND PORTFOLIO: Daniel F. McDonald and Maria J. McDonald, 8550 Old
Dominion Drive, McLean, VA 22102, owned 9% of such Portfolio's total
outstanding Class A shares.
Frank R. Mori, 935 Park Avenue, New York, NY 10028, owned 8% of such
Portfolio's total outstanding Class A shares.
Cushman Trust, C/O Cambrian Services, 1114 Avenue of the Americas, Suite 2702,
New York, NY 10036, owned 6% of such Portfolio's total outstanding Class A
shares.
Arnold E. Bellowe and Jill I. Bellowe Trustees, 915 Park Lane, Montecito, CA
93108-1421, owned 5% of such Portfolio's total outstanding Class A shares.
Alok and Maya Sama, C/O Morgan Stanley Hong Kong Pouch, 1251 6th Avenue, New
York, NY 10020-1104, owned 75% of such Portfolio's total outstanding Class B
shares.
James W. Grisham and Diana E. Grisham, 454 South Pleasant Avenue, Ridgewood, NJ
07450-5446, owned 24% of such Portfolio's total outstanding Class B shares.
SMALL CAP VALUE EQUITY PORTFOLIO: Valassis Enterprises - Equity, C/O
Franklin Enterprises, 520 Lake Cook Road, Deerfield, IL 60015, owned 8% of
such Portfolio's total outstanding Class A shares.
McMahan Furniture Company, P.O. Box 8000, Carlsbad, CA 92018, owned 8% of
such Portfolio's total outstanding Class A shares.
Wendel and Company, C/O The Bank of New York MFD Section, P.O. Box 1066 Wall
Street Station, New York, NY 10286, owned 6% of such Portfolio's total
outstanding Class A shares.
Barlett and Company, Profit Sharing Plan and Trust, 4800 Main Street, Kansas,
MO 64112, owned 20% of such Portfolio's total outstanding Class B shares.
Robert R. Bennett IRA Rollover, MSTC Custodian, 18853 N. 88th Drive, Peoria,
AZ 85382, owned 7% of such Portfolio's total outstanding Class B shares.
Kinney Printing Co-Employees, Attn: Dolores M. Miklos, 4801 South Lawndale,
Chicago, IL 60632-3018, owned 5% of such Portfolio's total outstanding Class B
shares.
33
<PAGE>
U.S. REAL ESTATE PORTFOLIO: Morgan Stanley & Co. Pension Fund, C/O Northern
Trust Company Custodian, 770 Broadway, New York, NY 10003, owned 9% of such
Portfolio's total outstanding Class A shares.
Charles Schwab & Company Inc., 101 Montgomery Street, San Francisco, CA
94104, owned 8% of such Portfolio's total outstanding Class A shares.
European Patent Organization Pension Reserve Fund, Erhardtstrasse 27, Munich,
Germany 80331, owned 6% of such Portfolio's total outstanding Class A shares.
VALUE EQUITY PORTFOLIO: McMahan Furniture Company, P.O. Box 8000, Carlsbad,
CA 92018, owned 7% of such Portfolio's total outstanding Class A shares.
Victoria B. McLaughlin, Upper Dogwood Lane, Rye, NY 10580, owned 6% of such
Portfolio's total outstanding Class B shares.
Delaware Charter Guarantee & Trust Company, C/F Nelaura O. Lewis, IRA Rollover,
78 Cedar Cliff Road, Riverside, CT 06878, owned 5% of such Portfolio's total
outstanding Class B shares.
George and Susan Fugelsang, 17 Calhoun Drive, Greenwich, CT 06831, owned 5%
of such Portfolio's total outstanding Class B shares.
NET ASSET VALUE FOR MONEY MARKET PORTFOLIOS
The Money Market Portfolio and the Municipal Money Market Portfolio seek
to maintain a stable net asset value per share of $1.00. These Portfolios use
the amortized cost method of valuing their securities, which does not take into
account unrealized gains or losses. The use of amortized cost and the
maintenance of each Portfolio's per share net asset value at $1.00 is based on
the Portfolio's election to operate under the provisions of Rule 2a-7 under the
1940 Act. As a condition of operating under that Rule, each of the Money Market
Portfolios must maintain a dollar-weighted average portfolio maturity of 90 days
or less, purchase only instruments having remaining maturities of 397 days or
less, and invest only in securities which are of "eligible quality" as
determined in accordance with regulations of the Commission.
The Rule also requires that the Directors, as a particular
responsibility within the overall duty of care owed to shareholders, establish
procedures reasonably designed, taking into account current market conditions
and each Portfolio's investment objectives, to stabilize the net asset value per
share as computed for the purposes of sales and redemptions at $1.00. These
procedures include periodic review, as the Directors deem appropriate and at
such intervals as are reasonable in light of current market conditions, of the
relationship between the amortized cost value per share and a net asset value
per share based upon available indications of market value. In such review,
investments for which market quotations are readily available are valued at the
most recent bid price or quoted yield available for such securities or for
securities of comparable maturity, quality and type as obtained from one or more
of the major market makers for the securities to be valued. Other investments
and assets are valued at fair value, as determined in good faith by the
Directors.
In the event of a deviation of over 1/2 of 1% between a Portfolio's net
asset value based upon available market quotations or market equivalents and
$1.00 per share based on amortized cost, the Directors will promptly consider
what action, if any, should be taken. The Directors will also take such action
as they deem appropriate to eliminate or to reduce to the extent reasonably
practicable any material dilution or other unfair results which might arise from
differences between the two. Such action may include redemption in kind,
selling instruments prior to maturity to realize capital gains or losses or to
shorten the average maturity, withholding dividends, paying distributions from
capital or capital gains or utilizing a net asset value per share as determined
by using available market quotations.
There are various methods of valuing the assets and of paying dividends
and distributions from a money market fund. Each of the Money Market and
Municipal Money Market Portfolios values its assets at amortized cost while also
monitoring the available market bid price, or yield equivalents. Since
dividends from net investment income will be declared daily and paid monthly,
the net asset value per share of each Portfolio will ordinarily remain at $1.00,
but each Portfolio's daily dividends will vary in amount. Net realized gains,
if any, will normally be declared and paid monthly.
34
<PAGE>
PERFORMANCE INFORMATION
The Fund may from time to time quote various performance figures to
illustrate the Portfolios' past performance.
Performance quotations by investment companies are subject to rules
adopted by the Commission, 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 Commission.
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 Commission. 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, except the Money Market and Municipal
Money Market Portfolios, may advertise total return for each class of 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.
The average annual compounded rates of return (unless otherwise noted)
for the Fund's Portfolios for the one year and five year periods ended December
31, 1995 and for the period from inception through December 31, 1995 are as
follows:
<TABLE>
<CAPTION>
Name of Portfolio Since Date
and Date of Inception One Year Five Year of Inception
--------------------- -------- --------- ------------
<S> <C> <C> <C>
International Equity
August 4, 1989. . . . . . . . 11.77% 14.24% 10.82%
Emerging Growth
November 1, 1989. . . . . . . 33.31 14.48 13.36
Value Equity
January 31, 1990. . . . . . . 33.69 15.65 11.86
Balanced
February 28, 1990 . . . . . . 23.63 11.45 10.31
Equity Growth
April 2, 1991 . . . . . . . . 45.02 N/A 14.33
<CAPTION>
Name of Portfolio Since Date
and Date of Inception One Year Five Year of Inception
--------------------- -------- --------- ------------
<S> <C> <C> <C>
Global Fixed Income
May 1, 1991 . . . . . . . . . 19.32 N/A 8.95
Fixed Income
May 15, 1991. . . . . . . . . 18.76 N/A 9.18
Asian Equity
July 1, 1991. . . . . . . . . 6.87 N/A 21.85
35
<PAGE>
Active Country Allocation
<CAPTION>
<S> <C> <C> <C>
January 17, 1992. . . . . . . 10.57 N/A 8.46
Global Equity
July 15, 1992 . . . . . . . . 18.66 N/A 18.21
Emerging Markets
September 25, 1992. . . . . . (12.77) N/A 13.16
High Yield
September 28, 1992. . . . . . 23.35 N/A 12.28
International Small Cap
December 15, 1992 . . . . . . 2.60 N/A 16.30
Small Cap Value Equity
December 17, 1992 . . . . . . 20.63 N/A 11.61
European Equity
April 2, 1993 . . . . . . . . 11.85 N/A 18.68
Emerging Markets Debt
February 1, 1994. . . . . . . 28.23 N/A 5.18
Gold
February 1, 1994. . . . . . . 13.21 N/A 1.87
Japanese Equity
April 25, 1994. . . . . . . . (3.64) N/A (3.17)
Latin American
January 18, 1995. . . . . . . N/A N/A (8.68)
Municipal Bond
January 18, 1995. . . . . . . N/A N/A 8.80
U.S. Real Estate
February 24, 1995 . . . . . . N/A N/A 21.07
Aggressive Equity
March 8, 1995 . . . . . . . . N/A N/A 41.25
</TABLE>
The cumulative total rate of return for the International Magnum
Portfolio from inception to the date of the financial statements included
herein is (0.30)% for the Class A shares and (0.50)% for the Class B shares.
These figures were calculated according to the following formula:
P(1 + T)to the nth power = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
36
<PAGE>
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).
CALCULATION OF YIELD FOR NON-MONEY MARKET PORTFOLIOS
From time to time certain of the Fund's 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.
The respective yields for certain of the Fund's Portfolios for the
30-day period ended December 31, 1995 were as follows:
<TABLE>
<CAPTION>
PORTFOLIO NAME 30-DAY YIELD
-------------- ------------
<S> <C>
Emerging Markets Debt . . . . . . . 15.67%
Fixed Income. . . . . . . . . . . . 6.39%
Global Fixed Income . . . . . . . . 5.91%
High Yield. . . . . . . . . . . . . 10.65%
Municipal Bond. . . . . . . . . . . 4.17%
</TABLE>
These figures were obtained using the following formula:
Yield = 2[( a - b + 1 )to the 6th power - 1]
------
cd
where:
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.
CALCULATION OF YIELD FOR MONEY MARKET PORTFOLIOS
The current yield of the Money Market and Municipal Money Market
Portfolios is calculated daily on a base period return for a hypothetical
account having a beginning balance of one share for a particular period of time
(generally 7 days). The return is determined by dividing the net change
(exclusive of any capital changes in such account) by its average net asset
value for the period, and then multiplying it by 365/7 to determine the
annualized current yield. The calculation of net change reflects the value of
additional shares purchased with the dividends by the Portfolio, including
dividends on both the original share and on such additional shares. The yields
of the Money Market and Municipal Money Market Portfolios for the 7-day period
ended December 31, 1995 were 5.21% and 3.91%, respectively. An effective yield,
which reflects the effects of compounding and represents an annualization of the
current yield with all dividends reinvested, may also be calculated for each
Portfolio by dividing the base period return by 7, adding 1 to the quotient,
raising the sum to the 365th power, and subtracting 1 from the result. The
effective yields of the Money Market and Municipal Money Market Portfolios for
the 7-day period ended December 31, 1995 were 5.34% and 3.99%, respectively.
37
<PAGE>
The yield of a Portfolio will fluctuate. The annualization of a week's
dividend is not a representation by the Portfolio as to what an investment in
the Portfolio will actually yield in the future. Actual yields will depend on
such variables as investment quality, average maturity, the type of instruments
the Portfolio invests in, changes in interest rates on instruments, changes in
the expenses of the Fund and other factors. Yields are one basis investors may
use to analyze the Portfolios of the Fund, and other investment vehicles;
however, yields of other investment vehicles may not be comparable because of
the factors set forth in the preceding sentence, differences in the time periods
compared, and differences in the methods used in valuing portfolio instruments,
computing net asset value and calculating yield.
TAXABLE EQUIVALENT YIELD FOR THE MUNICIPAL BOND AND MUNICIPAL MONEY MARKET
PORTFOLIO
It is easy to calculate your own taxable equivalent yield if you know
your tax bracket. The formula is:
Tax Free Yield
--------------------
1 - Your Tax Bracket = Your Taxable Equivalent Yield
For example, if you are in the 28% tax bracket and can earn a tax-free
yield of 7.5%, the taxable equivalent yield would be 10.42%.
The table below indicates the advantages of investments in Municipal
Bonds for certain investors. Tax-exempt rates of interest payable on a
Municipal Bond (shown at the top of each column) are equivalent to the taxable
yields set forth opposite the respective income tax levels, based on income tax
rates effective for the tax year 1995 under the Internal Revenue Code. There
can, of course, be no guarantee that the Municipal Bond Portfolio or Municipal
Money Market Portfolio will achieve a specific yield. Also, it is possible that
some portion of the Portfolio's dividends may be subject to Federal income
taxes. A substantial portion, if not all, of such dividends may be subject to
state and local taxes.
TAXABLE EQUIVALENT YIELD TABLE
<TABLE>
<CAPTION>
Sample Level of Taxable Equivalent Rates
Taxable Income Based on Tax-Exempt Yield of:
-------------- -----------------------------
Federal
Income
Joint Single Tax
Return Return Bracket 3% 4% 5% 6% 7% 8% 9% 10% 11%
- ------ ------ ------- -- -- -- -- -- -- -- --- ---
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$0-39,000 $0-23,350 15.0% 3.5% 4.7% 5.9% 7.1% 8.2% 9.4% 10.6% 11.8% 12.9%
39,000-94,250 23,350-56,550 28.0 4.2 5.6 6.9 8.3 9.7 11.1 12.5 13.9 15.3
94,250-143,600 56,550-117,950 31.0 4.3 5.8 7.2 8.7 10.1 11.6 13.0 14.5 15.9
143,600-256,500 117,950-256,500 36.0 4.7 6.3 7.8 9.4 10.9 12.5 14.1 15.6 17.2
over 256,500 over 256,500 39.6 5.0 6.6 8.3 9.9 11.6 13.2 14.9 16.6 18.2
</TABLE>
- -------
* Net amount subject to 1995 Federal Income Tax after deductions and
exemptions, not indexed for 1995 income tax rates.
The taxable equivalent yields for the Municipal Money Market and Municipal Bond
Portfolios for the seven days ended December 31, 1995 assuming a Federal income
tax rate of 39.6% (maximum rate), were 6.47% and 7.86%, respectively. The
taxable equivalent effective yields for the Municipal Money Market and Municipal
Bond Portfolios for the seven days ended December 31, 1995, assuming the same
tax rate, were 6.61% and 8.05%, respectively.
COMPARISONS
To help investors better evaluate how an investment in a Portfolio of
Morgan Stanley Institutional Fund, Inc. 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.
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(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) 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.
(d) Lipper -- 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.
(e) Mutual Fund Source Book, published by Morningstar, Inc. --
analyzes price, yield, risk and total return for equity funds.
(f) Savings and Loan Historical Interest Rates -- as published in the
U.S. Savings & Loan League Fact Book.
(g) 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.
(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 only 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+ covers 49
instruments from 14 countries. At $96 billion, its market cap is
nearly 50% higher than the EMBI's. 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) 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) 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. 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).
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(j) Indata Balanced-Median Index -- an unmanaged index and includes
an asset allocation of 7% cash, 39% bonds and 54% equity based on
$37.8 billion in assets among 538 portfolios for the year ended
December 31, 1995 (assumes dividends reinvested).
(k) Indata Equity-Median Stock Index -- an unmanaged index which
includes an average asset allocation of 5% cash and 95% equity
based on $30.6 billion in assets among 562 portfolios for the
year ended December 31, 1995.
(l) 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.
(m) J.P. Morgan Traded Global Bond Index -- an unmanaged index of
securities and includes Australia, Belgium, Canada, Denmark,
France, Germany, Italy, Japan, The Netherlands, Spain, Sweden,
United Kingdom and the United States.
(n) 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.
(o) Lehman Brothers LONG-TERM Treasury Bond -- composed of all bonds
covered by the Lehman Brothers Treasury Bond Index with
maturities of 10 years or greater.
(p) The Lehman 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
larger.
(q) Lipper Capital Appreciation Index -- a composite of mutual funds
managed for maximum capital gains.
(r) 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.
(s) 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.
(t) 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).
(u) Morgan Stanley Capital International Europe Index -- an unmanaged
index of common stocks and includes 14 countries throughout
Europe.
(v) Morgan Stanley Capital International Japan Index -- an unmanaged
index of common stocks.
(w) 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).
(x) 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.
(y) NASDAQ Composite Index -- an unmanaged index of common stocks.
(z) 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.
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(aa) 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.
(bb) 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.
(cc) Philadelphia Gold and Silver Index -- an unmanaged index
comprised of seven leading companies involved in the mining of
gold and silver.
(dd) 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.
(ee) Salomon Brothers GNMA Index -- includes pools of mortgages
originated by private lenders and guaranteed by the mortgage
pools of the Government National Association.
(ff) Salomon Brothers High Grade Corporate Bond Index -- consists of
publicly issued, non-convertible corporate bonds rated AA or AAA.
It a is value-weighted, total return index, including
approximately 800 issues with maturities of 12 years or greater.
(gg) Salomon Brothers Broad Investment Grade Bond -- 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.
(hh) 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.
(ii) 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.
(jj) 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 futures. In addition, there can be no
assurance that the Fund will continue this performance as compared to such other
averages.
GENERAL INFORMATION
DESCRIPTION OF SHARES AND VOTING RIGHTS
The Fund's Articles of Incorporation, as amended and restated, permit
the Directors to issue shares 34 billion of common stock, par value $.001 per
share, from an unlimited number of classes ("Portfolios") of shares. Currently
the Fund consists of shares of twenty-eight Portfolios (China Growth, Mortgage-
Backed Securities, MicroCap and International Magnum Portfolios are not
currently offering shares).
The shares of each Portfolio of the Fund are 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
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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 shortly after the purchase of shares
of a Portfolio by an investor may have the effect of reducing the per share net
asset value of that Portfolio by the per share amount of the dividend or
distribution. Furthermore, such dividends or distributions, although in effect
a return of capital, are subject to income taxes for shareholders subject to tax
as set forth herein and in the applicable Prospectus.
As set forth in the Prospectuses, 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 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 serves as the Fund's domestic custodian. Chase is not affiliated
with Morgan Stanley & Co. Incorporated. Morgan Stanley Trust Company, Brooklyn,
NY, acts as the Fund's custodian for foreign assets held outside the United
States and employs subcustodians who were approved by the Directors of the Fund
in accordance with Rule 17f-5 adopted by the Commission under the 1940 Act.
Morgan Stanley Trust Company is an affiliate of Morgan Stanley & Co.
Incorporated. In the selection of foreign subcustodians, the Directors consider
a number of factors, including, but not limited to, the reliability and
financial stability of the institution, the ability of the institution to
provide efficiently the custodial services required for the Fund, and the
reputation of the institution in the particular country or region.
DESCRIPTION OF SECURITIES AND RATINGS
I. DESCRIPTION OF COMMERCIAL PAPER AND BOND RATINGS
EXCERPTS FROM MOODY'S INVESTORS SERVICE, INC. ("MOODY'S") DESCRIPTION OF
BOND RATINGS: Aaa - Bonds which are rated Aaa are judged to be 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 which are 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 in 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. Moody's
applies numerical modifiers 1, 2 and 3 in the Aa and A rating categories. The
modifier 1 indicates that the security ranks at a higher end of the rating
category, modifier 2 indicates a mid-range rating and the modifier 3 indicates
that the issue ranks at the lower end of the rating category. A - Bonds which
are 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
which are 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 which are 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 which are
rated B generally lack characteristics of the desirable investment. Assurance
of interest
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and principal payments or of maintenance of other terms of the contract over any
long period of time may be small. Caa - Bonds which are 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 which are rated Ca
represent obligations which are speculative in a high degree. Such issues are
often in default or have other marked shortcomings.
C - Bonds which are 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.
EXCERPTS FROM STANDARD & POOR'S RATINGS GROUP ("S&P") DESCRIPTION OF BOND
RATINGS: AAA - Bonds rated AAA have the highest rating assigned by Standard &
Poor's to a debt obligation and indicate an extremely strong capacity to pay
principal and interest. AA - Bonds rated AA have a very strong capacity to pay
interest and repay principal and differ from the highest rated issues only to a
small degree. A - Bonds rated A have a strong capacity to pay interest and
repay principal although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than bonds in higher
rated categories. 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 for debt in higher rated
categories. BB, B, CCC, CC - Debt rated BB, B, CCC and CC is regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB
indicates the lowest degree of speculation and CC the highest degree of
speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions. C - The rating C is reserved for income bonds
on which no interest is being paid. D - Debt rated D is in default, and payment
of interest and/or repayment of principal is in arrears.
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: S-1+ -- very strong
capacity to pay principal and interest; SP-2 -- strong capacity to pay principal
and interest.
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.
II. DESCRIPTION OF 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 the Government National Mortgage Associates, 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 Federal National
Mortgage Association, 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 the Federal Home Loan Mortgage Corporation, 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.
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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 the Federal National Mortgage Association.
III. DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds generally include debt obligations issued by states and
their political subdivisions, and duly constituted authorities and corporations,
to obtain funds to construct, repair or improve various public facilities such
as airports, bridges, highways, hospitals, housing, schools, streets and water
and sewer works. Municipal Bonds may also be issued to refinance outstanding
obligations as well as to obtain funds for general operating expenses and for
loans to other public institutions and facilities.
The two principal classifications of Municipal Bonds are "general
obligation" and "revenue" or "special tax" bonds. General obligation bonds are
secured by the issuer's pledge of its full faith, credit and taxing power for
the payment of principal and interest. Revenue or special tax bonds are payable
only from the revenues derived from a particular facility or class of facilities
or, in some cases, from the proceeds of a special excise or other tax, but not
from general tax revenues. The Municipal Bond Portfolio and the Municipal Money
Market Portfolio may also invest in tax-exempt industrial development bonds,
short-term municipal obligations, project notes, demand notes and tax-exempt
commercial paper in accordance with the Portfolio's investment objectives and
policies.
Industrial revenue bonds (i.e., private activity bonds) in most cases
are revenue bonds and generally do not have the pledge of the credit of the
issuer. The payment of the principal and interest on such industrial revenue
bonds is dependent solely on the ability of the user of the facilities financed
by the bonds to meet its financial obligations and the pledge, if any, of real
and personal property so financed as security for such payment. Short-term
municipal obligations issued by states, cities, municipalities or municipal
agencies include Tax Anticipation Notes, Revenue Anticipation Notes, Bond
Anticipation Notes, Construction Loan Notes and Short-Term Discount Notes.
Project Notes are instruments guaranteed by the Department of Housing and Urban
Development but issued by a state or local housing agency. While the issuing
agency has the primary obligation on such Project notes, they are also secured
by the full faith and credit of the United States.
Note obligations with demand or put options may have a stated maturity
in excess of one year, but allow any holder to demand payment of principal plus
accrued interest upon a specified number of days' notice. Frequently, such
obligations are secured by letters of credit or other credit support
arrangements provided by banks. The issuer of such notes normally has a
corresponding right, after a given period, to repay in its discretion the
outstanding principal of the notes plus accrued interest upon a specific number
of days' notice to the bondholders. The interest rate on a demand note may be
based upon a known lending rate, such as a bank's prime rate, and be adjusted
when such rate changes, or the interest rate on a demand note may be a market
rate that is adjusted at specified intervals. The demand notes in which the
Municipal Money Market Portfolio will invest are payable on not more than one
year's notice.
The yields of Municipal Bonds depend on, among other things, general
money market conditions, conditions in the Municipal Bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's and S&P represent their opinions of the quality
of the Municipal Bonds. It should be emphasized that such ratings are general
and are not absolute standards of quality. Consequently, Municipal Bonds with
the same maturity, coupon and rating may have different yields, while Municipal
Bonds of the same maturity and coupon, but with different ratings, may have the
same yield. It will be the responsibility of the Adviser to appraise
independently the fundamental quality of the bonds held by the Municipal Bond
Portfolio and the Municipal Money Market Portfolio.
Municipal Bonds are sometimes purchased on a "when issued" basis meaning
the buyer has committed to purchasing certain specified securities at an
agreed-upon price when they are issued. The period between commitment date and
issuance date can be a month or more. It is possible that the securities will
never be issued and the commitment canceled.
From time to time proposals have been introduced before Congress to
restrict or eliminate the Federal income tax exemption for interest on Municipal
Bonds. Similar proposals may be introduced in the future. If any such proposal
were enacted, it might restrict or eliminate the ability of either the Municipal
Bond Portfolio or the Municipal Money Market Portfolio to achieve its investment
objective. In that event, the Fund's Directors and officers would reevaluate
its investment objective and policies and consider recommending to its
shareholders changes in such objective and policies.
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Similarly, from time to time proposals have been introduced before State
and local legislatures to restrict or eliminate the State and local income tax
exemption (to the extent such an exemption applies, which may not apply in all
cases) for interest on Municipal Bonds. Similar proposals may be introduced in
the future. If any such proposal were enacted, it might restrict or eliminate
the ability of either of the Municipal Bond Portfolio or the Municipal Money
Market Portfolio to achieve its investment objective. In that event, the Fund's
Directors and officers would reevaluate the Portfolio's investment objective and
policies and consider recommending to its shareholders changes in such objective
and policies.
IV. DESCRIPTION OF MORTGAGE-BACKED SECURITIES
"Mortgage-Backed Securities" are securities that, directly or
indirectly, represent a participation in, or are secured by and payable from,
mortgage loans on real property. Mortgage-backed securities include
collateralized mortgage obligations ("CMOs"), pass-through securities issued or
guaranteed by agencies or instrumentalities of the U.S. government or by private
sector entities.
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 Pass-Through 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 or "tranches." The principal and
interest on the underlying Mortgage Assets may be allocated among the several
classes of a series of CMOs in many ways.
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 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.
In a CMO, a series of bonds or certificates are issued in multiple
classes. Each class of CMOs, 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. 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. Interest is paid or accrues
on CMOs on a monthly, quarterly or semi-annual basis. 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 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
Mortgage-Backed Securities with similar average lives. Because of the
uncertainty of the cash flows on these tranches, the market prices of and yields
on these tranches are more volatile.
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-backed securities.
MORTGAGE PASS-THROUGH SECURITIES. Mortgage pass-through securities in
which the Mortgage-Backed Securities Portfolio may invest include pass-through
securities issued or guaranteed by agencies or instrumentalities of the U.S.
government or by private sector entities. Mortgage pass-through securities
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. FNMA
and FHLMC obligations are not backed by the full faith and credit of the U.S.
government as GNMA certificates are, but FNMA and FHLMC securities are supported
by the instrumentalities' right to borrow from the United States Treasury. Each
of GNMA, FNMA and FHLMC guarantees timely distributions of interest to
certificate holders.
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Each of GNMA and FNMA 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 now issued Mortgage-
Backed Securities (FHLMC Gold Pcs) which also guarantee timely payment of
monthly principal reductions. 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.
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 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 by pools of other eligible mortgage loans. The
Housing Act provides that the full faith and credit of the United States
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 United States Treasury with no
limitations as to amount.
Each Ginnie Mae Certificate will represent 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.
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 United States government.
Each Fannie Mae Certificate will represent a pro rata interest in one or
more pools of FHA Loans, 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 will 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.
CREDIT ENHANCEMENT. Mortgage-backed 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 Mortgage-Backed Securities Portfolio will not pay any
additional fees for such credit support, although the existence of credit
support may increase the price the Portfolio pays for a security.
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The ratings of mortgage-backed 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.
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 thereof 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.
V. FOREIGN INVESTMENTS
The Active Country Allocation, International Equity, International Fixed
Income, Global Equity, Global Fixed Income, Asian Equity, European Equity,
Japanese Equity, International Small Cap, Latin American and China Growth
Portfolios will invest, and the Emerging Growth, Emerging Markets, Emerging
Markets Debt, Value Equity, Equity Growth, MicroCap, Balanced, Small Cap Value
Equity, International Magnum, Fixed Income, High Yield and Gold Portfolios may
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. For a
description of the effect on the Portfolios of currency exchange rate
fluctuation, see "Investment Objectives and Policies -- Forward Foreign Currency
Exchange Contracts" above. 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. Foreign securities not listed on a
recognized domestic or foreign exchange are regarded as not readily marketable
and therefore such investments will be limited to 15% of a Portfolio's net asset
value at the time of purchase.
Although the Portfolios 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. Except in the case of
the International Equity, Global Equity, European Equity, Japanese Equity, Asian
Equity, Global Fixed Income, International Fixed Income, International Magnum,
International Small Cap, Latin American and China Growth Portfolios, it is not
expected that a Portfolio or its shareholders would be able to claim a credit
for U.S. tax purposes with respect to any such foreign taxes. However, these
foreign withholding taxes may not have a significant impact on such Portfolios,
because each Portfolio's investment objective is to seek long-term capital
appreciation and any dividend or interest income should be considered
incidental.
FINANCIAL STATEMENTS
The audited Financial Statements for the fiscal year ended December 31,
1995 and the Report of Price Waterhouse LLP, independent accountants, dated
February 9, 1996 relating to the financial statements and financial
highlights of each of the Portfolios except for the Mortgage-Backed
Securities, China Growth, MicroCap and International Magnum Portfolios, which
had not commenced operation as of December 31, 1995, are included as
part of Post-Effective Amendment No. 29 to the Registration Statement on
Form N-1A of Morgan Stanley Institutional Fund, Inc. (File No. 33-23166) filed
with the Securities and Exchange Commission on April 30, 1996 is hereby
incorporated by reference as if set forth in full herein. The following are
unaudited Financial Statements for the period from inception on March 15,
1996 to July 31, 1996 for the International Magnum Portfolio.
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