<PAGE>
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OFFICERS AND DIRECTORS
Barton M. Biggs James W. Grisham
CHAIRMAN OF THE BOARD VICE PRESIDENT
Frederick B. Whittemore Michael F. Klein
VICE-CHAIRMAN OF THE VICE PRESIDENT
BOARD Harold J. Schaaff, Jr.
Warren J. Olsen VICE PRESIDENT
PRESIDENT AND DIRECTOR Joseph P. Stadler
John D. Barrett II VICE PRESIDENT
DIRECTOR Valerie Y. Lewis
Gerard E. Jones SECRETARY
DIRECTOR Karl O. Hartmann
Andrew McNally, IV ASSISTANT SECRETARY
DIRECTOR James R. Rooney
Samuel T. Reeves TREASURER
DIRECTOR Joanna M. Haigney
Fergus Reid ASSISTANT TREASURER
DIRECTOR
Frederick O. Robertshaw
DIRECTOR
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INVESTMENT ADVISER AND ADMINISTRATOR
Morgan Stanley Asset Management Inc.
1221 Avenue of the Americas
New York, New York 10020
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DISTRIBUTOR
Morgan Stanley & Co. Incorporated
1251 Avenue of the Americas
New York, New York 10020
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CUSTODIANS
The Chase Manhattan Bank, N.A.
770 Broadway
New York, New York 10003
Morgan Stanley Trust Company
One Pierrepont Plaza
Brooklyn, New York 11210
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LEGAL COUNSEL
Morgan, Lewis & Bockius LLP
2000 One Logan Square
Philadelphia, Pennsylvania 19103
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INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York 10036
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For current performance, current net asset value, or for assistance with your
account, please contact the Fund at (800) 548-7786. This report is authorized
for distribution only when preceded or accompanied by prospectuses of the Morgan
Stanley Institutional Fund, Inc.
[LOGO] MORGAN STANLEY
INSTITUTIONAL FUND, INC.
P.O. Box 2798
Boston, MA 02208-2798
[LOGO] MORGAN STANLEY
INSTITUTIONAL FUND, INC.
FIXED INCOME PORTFOLIO
FIRST QUARTER REPORT
MARCH 31, 1996
<PAGE>
LETTER TO SHAREHOLDERS
- -------
The Fixed Income Portfolio invests primarily in a diversified portfolio of U.S.
Government securities, corporate bonds (including competitively priced
Eurodollar bonds), mortgage-backed securities and other fixed income securities.
Targeted rates of return for the Portfolio are based on current and projected
market and economic conditions and on a conservative investment management
approach.
For the three month period ended March 31, 1996, the Portfolio had a total
return of -1.59% for the Class A shares and -1.68% for the Class B shares, as
compared to a total return of -1.78% for the Lehman Aggregate Bond Index. The
average annual total return for the twelve months ended March 31, 1996 and for
the period from inception on May 15, 1991 through March 31, 1996 was 11.78% and
8.34%, respectively, for the Class A shares, as compared to 10.78% and 8.46%,
respectively, for the Index. As of March 31, 1996, the Portfolio had an SEC
30-day yield of 6.20% for the Class A shares and 6.00% for the Class B shares.
PERFORMANCE COMPARED TO THE LEHMAN AGGREGATE BOND INDEX(1)
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<TABLE>
<CAPTION>
TOTAL RETURNS(2)
---------------------------------------
ONE AVERAGE ANNUAL
YTD YEAR SINCE INCEPTION
--------- --------- -----------------
<S> <C> <C> <C>
PORTFOLIO--CLASS A............... -1.59% 11.78% 8.34%
PORTFOLIO--CLASS B(3)............ -1.68 N/A N/A
INDEX............................ -1.78 10.78 8.46
</TABLE>
1. The Lehman Aggregate Bond Index is an unmanaged index made up of the
Government/Corporate Index, the Mortgage-Backed Securities Index and the
Asset-Backed Securities Index.
2. Total returns for the Portfolio reflect expenses waived and reimbursed, if
applicable, by the Adviser. Without such waiver and reimbursement, total
returns would be lower.
3. The Portfolio began offering Class B shares on January 2, 1996.
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
- ------------------------------
THE PERFORMANCE RESULTS PROVIDED ARE FOR INFORMATIONAL PURPOSES ONLY AND SHOULD
NOT BE CONSTRUED AS A GUARANTEE OF THE PORTFOLIO'S FUTURE PERFORMANCE. PAST
PERFORMANCE SHOWN IS NOT PREDICTIVE OF FUTURE PERFORMANCE. INVESTMENT RETURN AND
PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY
BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. YIELDS WILL FLUCTUATE AS MARKET
CONDITIONS CHANGE.
There was a meaningful shift in investor psychology during the first quarter of
1996. Back in November and December the markets were focusing on the strong
likelihood for meaningful budget reform, a lackluster growth trend for the
economy, low levels of inflation and an accommodative Federal Reserve policy.
All of the forward-looking "good news" was priced into the term structure of
rates. In fact, investors would have needed to extend out to seven or eight
years just to get the yield available on overnight funds. Bullish investor
sentiment was near record-high levels. The old adage that "the consensus is
never right" was proven correct once again during the first quarter, as long
bond prices fell over 11 points.
The shift in psychology was gradual. Early in the year, economic indicators were
still weak, probably the result of one of the snowiest winter seasons on record.
The Fed moved to lower the federal funds and discount rate by 1/4% on January
31st. This move was well advertised in the market and had no real impact on bond
prices. Then consumer and wholesale prices for January and February were
reported somewhat higher than consensus. At the same time, the GOP primary
process made investors increasingly concerned about a change in the political
landscape. Investors worried about a shift back to Democratic control of
Congress, diminishing the chances for meaningful budget reform. The most telling
blow occurred in early March with the dramatic increase in non-farm payrolls.
The market was expecting an increase of about 120,000. The reported gain of
705,000, along with a January upward revision, sent the market down over three
points in the cash market. Reasoning that such strong employment numbers were a
sure sign of a vigorously expanding economy, investors who had been expecting
further rate cuts began to focus on the possibility that the Federal Reserve's
next move might actually be to tighten credit.
Changing market perceptions and a highly volatile rate environment had a rather
dramatic effect on the shape of the yield curve within the quarter. As an
example, the spread between two-year and 30-year Treasuries widened over 32
basis points from 1/1/96 to 2/28/96. Then, in March, this spread narrowed back
by over 20 basis points.
2
<PAGE>
The mortgage sector had by far the best returns for the quarter. The Lehman
Mortgage Index declined 0.44%, while the corporate component fell 2.58% and the
Treasury sector declined by 2.28%. Adjusted for the difference in duration,
corporates outperformed Treasuries by a small amount. Within the mortgage
sector, higher coupons did best. Mortgages with 9.00% coupons, and above,
achieved positive returns.
Foreign bond markets, led by Spain, Italy, France and Germany, performed very
well relative to the U.S. bond market. For example, German government bonds
began the quarter yielding about 25 basis points more than equivalent U.S.
Treasury issues; they finished the quarter about 30 basis points lower,
resulting in excellent performance.
1ST QUARTER STRATEGY REVIEW
We began the quarter with durations somewhat shorter than the benchmark. As
rates began to increase, we moved back to a neutral position in mid-February.
During March, we reduced durations once again, and finished the quarter somewhat
shorter than the benchmark. We have selectively reduced our corporate holdings
as spreads continued to trade at historically narrow levels, making it difficult
to identify real value in the A-rated-and-above sector of the market. Our
mortgage weighting is slightly above the market. We think this sector offers
more attractive value than corporate bonds. Finally, we began to reduce our
weighting in German government bonds. While we believe they continue to offer
good value, the yield spread between the two markets is very volatile, and we
should be able to buy them back at better levels.
OUTLOOK FOR SECOND QUARTER
The current rate structure has priced in an increase in Federal Funds of almost
50 basis points. We do not envision the Fed tightening that much over the next
six to nine months. However, while current psychology has turned much more
negative, most investors have remained longer than their respective benchmarks.
This condition provides a negative technical picture which only capitulation
will solve. As long rates approach 7-7 1/8%, there should be an opportunity to
extend durations in the Portfolio.
Selective spread product, particularly mortgages, will continue to provide a
yield advantage over the benchmark. We think that mortgages offer the best
opportunity to enhance yield--moderate discount 6 1/2-7% GNMAs should perform
very well over the next several months.
Warren Ackerman, III
PORTFOLIO MANAGER
April 1996
3
<PAGE>
INVESTMENTS (UNAUDITED)
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MARCH 31, 1996
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------- ---------
<C> <S> <C>
FIXED INCOME SECURITIES (92.4%)
U.S. GOVERNMENT AND AGENCY OBLIGATIONS (62.9%)
U.S. TREASURY BONDS (1.6%)
$ 2,500 7.50%, 11/15/16 $ 2,678
---------
U.S. TREASURY NOTES (34.5%)
15,000 8.25%, 7/15/98 15,769
20,000 6.25%, 5/31/00 20,125
5,000 6.25%, 2/15/03 4,985
17,500 7.25%, 8/15/04 18,462
---------
59,341
---------
FEDERAL HOME LOAN MORTGAGE CORPORATION (0.2%)
90 8.00%, 1/01/09 93
91 9.00%, 11/01/09 96
94 8.00%, 8/01/10 97
13 13.00%, 9/01/10 15
---------
301
---------
FEDERAL NATIONAL MORTGAGE ASSOCIATION (12.8%)
5,025 6.00%, 9/01/10 4,813
8,040 6.50%, 12/01/10 7,864
13 14.75%, 10/01/12 15
9,905 6.50%, 4/01/24 9,410
---------
22,102
---------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (13.8%)
9 11.00%, 12/15/15 10
15 10.00%, 5/15/19 17
7,833 6.00%, 2/15/24 7,231
7,123 8.00%, 3/15/24 7,270
9,485 7.00%, 5/15/24 9,239
---------
23,767
---------
TOTAL U.S. GOVERNMENT AND AGENCY OBLIGATIONS 108,189
---------
FOREIGN GOVERNMENT AND AGENCY OBLIGATIONS (8.0%)
5,000 Republic of Italy 6.875%, 9/27/23 4,486
5,400 Treuhandanstalt 6.50%, 4/23/03 3,735
7,940 Treuhandanstalt 6.75%, 5/13/04 5,517
---------
TOTAL FOREIGN GOVERNMENT AND AGENCY
OBLIGATIONS 13,738
---------
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------- ---------
<C> <S> <C>
CORPORATE BONDS AND NOTES (16.1%)
FINANCE (16.1%)
$ 7,500 Farmers Insurance 8.625%, 5/01/24 $ 7,121
5,000 Ford Motor Credit Co. 6.25%,
11/08/00 4,928
5,000 General Motors Acceptance Corp.
7.375%, 6/22/00 5,145
5,000 Goldman Sachs Group 6.25%, 2/01/03 4,781
3,000 John Hancock 7.375%, 2/15/24 2,831
3,000 Metropolitan Life Insurance 7.80%,
11/01/25 2,937
---------
TOTAL CORPORATE BONDS AND NOTES 27,743
---------
ASSET BACKED SECURITIES (5.4%)
21 Federal Home Loan Mortgage Corp.,
REMIC 16-B 10.00%, 10/15/19 21
17 Federal National Mortgage
Association, REMIC 92-59F,
(Floating Rate), 5.869%, 8/25/06 17
100 Ford Credit Auto Loan Master
Trust, 92-1A 6.875%, 1/15/99 101
113 ML Asset Backed Corporation,
Series 1993-1, Class A2, 5.125%,
7/15/98 113
3,934 Resolution Trust Corp. Series
1991-M5, Class A, 9.00%, 3/25/17 4,051
5,000 Standard Credit Card Trust 6.75%,
6/07/00 5,059
---------
TOTAL ASSET BACKED SECURITIES 9,362
---------
TOTAL FIXED INCOME SECURITIES (Cost $158,093) 159,032
---------
SHORT-TERM INVESTMENT (5.6%)
REPURCHASE AGREEMENT (5.6%)
9,677 Goldman Sachs, 5.35%, dated
3/29/96, due 4/01/96, to be
repurchased at $9,681,
collateralized by $7,890 United
States Treasury Bonds, 10.75%,
due 2/15/03, valued at $9,878
(Cost $9,677) 9,677
---------
TOTAL INVESTMENTS (98.0%) (Cost $167,770) 168,709
---------
OTHER ASSETS AND LIABILITIES (2.0%)
Other Assets 51,039
Liabilities (47,681)
---------
3,358
---------
NET ASSETS (100%) $172,067
---------
---------
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
AMOUNT
(000)
---------
<C> <S> <C>
CLASS A SHARES:
Net Assets $170,736
Shares Issued and Outstanding ($0.001 par value)
(Authorized 500,000,000 shares) 16,213
Net Asset Value, Offering and Redemption Price
Per Share $10.53
---------
---------
CLASS B SHARES:
Net Assets $1,331
Shares Issued and Outstanding ($0.001 par value)
(Authorized 500,000,000 shares) 126
Net Asset Value, Offering and Redemption Price
Per Share $10.52
---------
---------
</TABLE>
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REMIC -- Real Estate Mortgage Investment Conduit
5
