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P R O S P E C T U S
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U.S. EQUITY PLUS PORTFOLIO
A PORTFOLIO OF THE
MORGAN STANLEY INSTITUTIONAL FUND, INC.
P.O. BOX 2798, BOSTON, MASSACHUSETTS 02208-2798
FOR INFORMATION CALL 1-800-548-7786
----------------
Morgan Stanley Institutional Fund, Inc. (the "Fund") is a no-load, open-end
management investment company, or mutual fund, which offers redeemable shares in
a series of diversified and nondiversified investment portfolios ("portfolios").
The Fund is designed to provide clients with attractive alternatives for meeting
their investment needs. The Fund currently consists of thirty portfolios
representing a broad range of investment choices. This prospectus (the
"Prospectus") pertains to the Class A and Class B shares of the U.S. Equity Plus
Portfolio (the "Portfolio"). The Class A and Class B shares currently offered by
the Portfolio have different minimum investment requirements and fund expenses.
Shares of the portfolios are offered with no sales charge, exchange fee or
redemption fee (except that the International Small Cap Portfolio may impose a
transaction fee).
The Fund is designed to meet the investment needs of discerning investors
who place a premium on quality and personal service. With Morgan Stanley Asset
Management Inc. as Adviser and Administrator (the "Adviser" and the
"Administrator"), and with Morgan Stanley & Co. Incorporated ("Morgan Stanley")
as Distributor, the Fund makes available to institutional and high net worth
individual investors a series of portfolios which benefit from the investment
expertise and commitment to excellence associated with Morgan Stanley and its
affiliates.
This Prospectus is designed to set forth concisely the information about the
Fund that a prospective investor should know before investing and it should be
retained for future reference. The Fund offers additional portfolios which are
described in other prospectuses and under "Prospectus Summary" below. The Fund
currently offers the following portfolios: (i) GLOBAL AND INTERNATIONAL EQUITY
- -- Active Country Allocation, Asian Equity, Emerging Markets, European Equity,
Global Equity, Gold, International Equity, International Magnum, International
Small Cap, Japanese Equity and Latin American Portfolios; (ii) U.S. EQUITY --
Aggressive Equity, Emerging Growth, Equity Growth, Small Cap Value Equity,
Technology, U.S. Equity Plus, U.S. Real Estate and Value Equity Portfolios;
(iii) EQUITY AND FIXED INCOME -- Balanced Portfolio; (iv) FIXED INCOME --
Emerging Markets Debt, Fixed Income, Global Fixed Income, High Yield and
Municipal Bond Portfolios; (v) MONEY MARKET -- Money Market and Municipal Money
Market Portfolios. Additional information about the Fund is contained in a
"Statement of Additional Information," dated May 1, 1997 as amended July 21,
1997, which is incorporated herein by reference. The Statement of Additional
Information and the prospectuses pertaining to the other portfolios of the Fund
are available upon request and without charge by writing or calling the Fund at
the address and telephone number set forth above.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
THE DATE OF THIS PROSPECTUS IS JULY 21, 1997.
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FUND EXPENSES
The following table illustrates all expenses and fees that a shareholder of
the U.S. Equity Plus Portfolio will incur:
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES
- ----------------------------------------------------------------------------------------------
<S> <C>
Maximum Sales Load Imposed on Purchases
Class A..................................................................................... None
Class B..................................................................................... None
Maximum Sales Load Imposed on Reinvested Dividends
Class A..................................................................................... None
Class B..................................................................................... None
Deferred Sales Load
Class A..................................................................................... None
Class B..................................................................................... None
Redemption Fees
Class A..................................................................................... None
Class B..................................................................................... None
Exchange Fees
Class A..................................................................................... None
Class B..................................................................................... None
<CAPTION>
ANNUAL FUND OPERATING EXPENSES
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(AS A PERCENTAGE OF AVERAGE NET ASSETS)
<S> <C>
Management Fee (Net of Fee Waiver)*
Class A..................................................................................... 0.34%
Class B..................................................................................... 0.34%
12b-1 Fees
Class A..................................................................................... None
Class B..................................................................................... 0.25%
Other Expenses
Class A..................................................................................... 0.46%+
Class B..................................................................................... 0.46%+
---------
Total Operating Expenses (Net of Fee Waivers or Expense Reimbursements)*
Class A..................................................................................... 0.80%
Class B..................................................................................... 1.05%
---------
---------
</TABLE>
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* The Adviser has agreed to waive its management fees and/or reimburse the
Portfolio, if necessary, if such fees would cause the total annual operating
expenses of the Portfolio to exceed a specified percentage of its average
daily net assets. Absent the fee waiver, the management fee would be 0.45%.
Absent the fee waivers and/or expense reimbursements, the Portfolio's total
operating expenses are expected to be 0.91%+ of the average daily net assets
of the Class A shares and 1.16%+ of the average daily net assets of the Class
B shares. As a result of this reduction, the Management Fee stated above is
lower than the contractual fee stated under "Management of the Fund." The
Adviser reserves the right to terminate any of its fee waivers and/or expense
reimbursements at any time in its sole discretion. For further information on
Portfolio expenses, see "Management of the Fund."
+ Estimated.
2
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The purpose of the table above is to assist the investor in understanding
the various expenses that an investor in the Portfolio will bear directly or
indirectly. Expenses and fees for the Portfolio are based on estimates assuming
that the average daily net assets of both the Class A and Class B shares of the
Portfolio will be $50,000,000. Due to the continuous nature of Rule 12b-1 fees,
long term Class B shareholders may pay more than the equivalent of the maximum
front-end sales charges otherwise permitted by the National Association of
Securities Dealers, Inc. ("NASD") Conduct Rules.
The following example illustrates the expenses that you would pay on a
$1,000 investment assuming (1) a 5% annual rate of return and (2) redemption at
the end of each time period. As noted in the table above, the Portfolio charges
no redemption fees of any kind. The following example is based on the total
operating expenses of the Portfolio after fee waivers.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Class A................................................ $ 8 $ 26 * *
Class B................................................ $ 11 $ 33 * *
</TABLE>
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* Because the Portfolio is new, the Fund has not projected expenses for the
Portfolio beyond the three year period shown.
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES OR PERFORMANCE. THE PORTFOLIO IS NEW AND ACTUAL EXPENSES MAY BE GREATER
OR LESS THAN THOSE SHOWN.
3
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PROSPECTUS SUMMARY
THE FUND
The Fund consists of thirty portfolios, offering institutional investors and
high net worth individual investors a broad range of investment choices coupled
with the advantages of a no-load mutual fund with Morgan Stanley and its
affiliates providing customized services as Adviser, Administrator and
Distributor. Each portfolio offers Class A shares and, except for the
International Small Cap, Money Market and Municipal Money Market Portfolios,
also offers Class B shares. Each portfolio has its own investment objective and
policies designed to meet its specific goals. The investment objective of the
Portfolio described in this Prospectus is as follows:
-The U.S. EQUITY PLUS PORTFOLIO seeks long term capital appreciation by
investing primarily in equity securities of issuers included in the S&P 500
Index ("S&P 500").
The other portfolios of the Fund are described in other prospectuses which
may be obtained from the Fund at the address and phone number noted on the cover
of this Prospectus. The investment objectives of these other portfolios are
listed below.
GLOBAL AND INTERNATIONAL EQUITY:
-The ACTIVE COUNTRY ALLOCATION PORTFOLIO seeks long-term capital
appreciation by investing in accordance with country weightings determined
by the Adviser in equity securities of non-U.S. issuers which, in the
aggregate, replicate broad country indices.
-The ASIAN EQUITY PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of Asian issuers.
-The CHINA GROWTH PORTFOLIO seeks to provide long-term capital appreciation
by investing primarily in equity securities of issuers in The People's
Republic of China, Hong Kong and Taiwan.
-The EMERGING MARKETS PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of emerging country issuers.
-The EUROPEAN EQUITY PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of European issuers.
-The GLOBAL EQUITY PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of issuers throughout the world,
including U.S. issuers.
-The GOLD PORTFOLIO seeks long-term capital appreciation by investing
primarily in equity securities of foreign and domestic issuers engaged in
gold-related activities.
-The INTERNATIONAL EQUITY PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of non-U.S. issuers.
-The INTERNATIONAL MAGNUM PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of non-U.S. issuers domiciled in
EAFE countries.
-The INTERNATIONAL SMALL CAP PORTFOLIO seeks long-term capital appreciation
by investing primarily in equity securities of non-U.S. issuers with equity
market capitalizations of less than $1 billion.
-The JAPANESE EQUITY PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of Japanese issuers.
-The LATIN AMERICAN PORTFOLIO seeks long-term capital appreciation by
investing primarily in equity securities of Latin American issuers and,
from time to time, debt securities issued or guaranteed by Latin American
governments or governmental entities.
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U.S. EQUITY:
-The AGGRESSIVE EQUITY PORTFOLIO seeks capital appreciation by investing
primarily in corporate equity and equity-linked securities.
-The EMERGING GROWTH PORTFOLIO seeks long-term capital appreciation by
investing primarily in growth-oriented equity securities of small- to
medium-sized corporations.
-The EQUITY GROWTH PORTFOLIO seeks long-term capital appreciation by
investing in growth-oriented equity securities of medium and large
capitalization companies.
-The MICROCAP PORTFOLIO seeks long-term capital appreciation by investing
primarily in growth-oriented equity securities of small corporations.
-The SMALL CAP VALUE EQUITY PORTFOLIO seeks high long-term total return by
investing in undervalued equity securities of small- to medium-sized
companies.
-The TECHNOLOGY PORTFOLIO seeks long-term capital appreciation by investing
primarily in equity securities of companies that, in the opinion of the
Portfolio's investment adviser, are expected to benefit from their
involvement in technology and technology-related industries.
-The U.S. REAL ESTATE PORTFOLIO seeks to provide above average current
income and long-term capital appreciation by investing primarily in equity
securities of companies in the U.S. real estate industry, including real
estate investment trusts.
-The VALUE EQUITY PORTFOLIO seeks high total return by investing in equity
securities which the Adviser believes to be undervalued relative to the
stock market in general at the time of purchase.
EQUITY AND FIXED INCOME:
-The BALANCED PORTFOLIO seeks high total return while preserving capital by
investing in a combination of undervalued equity securities and fixed
income securities.
FIXED INCOME:
-The EMERGING MARKETS DEBT PORTFOLIO seeks high total return by investing
primarily in debt securities of government, government-related and
corporate issuers located in emerging countries.
-The FIXED INCOME PORTFOLIO seeks to produce a high total return consistent
with the preservation of capital by investing in a diversified portfolio of
fixed income securities.
-The GLOBAL FIXED INCOME PORTFOLIO seeks to produce an attractive real rate
of return while preserving capital by investing in fixed income securities
of issuers throughout the world, including U.S. issuers.
-The HIGH YIELD PORTFOLIO seeks to maximize total return by investing in a
diversified portfolio of high yield fixed income securities that offer a
yield above that generally available on debt securities in the four highest
rating categories of the recognized rating services.
-The MORTGAGE-BACKED SECURITIES PORTFOLIO seeks to produce as high a level
of current income as is consistent with the preservation of capital by
investing primarily in a variety of investment-grade mortgage-backed
securities.
-The MUNICIPAL BOND PORTFOLIO seeks to produce a high level of current
income consistent with preservation of principal by investing primarily in
municipal obligations, the interest on which is exempt from federal income
tax.
5
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MONEY MARKET:
-The MONEY MARKET PORTFOLIO seeks to maximize current income and preserve
capital while maintaining high levels of liquidity through investing in
high quality money market instruments with remaining maturities of one year
or less.
-The MUNICIPAL MONEY MARKET PORTFOLIO seeks to maximize current tax-exempt
income and preserve capital while maintaining high levels of liquidity
through investing in high quality money market instruments with remaining
maturities of one year or less which are exempt from federal income tax.
THE CHINA GROWTH, MICROCAP AND MORTGAGE-BACKED SECURITIES PORTFOLIOS ARE
CURRENTLY NOT BEING OFFERED.
INVESTMENT MANAGEMENT
Morgan Stanley Asset Management Inc., a wholly-owned subsidiary of Morgan
Stanley, Dean Witter, Discover & Co., which, together with its affiliated asset
management companies, at May 31, 1997 had approximately $303 billion in assets
under management as an investment manager or as a fiduciary adviser, acts as
investment adviser to the Fund and each of its portfolios. See "Management of
the Fund -- Investment Adviser" and "Management of the Fund -- Administrator."
HOW TO INVEST
Class A shares of the Portfolio are offered directly to investors at net
asset value with no sales commission or 12b-1 charges. Class B shares of the
Portfolio are offered at net asset value with no sales commission, but with a
12b-1 fee, which is accrued daily and paid quarterly, equal to 0.25% of the
Class B shares' average daily net assets on an annualized basis. Share purchases
may be made by sending investments directly to the Fund or through the
Distributor. The minimum initial investment, generally, is $500,000 for Class A
shares of the Portfolio and $100,000 for Class B shares of the Portfolio. The
minimum initial investment amount is reduced for certain categories of
investors. For additional information on how to purchase shares and minimum
initial investments, see "Purchase of Shares."
HOW TO REDEEM
Shares of the Portfolio may be redeemed at any time, without cost, at the
net asset value per share of shares of the applicable class next determined
after receipt of the redemption request. The redemption price may be more or
less than the purchase price. Certain redemptions that cause the value of an
account to remain for a continuous 60-day period below the minimum investment
amount for Class A shares or for Class B shares may result in involuntary
redemption or automatic conversion. For additional information on how to redeem
shares and involuntary redemption or conversion, see "Purchase of Shares --
Minimum Account Sizes and Involuntary Redemption of Shares" and "Redemption of
Shares."
RISK FACTORS
The investment policies of the Portfolio entail certain risks and
considerations of which an investor should be aware. The Portfolio will invest
in equity securities which are subject to market risks that may cause their
prices to fluctuate over time. Fluctuations in the value of the equity
securities held by the Portfolio will cause the value of the Portfolio's shares
to fluctuate. In addition, the Portfolio may invest in securities index futures
contracts. The Portfolio may also invest in repurchase agreements, may lend its
portfolio securities, and may purchase securities on a when-issued or delayed
delivery basis. Each of these investment strategies involves specific risks
which are described under "Additional Investment Information" herein and under
"Investment Objectives and Policies" in the Statement of Additional Information.
6
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INVESTMENT OBJECTIVE AND POLICIES
The Portfolio's investment objective is to provide long-term capital
appreciation by investing primarily in equity securities of issuers included in
the S&P 500. The Portfolio's investment objective is a fundamental policy which
may not be changed without the approval of a majority of the Portfolio's
outstanding voting securities. There is no assurance that the Portfolio will
attain its objective. Other investment policies described below are not
fundamental policies and may be changed without shareholder approval. In
addition to the investments and strategies described below, the Portfolio may
invest in certain securities and obligations as set forth in "Additional
Investment Information" below and as described under "Investment Objectives and
Policies" in the Statement of Additional Information.
The Portfolio seeks a total return that exceeds the return of the S&P 500
with price volatility similar to that of the S&P 500. With respect to the
Portfolio, equity securities include common and preferred stocks, convertible
securities, and rights and warrants to purchase common stocks. Under normal
circumstances, the Portfolio will invest at least 65% of its assets in U.S.
equity securities (including American Depositary Receipts ("ADRs")) and at least
80% of its assets in equity securities.
The S&P 500 is a widely recognized, unmanaged index of U.S. equity market
activity. The performance of the S&P 500 is based upon the aggregate performance
of a selected portfolio of publicly traded common stocks which are market value
weighted (shares outstanding times stock price) so that each company's influence
on index performance is directly proportional to its market value. The S&P 500
includes monthly adjustments to reflect reinvestment of dividends and other
distributions thereby reflecting the total return of the securities comprising
the index. The S&P 500 is produced by Standard & Poor's, a division of The
McGraw-Hill Companies, Inc. ("S&P"). "Standard & Poor's", "S&P" and "S&P 500"
are trademarks of S&P and have been licensed for use by Morgan Stanley.
The Adviser's approach in selecting among the issuers comprising the S&P 500
is both value and growth driven. By applying its proprietary portfolio
management process, the Adviser will seek to identify those securities which it
believes to be undervalued and/or to have superior growth potential. In
constructing the Portfolio's investment portfolio, the Adviser will apply a
systematic stock screening and selection process using current and historical
stock prices, earnings, cash flow, dividend yield information, consensus
earnings and earnings growth forecasts, and Morgan Stanley analyst
recommendations for the stocks represented in the S&P 500, as well as other
economic variables. In the selection process, the Adviser seeks to produce a
portfolio of stocks and portfolio weightings thereof which maximizes the
expected performance of the Portfolio relative to the S&P 500 while maintaining
a stable difference between the return of the Portfolio and the return of the
index.
In addition, the Portfolio may enter into securities index futures contracts
that are traded on recognized securities or futures exchanges. The Portfolio may
enter into such futures contracts as an efficient way to initiate an investment
in a basket of securities and/or to gain equity market exposure with small cash
balances. For more information, see "Additional Investment Information" below.
7
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ADDITIONAL INVESTMENT INFORMATION
AMERICAN DEPOSITARY RECEIPTS. The Portfolio may invest in ADRs. ADRs are
securities, typically issued by a U.S. financial institution (a "depositary"),
that evidence ownership interests in a security or a pool of securities issued
by a foreign issuer (the "underlying issuer") and deposited with the depositary.
ADRs include American Depositary Shares and New York Shares and may be
"sponsored" or "unsponsored." Sponsored ADRs are established jointly by a
depositary and the underlying issuer, whereas unsponsored ADRs may be
established by a depositary without participation by the underlying issuer. The
issuers of the stock of unsponsored ADRs are not obligated to disclose material
information in the United States and therefore, there may not be a correlation
between such information and the market value of the ADR. Generally, ADRs in
registered form are designed for use in the U.S. securities market and ADRs in
bearer form are designed for use in securities markets outside the United
States.
CONVERTIBLE SECURITIES AND WARRANTS. The Portfolio may invest in securities
such as convertible securities, preferred stock, warrants or other securities
exchangeable under certain circumstances for shares of common stock. Warrants
are instruments giving holders the right, but not the obligation, to buy shares
of a company at a given price during a specified period.
LOANS OF PORTFOLIO SECURITIES. The Portfolio may lend its securities to
brokers, dealers, domestic and foreign banks or other financial institutions for
the purpose of increasing its net investment income. These loans must be secured
continuously by cash or equivalent collateral or by a letter of credit at least
equal to the market value of the securities loaned plus accrued interest or
income. There may be risks of delay in recovery of the securities or even loss
of rights in the collateral should the borrower of the securities fail
financially. The Portfolio will not enter into securities loan transactions
exceeding, in the aggregate, 33 1/3% of the market value of the Portfolio's
total assets.
MONEY MARKET INSTRUMENTS. The Portfolio is permitted to invest in money
market instruments, although the Portfolio intends to stay invested in
securities satisfying its primary investment objective to the extent practical.
The Portfolio may make money market investments pending other investment or
settlement for liquidity, or in adverse market conditions. See "Temporary
Investments." The money market investments permitted for the Portfolio include
obligations of the U.S. Government and its agencies and instrumentalities,
obligations of foreign sovereignties, other debt securities, commercial paper,
bank obligations, certificates of deposit (including Eurodollar certificates of
deposit) and repurchase agreements.
REPURCHASE AGREEMENTS. The Portfolio may enter into repurchase agreements
with brokers, dealers or banks that meet the credit guidelines established by
the Fund's Board of Directors. In a repurchase agreement, the Portfolio buys a
security from a seller that has agreed to repurchase it at a mutually agreed
upon date and price, reflecting the interest rate effective for the term of the
agreement. The term of these agreements is usually from overnight to one week
and never exceeds one year. Repurchase agreements may be viewed as a fully
collateralized loan of money by the Portfolio to the seller. The Portfolio
always receives securities with a market value at least equal to the purchase
price (including accrued interest) as collateral, and this value is maintained
during the term of the agreement. If the seller defaults and the collateral
value declines, the Portfolio might incur a loss. If bankruptcy proceedings are
commenced with respect to the seller, the Portfolio's realization upon the
collateral may be delayed or limited. The Portfolio may not enter into
repurchase agreements with more than
8
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seven days to maturity if, as a result, more than 15% of the market value of the
Portfolio's net assets are invested in these agreements and other investments
for which market quotations are not readily available or which are otherwise
illiquid.
SECURITIES INDEX FUTURES CONTRACTS. The Portfolio may purchase and sell
securities index futures contracts. A securities index futures contract is an
agreement to take or make delivery of an amount of cash equal to the difference
between the value of the index at the beginning and at the end of the contract
period. The Portfolio may enter into such futures contracts as an efficient way
to initiate an investment in a basket of securities and/or to gain equity market
exposure with small cash balances. Subject to applicable laws, the Portfolio may
engage in transactions in securities index futures contracts which are traded on
a recognized securities or futures exchange.
Under rules adopted by the Commodity Futures Trading Commission, the
Portfolio may enter into futures contracts and options thereon for both hedging
and non-hedging purposes, provided that not more than 5% of the Portfolio's
total assets at the time of entering the transaction are required as margin and
option premiums to secure obligations under such contracts relating to
non-hedging activities. The Portfolio will limit its use of future contracts, in
combination with any other derivative instruments, to 33 1/3% of its total
assets measured by the aggregate notional amount of outstanding derivative
instruments.
Gains and losses on futures contracts depend on the Adviser's ability to
predict correctly the direction of securities prices, interest rates and other
economic factors. Other risks associated with the use of futures contracts are
(i) imperfect correlation between the change in market value of investments held
by the Portfolio and the prices of futures relating to investments purchased or
sold by the Portfolio, and (ii) possible lack of a liquid secondary market for a
futures contract and the resulting inability to close a futures position. The
risk that the Portfolio will be unable to close out a futures position will be
minimized by only entering into futures contracts for which there appears to be
a liquid exchange or secondary market. The risk of loss in trading on futures
contracts in some strategies can be substantial, due to both the low margin
deposits required and the extremely high degree of leverage involved in futures
pricing.
TEMPORARY INVESTMENTS. During periods in which the Adviser believes changes
in economic or financial conditions make it advisable for temporary, defensive
purposes or during such periods when the Portfolio is not fully invested (only
to the extent permitted by its investment policies), the Portfolio may invest
its assets in certain short-term (less than twelve months to maturity) and
medium-term (not greater than five years to maturity) debt securities or hold
cash. The short-term and medium-term debt securities in which the Portfolio may
invest consist of (a) obligations of governments, agencies or instrumentalities
of the United States; (b) bank deposits and bank obligations (including
certificates of deposit, time deposits and bankers' acceptances) of U.S. banks;
(c) finance company and corporate commercial paper and other short-term
corporate debt obligations of U.S. issuers. The short-term and medium-term debt
securities in which the Portfolio may invest will be rated investment grade by
recognized rating services such as Moody's Investors Service, Inc. ("Moody's")
or S&P (in the case of Moody's and S&P, meaning rated A or higher by either).
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. The Portfolio may purchase
securities on a when-issued or delayed delivery basis. In such transactions,
instruments are bought with payment and delivery taking place in the future in
order to secure what is considered to be an advantageous yield or price at the
time of the transaction. Delivery of and payment for these securities may take
as long as a month or more after the date of
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the purchase commitment but will take place no more than 120 days after the
trade date. The Portfolio will maintain with the custodian a separate account
with a segregated portfolio of cash or liquid securities in an amount at least
equal to these commitments. The payment obligation and the interest rates that
will be received are each fixed at the time the Portfolio enters into the
commitment and no interest accrues to the Portfolio until settlement. Thus, it
is possible that the market value at the time of settlement could be higher or
lower than the purchase price if, among other factors, the general level of
interest rates has changed. It is a current policy of the Portfolio not to enter
into when-issued commitments exceeding in the aggregate 15% of the market value
of the Portfolio's total assets less liabilities, other than the obligations
created by these commitments.
INVESTMENT LIMITATIONS
The Portfolio is a diversified investment company and is therefore subject
to the following fundamental limitations: as to 75% of its total assets, the
Portfolio may not (a) invest more than 5% of its total assets in the securities
of any one issuer, except obligations of the U.S. Government, its agencies, and
instrumentalities, or
(b) own more than 10% of the outstanding voting securities of any one issuer.
The Portfolio also operates under certain investment restrictions that are
deemed fundamental investment limitations and may be changed only with the
approval of the holders of a majority of the Portfolio's outstanding shares and
under certain non-fundamental investment limitations that may be changed without
shareholder approval. See "Investment Limitations" in the Statement of
Additional Information."
MANAGEMENT OF THE FUND
INVESTMENT ADVISER. Morgan Stanley Asset Management Inc. is the Adviser and
Administrator of the Fund and each Portfolio. The Adviser provides investment
advice and portfolio management services, pursuant to an Investment Advisory
Agreement and, subject to the supervision of the Fund's Board of Directors,
makes each of the Portfolio's day-to-day investment decisions, arranges for the
execution of portfolio transactions and generally manages each of the
Portfolio's investments. The Adviser is entitled to receive from the U.S. Equity
Plus Portfolio an annual management fee, payable quarterly, equal to 0.45% of
the average daily net assets of the Portfolio. The Adviser has agreed to a
reduction in the fees payable to it and to reimburse the Portfolio, if
necessary, if such fees would cause total annual operating expenses of the
Portfolio to exceed 0.80% of the average daily net assets of the Class A shares
of the Portfolio and 1.05% of the average daily net assets of the Class B shares
of the Portfolio.
The Adviser, with principal offices at 1221 Avenue of the Americas, New
York, New York 10020, conducts a worldwide portfolio management business and
provides a broad range of portfolio management services to customers in the
United States and abroad. Morgan Stanley, Dean Witter, Discover & Co. is the
parent of the Adviser and Morgan Stanley. At May 31, 1997, the Adviser, together
with its affiliated asset management companies, managed investments totalling
approximately $303 billion, including assets under active management and assets
for which the Adviser or its affiliates act as Named Fiduciary or Fiduciary
Adviser. See "Management of the Fund" in the Statement of Additional
Information.
PORTFOLIO MANAGERS. NARAYAN RAMACHANDRAN AND EUGENE FLOOD JR. Narayan
Ramachandran joined Morgan Stanley Asset Management in 1996. He is a Principal
of the Adviser and leads the quantitative equity strategies effort of the
Structured Asset Management business at the Adviser. He was previously Managing
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Director at RogersCasey Associates, Inc. ("RogersCasey"), an investment
consulting and special assets advisory firm based in Darien, Connecticut. As
President of RogersCasey's investment advisory subsidiary, he was responsible
for leading the special assets advisory business with $2 billion in assets under
management. Prior to that, he was Director of Research for RogersCasey, with his
research efforts focused on quantitative investment models. He has a B.S. in
Chemical Engineering from the Indian Institute of Technology in Bombay and an
M.B.A. from the University of Michigan at Ann Arbor. Eugene Flood joined Morgan
Stanley in 1987. He is a Senior Equity Portfolio Manager of Structured Asset
Management and a Principal of the Adviser. He has traded a broad spectrum of
instruments including equities, fixed income, foreign exchange and commodities.
Additionally, he has consulted for a variety of private sector companies and
government agencies. Prior to joining the Firm, Dr. Flood was on the faculty of
Stanford University's Graduate School of Business, where he taught Finance. Dr.
Flood received an A.B. in Economics from Harvard University and a Ph.D. in
Economics from the Massachusetts Institute of Technology.
ADMINISTRATOR. The Adviser also provides administrative services to the
Fund pursuant to an Administration Agreement. The services provided under the
Administration Agreement are subject to the supervision of the Officers and the
Board of Directors of the Fund and include day-to-day administration of matters
related to the corporate existence of the Fund, maintenance of its records,
preparation of reports, supervision of the Fund's arrangements with its
custodian and assistance in the preparation of the Fund's registration
statements under federal laws. The Administration Agreement also provides that
the Administrator, through its agents, will provide the Fund dividend disbursing
and transfer agent services to the Fund. For its services under the
Administration Agreement, the Fund pays the Adviser a monthly fee which on an
annual basis equals 0.15% of the average daily net assets of the Portfolio.
Under an agreement between the Adviser and The Chase Manhattan Bank
("Chase"), Chase provides certain administrative services to the Fund through
its corporate affiliate, Chase Global Funds Services Company ("CGFSC"). The
Adviser supervises and monitors such administrative services provided by CGFSC.
Their services are also subject to the supervision of the Board of Directors of
the Fund. CGFSC's business address is 73 Tremont Street, Boston, Massachusetts
02108-3913.
DIRECTORS AND OFFICERS. Pursuant to the Fund's Articles of Incorporation,
the Board of Directors decides upon matters of general policy and reviews the
actions of the Fund's Adviser, Administrator, Distributor and other service
providers. The Officers of the Fund conduct and supervise its daily business
operations.
DISTRIBUTOR. Morgan Stanley serves as the exclusive Distributor of the
shares of the Fund. Under its Distribution Agreement with the Fund, Morgan
Stanley sells shares of the Portfolio upon the terms and at the current offering
price described in this Prospectus. Morgan Stanley is not obligated to sell any
certain number of shares of any Portfolio.
The Portfolio currently offers only the classes of shares offered by this
Prospectus. The Portfolio may in the future offer one or more classes of shares
with features, distribution expenses or other expenses that are different from
those of the classes currently offered.
The Fund has adopted a Plan of Distribution with respect to the Class B
shares pursuant to Rule 12b-1 under the 1940 Act (the "Plan"). Under the Plan,
the Distributor is entitled to receive from the Portfolio a distribution fee,
which is accrued daily and paid quarterly, of 0.25% of the Class B shares'
average daily net
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assets on an annualized basis. The Distributor expects to reallocate most of its
fee to its investment representatives. The Distributor may, in its discretion,
voluntarily waive from time to time all or any portion of its distribution fee
and each of the Distributor and the Adviser is free to make additional payments
out of its own assets to promote the sale of Fund shares, including payments
that compensate financial institutions for distribution services or shareholder
services.
The Plan is designed to compensate the Distributor for its services, not to
reimburse the Distributor for its expenses, and the Distributor may retain any
portion of the fee that it does not expend in fulfillment of its obligations to
the Fund.
EXPENSES. The Portfolio is responsible for payment of certain other fees
and expenses (including legal fees, accountants' fees, custodial fees and
printing and mailing costs) specified in the Administration and Distribution
Agreements.
PURCHASE OF SHARES
Class A and Class B shares of the Portfolio may be purchased at the net
asset value per share next calculated after the Fund receives Federal Funds. See
"Valuation of Shares."
MINIMUM INVESTMENT AND ACCOUNT SIZES; CONVERSION FROM CLASS A TO CLASS B SHARES
For a Portfolio account, the minimum initial investment and minimum account
size are $500,000 for Class A shares and $100,000 for Class B shares. Certain
advisory or asset allocation accounts, such as Total Funds Management accounts,
managed by Morgan Stanley or its affiliates, including the Adviser ("Managed
Accounts") may purchase Class A shares without being subject to such minimum
initial investment or minimum account size requirements for a Portfolio account.
Employees of the Adviser and certain of its affiliates may purchase Class A
shares subject to conditions, including a lower minimum initial investment,
established by Officers of the Fund.
If the value of a Portfolio account containing Class A shares falls below
$500,000 (but remains at or above $100,000) because of shareholder
redemption(s), the Fund will notify the shareholder, and if the account value
remains below $500,000 (but remains at or above $100,000) for a continuous
60-day period, the Class A shares in such account will convert to Class B shares
and will be subject to the distribution fee and other features applicable to the
Class B shares. The Fund, however, will not convert Class A shares to Class B
shares based solely upon changes in the market that reduce the net asset value
of shares. Under current tax law, conversions between share classes are not a
taxable event to the shareholder. Managed Accounts are not subject to conversion
from Class A shares to Class B shares.
Investors may also invest in the Portfolio by purchasing shares through a
trust department, broker, dealer, agent, financial planner, financial services
firm or investment adviser. An investor may be charged an additional service or
transaction fee by that institution.
The minimum investment levels may be waived at the discretion of the Adviser
for (i) certain employees and customers of Morgan Stanley or its affiliates and
certain trust departments, brokers, dealers, agents, financial planners,
financial services firms, or investment advisers that have entered into an
agreement with Morgan Stanley or its affiliates; and (ii) retirement and
deferred compensation plans and trusts used to fund such
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plans, including, but not limited to, those defined in Section 401(a), 403(b) or
457 of the Code and "rabbi trusts." The Fund reserves the right to modify or
terminate the conversion features of the shares as stated above at any time upon
60-days notice to shareholders.
The Adviser reserves the right in its sole discretion to determine which of
such advisory or asset allocation accounts shall be Managed Accounts. For
information regarding Managed Accounts, please contact your Morgan Stanley
account representative or the Fund at the telephone number provided on the cover
of this Prospectus.
MINIMUM ACCOUNT SIZES AND INVOLUNTARY REDEMPTION OF SHARES
If the value of a Portfolio account falls below $100,000 because of
shareholder redemption(s), the Fund will notify the shareholder, and if the
account value remains below $100,000 for a continuous 60-day period, the shares
in such account are subject to redemption by the Fund and, if redeemed, the net
asset value of such shares will be promptly paid to the shareholder. The Fund,
however, will not redeem shares based solely upon changes in the market that
reduce the net asset value of shares.
The Fund reserves the right to modify or terminate the involuntary
redemption features of the shares as stated above at any time upon 60-days
notice to shareholders.
CONVERSION FROM CLASS B TO CLASS A SHARES
If the value of Class B shares in a Portfolio account increases, whether due
to shareholder share purchases or market activity, to $500,000 or more, the
Class B shares will convert to Class A shares. Under current tax law, such
conversion is not a taxable event to the shareholder. Class A shares converted
from Class B shares are subject to the same minimum account size requirements
that are applicable to Portfolio accounts containing Class A shares, as stated
above. The Fund reserves the right to modify or terminate this conversion
feature at any time upon 60-days notice to shareholders.
INITIAL PURCHASES DIRECTLY FROM THE FUND
The Fund's determination of an investor's eligibility to purchase shares of
a given class will take precedence over the investor's selection of a class.
Assuming the investor is eligible for the class, the Fund will select the most
favorable class for the investor, if the investor has not done so.
INITIAL INVESTMENTS
1) BY CHECK. An account may be opened by completing and signing an Account
Registration Form and mailing it, together with a check ($500,000 minimum for
Class A shares of the Portfolio and $100,000 for Class B shares of the
Portfolio, with certain exceptions for Morgan Stanley employees and select
customers) payable to "Morgan Stanley Institutional Fund, Inc. -- U.S. Equity
Plus Portfolio" to:
Morgan Stanley Institutional Fund, Inc.
P.O. Box 2798
Boston, Massachusetts 02208-2798
Payment will be accepted only in U.S. dollars, unless prior approval for payment
by other currencies is given by the Fund. The classes of shares of the Portfolio
to be purchased should be designated on the Account
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Registration Form. For purchases by check, the Fund is ordinarily credited with
Federal Funds within one business day. Thus, your purchase of shares by check is
ordinarily credited to your account at the net asset value per share of the
Portfolio determined on the next business day after receipt.
2) BY FEDERAL FUNDS WIRE. Purchases may be made by having your bank wire
Federal Funds to the Fund's bank account. In order to ensure prompt receipt
of your Federal Funds Wire, it is important that you follow these steps:
A. Telephone the Fund (toll free: 1-800-548-7786) and provide us with your
name, address, telephone number, Social Security or Tax Identification
Number, the portfolio name (i.e. U.S. Equity Plus Portfolio), the class
selected, the amount being wired, and by which bank. We will then provide
you with a Fund account number. (Investors with existing accounts should
also notify the Fund prior to wiring funds.)
B. Instruct your bank to wire the specified amount to the Fund's
WireConcentration Bank Account (be sure to have your bank include the
portfolio name (i.e. U.S. Equity Plus Portfolio), the class selected and
the account number assigned to you) as follows:
The Chase Manhattan Bank
One Manhattan Plaza
New York, NY 10081-1000
ABA #021000021
DDA #910-2-733293
Attn: Morgan Stanley Institutional Fund, Inc.
Ref: (U.S. Equity Plus Portfolio, your account number, your account name)
Please call the Fund at 1-800-548-7786 prior to wiring funds.
C. Complete and sign the Account Registration Form and mail it to the address
shown thereon.
The purchase price of the Class A and Class B shares of the Portfolio is the
net asset value next determined after the order is received. See "Valuation of
Shares." An order received prior to the close of the New York Stock Exchange
("NYSE"), which is currently 4:00 p.m. Eastern Time, will be executed at the
price computed on the date of receipt; 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 Transfer Agent receives payment by check or in Federal Funds
prior to the regular close of the NYSE on such day.
Federal Funds purchase orders will be accepted only on a day on which the Fund
and Chase (the "Custodian Bank") are open for business. Your bank may charge a
service fee for wiring Federal Funds.
3) BY BANK WIRE. The same procedure outlined under "By Federal Funds Wire"
above must be followed in purchasing shares by bank wire. However, money
transferred by bank wire may or may not be converted into Federal Funds the
same day, depending on the time the money is received and the bank handling
the wire. Prior to such conversion, an investor's money will not be invested
and, therefore, will not be earning dividends. Your bank may charge a service
fee for wiring funds.
ADDITIONAL INVESTMENTS
You may add to your account at any time (minimum additional investment
$1,000, except for automatic reinvestment of dividends and capital gains
distributions for which there are no minimums) by purchasing
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shares at net asset value by mailing a check to the Fund (payable to "Morgan
Stanley Institutional Fund, Inc. -- U.S. Equity Plus Portfolio") at the above
address or by wiring monies to the Custodian Bank as outlined above. It is very
important that your account name, the portfolio name and the class selected be
specified in the letter or wire to assure proper crediting to your account. In
order to ensure that your wire orders are invested promptly, you are requested
to notify one of the Fund's representatives (toll-free 1-800-548-7786) prior to
the wire date. Additional investments will be applied to purchase additional
shares in the same class held by a shareholder of the Portfolio account.
OTHER PURCHASE INFORMATION
Although the legal rights of Class A and Class B shares will be identical,
the different expenses borne by each class will result in different net asset
values and dividends. The net asset value of Class B shares will generally be
lower than the net asset value of Class A shares as a result of the distribution
expense charged to Class B shares. It is expected, however, that the net asset
value per share of the two classes will tend to converge immediately after the
recording of dividends which will differ by approximately the amount of the
distribution expense accrual differential between the classes.
In the interest of economy and convenience, and because of the operating
procedures of the Fund, certificates representing shares of the Portfolio will
not be issued. All shares purchased are confirmed to you and credited to your
account on the Fund's books maintained by the Adviser or its agents. You will
have the same rights and ownership with respect to such shares as if
certificates had been issued.
To ensure that checks are collected by the Fund, withdrawals of investments
made by check are not presently permitted until payment for the purchase has
been received, which may take up to eight business days after the date of
purchase. As a condition of this offering, if a purchase is cancelled due to
nonpayment or because your check does not clear, you will be responsible for any
loss the Fund or its agents incur. If you are already a shareholder, the Fund
may redeem shares from your account(s) to reimburse the Fund or its agents for
any loss. In addition, you may be prohibited or restricted from making future
investments in the Fund.
Investors may also invest in the Fund by purchasing shares through the
Distributor.
EXCESSIVE TRADING
Frequent trades involving either substantial portfolio assets or a
substantial portion of your account or accounts controlled by you can disrupt
management of a portfolio and raise its expenses. Consequently, in the interest
of all the stockholders of a portfolio and a portfolio's performance, the Fund
may in its discretion bar a stockholder that engages in excessive trading of
shares of any class of a portfolio from further purchases of shares of the Fund
for an indefinite period. The Fund considers excessive trading to be more than
one purchase and sale involving shares of the same class of a portfolio of the
Fund within any 120-day period. As an example, exchanging shares of portfolios
of the Fund as follows amounts to excessive trading: exchanging shares of
portfolio A for shares of portfolio B, then exchanging shares of portfolio B for
shares of portfolio C and again exchanging shares of portfolio C for shares of
portfolio B within a 120-day period. Two types of transactions are exempt from
these excessive trading restrictions: (1) trades exclusively between money
market portfolios; and (2) trades done in connection with an asset allocation
service, such as TFM Accounts or accounts managed or advised by the Adviser
and/or any of its affiliates.
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INVESTMENT IN FUNDS THROUGH A TOTAL FUNDS MANAGEMENT ("TFM") ACCOUNT
In addition to the considerable diversification among individual securities
you receive by investing in a particular portfolio, you can further reduce risk
by spreading your assets among several different portfolios that each have
different risk and return characteristics. TFM is an active investment
management service managed by Morgan Stanley or its affiliates, including Morgan
Stanley Asset Management Inc. (each, a "TFM Adviser"), that allocates your
investments across a combination of either Class A or Class B shares of certain
of the portfolios selected to meet your long-term investment objectives as well
as, in certain circumstances, your current income objectives.
The TFM Adviser has developed investment strategies for TFM Accounts to meet
the diverse financial needs of different investors. You can open a TFM Account
by meeting with one of the investment professionals of a Participating Dealer
who will review your situation and help you identify your long-term investment
and/or current income objectives. After using TFM criteria to determine your
long-term investment and/or current income objectives, you can choose one of
several TFM investment strategies. Based on your chosen strategy, your initial
investment will be allocated among a number of the Class A or Class B shares of
the portfolios. Depending on market conditions, the TFM Adviser periodically
reallocates the combination of portfolios or the percentage amounts invested in
the shares of each portfolio to implement your TFM investment strategy. In
addition, your TFM Account will be periodically rebalanced to maintain your TFM
strategy's current asset allocation mix, if and when the performance of one or
more of the Portfolios unbalances the strategy's mix. You will pay the TFM
Adviser a fee for the TFM Account service that is in addition to and separate
from the fees and expenses you will pay directly or indirectly as an investor in
the Portfolios. See "Fund Expenses."
From time to time, one or more of the Portfolios used for investment by the
TFM Accounts may experience relatively large investments or redemptions due to
the TFM Account allocations or rebalancings recommended by the TFM Adviser.
These transactions will affect the portfolios since portfolios that experience
redemptions as a result of reallocations or rebalancings may have to sell
portfolio securities and portfolios that receive additional cash will have to
invest it in additional portfolio securities. While it is impossible to predict
the overall impact of these transactions over time, there could be adverse
effects on portfolio management to the extent that portfolios may be required to
sell securities or invest cash at times when they would not otherwise do so.
These transactions could also have tax consequences if sales of securities
resulted in gains and could also increase transaction costs. The Adviser,
representing the interests of the portfolios, is committed to minimizing the
impact of TFM Account transactions on the portfolios. The Adviser, however, will
have a conflict in fulfilling this responsibility in that it also serves as a
TFM Adviser. In that capacity, the Adviser, representing the interests of the
TFM Accounts, also is committed to minimizing the impact of TFM Account
transactions on the Portfolios to the extent consistent with pursuing the
investment objectives of the TFM Accounts. In addition, an affiliate of the TFM
Adviser is the Distributor and is compensated on the sale, and may be
compensated for distribution or shareholder services on the sale, of shares of
the Portfolios. See "Purchase of Shares" and "Shareholder Services -- Exchange
Features." The Adviser will monitor the impact of TFM Account transactions on
the Portfolios.
REDEMPTION OF SHARES
You may withdraw all or any portion of the amount in your account by
redeeming shares at any time. Please note that purchases made by check are not
permitted to be redeemed until the payment of the purchase price
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has been collected, which may take up to eight business days after purchase. The
Fund will redeem Class A shares or Class B shares of the Portfolio at the next
determined net asset value of shares of the applicable class. On days that both
the NYSE and the Custodian Bank are open for business, the net asset value per
share of the Portfolio is determined at the regular close of trading of the NYSE
(currently 4:00 p.m. Eastern Time). Shares of the Portfolio may be redeemed by
mail or telephone. No charge is made for redemption. Any redemption proceeds may
be more or less than the purchase price of your shares depending on, among other
factors, the market value of the investment securities held by the Portfolio.
BY MAIL
The Portfolio will redeem its Class A shares or Class B shares at the net
asset value determined on the date the request is received, if the request is
received in "good order" before the regular close of the NYSE. Your request
should be addressed to Morgan Stanley Institutional Fund, Inc., P.O. Box 2798,
Boston, MA 02208-2798, except that deliveries by overnight courier should be
addressed to Morgan Stanley Institutional Fund, Inc., c/o Chase Global Funds
Services Company, 73 Tremont Street, Boston, MA 02108-3913.
"Good order" means that the request to redeem shares must include the
following documentation:
(a) A letter of instruction or a stock assignment specifying the class
and number of shares or dollar amount to be redeemed, signed by all
registered owners of the shares in the exact names in which they are
registered;
(b) Any required signature guarantees (see "Further Redemption
Information" below); and
(c) Other supporting legal documents, if required, in the case of
estates, trusts, guardianships, custodianships, corporations, pension
and profit-sharing plans and other organizations.
Shareholders who are uncertain of requirements for redemption should consult
with a Fund representative.
BY TELEPHONE
Provided you have previously elected the Telephone Redemption Option on the
Account Registration Form, you can request a redemption of your shares by
calling the Fund and requesting the redemption proceeds be mailed to you or
wired to your bank. Please contact one of the Fund's representatives for further
details. In times of drastic market conditions, the telephone redemption option
may be difficult to implement. If you experience difficulty in making a
telephone redemption, your request may be made by regular mail or express mail
and it will be implemented at the net asset value next determined after it is
received. Redemption requests sent to the Fund through express mail must be
mailed to the address of the Dividend Disbursing and Transfer Agent listed under
"General Information." The Fund and the Fund's transfer agent (the "Transfer
Agent") will employ reasonable procedures to confirm that the instructions
communicated by telephone are genuine. These procedures include requiring the
investor to provide certain personal identification information at the time an
account is opened and prior to effecting each transaction requested by
telephone. In addition, all telephone transaction requests will be recorded and
investors may be required to provide additional telecopied written instructions
regarding transaction requests. Neither the Fund nor the Transfer Agent will be
responsible for any loss, liability, cost or expense for following instructions
received by telephone that either of them reasonably believes to be genuine.
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To change the commercial bank or account designated to receive redemption
proceeds, a written request must be sent to the Fund at the address above.
Requests to change the bank or account must be signed by each shareholder and
each signature must be guaranteed.
FURTHER REDEMPTION INFORMATION
Normally the Fund will make payment for all shares redeemed within one
business day of receipt of the request, but in no event will payment be made
more than seven days after receipt of a redemption request in good order.
However, payments to investors redeeming shares which were purchased by check
will not be made until payment for the purchase has been collected, which may
take up to eight days after the date of purchase. The Fund may suspend the right
of redemption or postpone the date upon which redemptions are effected at times
when the NYSE is closed, or under any emergency circumstances as determined by
the Securities and Exchange Commission (the "Commission").
If the Board of Directors determines that it would be detrimental to the
best interests of the remaining shareholders of the Portfolio to make payment
wholly or partly in cash, the Fund may pay the redemption proceeds in whole or
in part by a distribution in-kind of securities held by the Portfolio in lieu of
cash in conformity with applicable rules of the Commission.
Distributions-in-kind will be made in readily marketable securities. Investors
may incur brokerage charges on the sale of portfolio securities so received in
payment of redemptions.
To protect your account, the Fund and its agents from fraud, signature
guarantees are required for certain redemptions to verify the identity of the
person who has authorized a redemption from your account. Please contact the
Fund for further information. See "Redemption of Shares" in the Statement of
Additional Information.
SHAREHOLDER SERVICES
EXCHANGE FEATURES
You may exchange shares that you own in the Portfolio for shares of any
other available portfolio(s) of the Fund (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 you receive in the
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. See
"Purchase of Shares." Shares of the portfolios may be exchanged by mail or
telephone. The privilege to exchange shares by telephone is automatic and made
available without shareholder election. Before you make an exchange, you should
read the prospectus of the portfolio(s) in which you seek to invest. Because an
exchange transaction is treated as a redemption followed by a purchase, an
exchange would be considered a taxable event for shareholders subject to tax.
The exchange privilege may be modified or terminated by the Fund at any time
upon 60-days notice to shareholders.
BY MAIL
In order to exchange shares by mail, you should include in the exchange
request the name, class of shares and account number of your current portfolio,
the name(s) of the portfolio(s) and class(es) of shares into which you intend to
exchange shares, and the signatures of all registered account holders. Send the
exchange request to Morgan Stanley Institutional Fund, Inc., P.O. Box 2798,
Boston, Massachusetts 02208-2798.
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BY TELEPHONE
When exchanging shares by telephone, have ready the name, class of shares
and account number of the Portfolio, the names of the portfolio(s) and class(es)
of shares into which you intend to exchange shares, your Social Security number
or Tax I.D. number, and your account address. Requests for telephone exchanges
received prior to 4:00 p.m. (Eastern Time) are processed at the close of
business that same day based on the net asset value of the class(es) of the
Portfolios involved in the exchange of shares at the close of business. Requests
received after 4:00 p.m. (Eastern Time) are processed the next business day
based on the net asset value determined at the close of business on such day.
For additional information regarding responsibility for the authenticity of
telephoned instructions, see "Redemption of Shares -- By Telephone" above.
TRANSFER OF REGISTRATION
You may transfer the registration of any of your Portfolio shares to another
person by writing to Morgan Stanley Institutional Fund, Inc., P.O. Box 2798,
Boston, MA 02208-2798. As in the case of redemptions, the written request must
be received in good order before any transfer can be made. Transferring the
registration of shares may affect the eligibility of your account for a given
class of the Portfolio's shares and may result in involuntary conversion or
redemption of your shares. See "Purchase of Shares" above.
VALUATION OF SHARES
The net asset value per share of a class of shares of the Portfolio is
determined by dividing the total market value of the Portfolio's investments and
other assets attributable to such class, less any liabilities attributable to
such class, by the total number of outstanding shares of such class of the
Portfolio. Net asset value is calculated separately for each class of the
Portfolio. Net asset value per share is determined as of the regular close of
the NYSE on each day that the NYSE is open for business. Price information on
listed securities is taken from the exchange where the security is primarily
traded. Securities listed on a U.S. securities exchange for which market
quotations are available are valued at the last quoted sale price on the day the
valuation is made. Unlisted securities and listed securities not traded on the
valuation date for which market quotations are readily available are valued at a
price within a range not exceeding the current asked price nor less than the
current bid price. The current bid and asked prices are determined based on the
average of the bid and asked prices quoted on such valuation date by reputable
brokers.
Bonds and other fixed income securities are valued according to the broadest
and most representative market, which will ordinarily be the over-the-counter
market. Net asset value includes interest on fixed income securities, which is
accrued daily. In addition, bonds and other fixed income securities may be
valued on the basis of prices provided by a pricing service when such prices are
believed to reflect the fair market value of such securities. The prices
provided by a pricing service are determined without regard to bid or last sale
prices, but take into account institutional trading in similar groups of
securities and any developments related to the specific securities. Securities
not priced in this manner are valued at the most recently quoted bid price or,
when securities exchange valuations are used, at the latest quoted sale price on
the day of valuation. If there is no such reported sale, the latest quoted bid
price will be used. Securities purchased with remaining maturities of 60 days or
less are valued at amortized cost, if it approximates market value. In the event
that amortized cost does not approximate market value, market prices as
determined above will be used.
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The value of other assets and securities for which quotations are not
readily available (including restricted securities) and those securities for
which it is inappropriate to determine prices in accordance with the above-
stated procedure are determined in good faith at fair value using methods
determined by the Board of Directors. For purposes of calculating net asset
value per share, all assets and liabilities initially expressed in foreign
currencies will be translated into U.S. dollars at the mean of the bid and asked
price of such currencies against the U.S. dollar last quoted by any major bank.
Although the legal rights of Class A and Class B shares will be identical,
the different expenses borne by each class will result in different net asset
values and dividends for the class. Dividends will differ by approximately the
amount of the distribution expense differential among the classes. The net asset
value of Class B shares will generally be lower than the net asset value of the
Class A shares as a result of the distribution expense charged to Class B
shares.
PERFORMANCE INFORMATION
The Fund may from time to time advertise total return for each class of the
Portfolio. THESE FIGURES ARE BASED ON HISTORICAL EARNINGS AND ARE NOT INTENDED
TO INDICATE FUTURE PERFORMANCE.
The Portfolio may advertise"total return" which shows what an investment in
a class of the Portfolio would have earned over a specified period of time (such
as one, five or ten years), assuming that all distributions and dividends by the
Portfolio were reinvested in the same class on the reinvestment dates during the
period. Total return does not take into account any federal or state income
taxes that may be payable on dividends and distributions or on redemption. The
Fund may also include comparative performance information in advertising or
marketing the Portfolio's shares, including data from Lipper Analytical
Services, Inc., other industry publications, business periodicals, rating
services and market indices.
The performance figures for Class B shares will generally be lower than
those for Class A shares because of the distribution fee charged to Class B
shares.
DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
All income dividends and capital gains distributions for a class of shares
will be automatically reinvested in additional shares at net asset value, except
that, upon written notice to the Fund or by checking off the appropriate box in
the Distribution Option Section on the Account Registration Form, a shareholder
may elect to receive income dividends and capital gains distributions in cash.
The Portfolio expects to distribute substantially all of its taxable net
investment income in the form of annual dividends. Net realized capital gains,
if any, after reduction for any available tax loss carryforwards will also be
distributed annually.
Undistributed net investment income is included in the Portfolio's net
assets for the purpose of calculating net asset value per share. Therefore, on
the "ex-dividend" date, the net asset value per share excludes the dividend
(i.e., is reduced by the per share amount of the dividend). Dividends paid
shortly after the purchase of shares by an investor, although in effect a return
of capital, are taxable to shareholders subject to income tax.
Because of the distribution fee and any other expenses that may be
attributable to the Class B shares, the net income attributable to and the
dividends payable on Class B shares will be lower than the net income
20
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attributable to and the dividends payable on Class A shares. As a result, the
net asset value per share of the classes of the Portfolio will differ at times.
Expenses of the Portfolio allocated to a particular class of shares will be
borne on a pro rata basis by each outstanding share of that class.
TAXES
The following summary of certain federal income tax consequences is based on
current tax laws and regulations, which may be changed by legislative, judicial,
or administrative action.
No attempt has been made to present a detailed explanation of the federal,
state, or local income tax treatment of the Portfolio or its shareholders.
Accordingly, shareholders are urged to consult their tax advisers regarding
specific questions as to federal, state and local income taxes.
The Portfolio is treated as a separate entity for federal income tax
purposes and is not combined with the Fund's other portfolios. The Portfolio
intends to qualify for the special tax treatment afforded regulated investment
companies under Subchapter M of the Code, so that the Portfolio will be relieved
of federal income tax on that part of its net investment income and net capital
gain that is distributed to shareholders.
The Portfolio intends to distribute substantially all of its taxable net
investment income (including, for this purpose, the excess of net short-term
capital gain over net long-term capital loss) to shareholders. Dividends from
the Portfolio's net investment income are taxable to shareholders as ordinary
income, whether received in cash or in additional shares. Such dividends paid by
the Portfolio will generally qualify for the 70% dividends-received deduction
for corporate shareholders to the extent of qualifying dividend income received
by the Portfolio from U.S. corporations. The Portfolio will report annually to
its shareholders the amount of dividend income qualifying for such treatment.
Distributions of net capital gains (the excess of net long-term capital gain
over net short-term capital loss) are taxable to shareholders as long-term
capital gain, regardless of how long the shareholder has held the Portfolio's
shares. The Portfolio will send reports annually to shareholders of the federal
income tax status of all distributions made during the preceding year.
The Portfolio intends to make sufficient distributions or deemed
distributions of its ordinary income and capital gain net income (the excess of
short-term and long-term capital gain over short-term and long-term capital
loss, including any available capital loss carryforwards), prior to the end of
each calendar year to avoid liability for federal excise tax.
Dividends and other distributions declared by the Portfolio in October,
November or December of any year and payable to shareholders of record on a date
in such month will be deemed to have been paid by the Portfolio and received by
the shareholders in that year if the distributions are paid by the Portfolio at
any time during the following January.
The Fund may be required to withhold and remit to the U.S. Treasury 31% of
any dividends, capital gains distributions and redemption proceeds paid to any
individual or certain other non-corporate shareholder (1) who has failed to
provide a correct taxpayer identification number (generally an individual's
social security number or non-individual's employer identification number) on
the Application Form, (2) who is subject to
21
<PAGE>
backup withholding by the Internal Revenue Service, or (3) who has not certified
to the Fund that such shareholder is not subject to backup withholding. This
backup withholding is not an additional tax, and any amounts withheld may be
credited against the shareholder's ultimate U.S. tax liability.
The sale, redemption or exchange of shares will result in taxable gain or
loss to the selling, redeeming or exchanging shareholder, depending upon whether
the fair market value of the sale, redemption or exchange proceeds exceed or is
less than the shareholder's adjusted tax basis in the sold, redeemed or
exchanged shares. If capital gain distributions have been made with respect to
shares that are sold at a loss after being held for six months or less, then the
loss is treated as a long-term capital loss to the extent of the capital gain
distributions.
Conversion of shares between classes are not taxable events to the
shareholder.
Shareholders are urged to consult with their tax advisers concerning the
application of state and local income taxes to investments in the Portfolio,
which may differ from the federal income tax consequences described above.
THE TAX DISCUSSION SET FORTH ABOVE IS INCLUDED FOR GENERAL INFORMATION ONLY.
PROSPECTIVE INVESTORS SHOULD CONSULT THEIR OWN TAX ADVISERS WITH RESPECT TO THE
TAX CONSEQUENCES TO THEM OF AN INVESTMENT IN THE PORTFOLIO.
PORTFOLIO TRANSACTIONS
The Adviser selects the brokers or dealers that will execute the purchases
and sales of investment securities for each of the Fund's portfolios. The
Adviser seeks the best execution of all portfolio transactions. A portfolio may
pay higher commission rates than the lowest available when the Adviser believes
it is reasonable to do so in light of the value of the research, statistical,
and pricing services provided by the broker effecting the transaction.
It is not the Fund's practice to allocate brokerage or principal business on
the basis of sales of shares which may be made through intermediary brokers or
dealers. However, the Adviser may, consistent with NASD rules, place portfolio
orders with qualified broker-dealers who recommend the applicable portfolio to
their clients or who act as agents in the purchase of shares of the portfolio
for their clients.
Subject to the overriding objective of obtaining the best execution of
orders, the Fund may use broker-dealer affiliates of the Adviser, including
Morgan Stanley, to effect portfolio brokerage transactions under procedures
adopted by the Fund's Board of Directors. For such transactions, the commission
rates and other remuneration paid to Morgan Stanley or other affiliates must be
fair and reasonable in comparison to those of other broker-dealers for
comparable transactions involving similar securities being purchased or sold
during a comparable time period.
GENERAL INFORMATION
DESCRIPTION OF COMMON STOCK
The Fund was organized as a Maryland corporation on June 16, 1988. The
Articles of Incorporation, as amended and restated, permit the Fund to issue up
to 36 billion shares of common stock, with $.001 par value per share. Pursuant
to the Fund's Articles of Incorporation, the Board of Directors may increase the
number of
22
<PAGE>
shares the Fund is authorized to issue without the approval of the shareholders
of the Fund. The Board of Directors has the power to designate one or more
classes of shares of common stock and to classify and reclassify any unissued
shares with respect to such classes. The shares of common stock of each
portfolio are currently classified into two classes, the Class A shares and the
Class B shares, except for the International Small Cap, Money Market and
Municipal Money Market Portfolios, which offer only Class A shares.
The shares of the Portfolio, when issued, will be fully paid, nonassessable,
fully transferable and redeemable at the option of the holder. The shares have
no preference as to conversion, exchange, dividends, retirement or other
features and have no pre-emptive rights. The shares of the Portfolio have
non-cumulative rights, which means that the holders of more than 50% of the
shares voting for the election of Directors can elect 100% of the Directors if
they choose to do so. Persons or organizations owning 25% or more of the
outstanding shares of the Portfolio may be presumed to "control" (as that term
is defined in the 1940 Act) the Portfolio. Under Maryland law, the Fund is not
required to hold an annual meeting of its shareholders unless required to do so
under the 1940 Act.
REPORTS TO SHAREHOLDERS
The Fund will send to its shareholders annual, semi-annual and quarterly
reports; the financial statements appearing in annual reports are audited by
independent accountants. Monthly unaudited portfolio data is also available from
the Fund upon request.
In addition, the Adviser or its agent, as Transfer Agent, will send to each
shareholder having an account directly with the Fund a monthly statement showing
transactions in the account, the total number of shares owned, and any dividends
or distributions paid.
CUSTODIAN
Chase is the Fund's Custodian for domestic and certain foreign assets. Chase
is not an affiliate of the Adviser or the Distributor. Morgan Stanley Trust
Company, Brooklyn, New York ("MSTC"), an affiliate of the Adviser and the
Distributor, acts as the Fund's custodian for assets held outside the United
States and employs subcustodians approved by the Board of Directors of the Fund
in accordance with regulations of the Securities and Exchange Commission for the
purpose of providing custodial services for such assets. MSTC may also hold
certain domestic assets for the Fund. For more information on the custodians,
see "General Information -- Custody Arrangements" in the Statement of Additional
Information.
DIVIDEND DISBURSING AND TRANSFER AGENT
Chase Global Funds Services Company, 73 Tremont Street, Boston,
Massachusetts 02108-3913, acts as Dividend Disbursing and Transfer Agent for the
Fund.
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP serves as independent accountants for the Fund and
audits its annual financial statements.
LITIGATION
The Fund is not involved in any litigation.
23
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MORGAN STANLEY INSTITUTIONAL FUND, INC.
U.S. EQUITY PLUS PORTFOLIO
P.O. BOX 2798, BOSTON, MA 02208-2798
ACCOUNT REGISTRATION FORM
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If you need assistance in filling out this form for the
ACCOUNT INFORMATION Morgan Stanley Institutional Fund, please contact your
Fill in where applicable Morgan Stanley representative or call us toll free
1-800-548-7786. Please print all items except signature, and
mail to the Fund at the address above.
A) REGISTRATION
1. INDIVIDUAL
2. JOINT TENANTS
(RIGHTS OF
SURVIVORSHIP PRESUMED
UNLESS
TENANCY IN COMMON
IS INDICATED)
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1.
First Name Initial Last Name
2.
First Name Initial Last Name
First Name Initial Last Name
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<C> <S> <C>
3. CORPORATIONS,
TRUSTS AND OTHERS
Please call the Fund
for additional documents
that may be required to
set up account and to
authorize transactions.
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3.
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<S> <C> <C> <C> <C>
Type of Registration: / / INCORPORATED / / UNINCORPORATED / / PARTNERSHIP / / UNIFORM GIFT/TRANSFER TO MINOR
ASSOCIATION (ONLY ONE CUSTODIAN AND MINOR PERMITTED)
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/ / TRUST ________________________ / / OTHER (Specify) ________________________
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<C> <S> <C>
B) MAILING ADDRESS
Please fill in
completely, including
telephone number(s).
</TABLE>
/ / United States Citizen / / Resident Alien
Street or P.O. Box
City
State Zip
Home Telephone No. Business Telephone No.
/ / Non-Resident Alien:
Permanent Address (Where you reside permanently for tax purposes)
Street Address
City
Country Postal Code
Home Telephone No. Business Telephone No.
Current Mailing Address (If different from Permanent Address)
Street Address
City
Country
Postal Code
Home Telephone No. Business Telephone No.
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<C> <S> <C> <C>
C) TAXPAYER Enter your Taxpayer Identification Number. For most individual
IDENTIFICATION taxpayers, this is your Social Security Number.
NUMBER
1. INDIVIDUAL
2. JOINT TENANTS
(RIGHTS OF
SURVIVORSHIP PRESUMED
UNLESS
TENANCY IN COMMON
IS INDICATED)
For Custodian account
of a minor (Uniform
Gifts/Transfers to Minor
Acts), give the Social
Security Number of
the minor
OR
1. TAXPAYER SOCIAL SECURITY NUMBER
IDENTIFICATION NUMBER ("SSN")
("TIN")
OR
2. TIN SSN
OR
TIN SSN
IMPORTANT TAX INFORMATION
You (as a payee) are required by law to provide us (as payer)
with your correct TIN(s) or SSN(s). Accounts that have a
missing or incorrect TIN(s) or SSN(s) will be subject to
backup withholding at a 31% rate on dividends, distributions
and other payments. If you have not provided us with your
correct TIN(s) or SSN(s), you may be subject to a $50 penalty
imposed by the Internal Revenue Service.
Backup withholding is not an additional tax; the tax liability
of persons subject to backup withholding will be reduced by
the amount of tax withheld. If withholding results in an
overpayment of taxes, a refund may be obtained.
You may be notified that you are subject to backup withholding
under Section 3406(a)(1)(C) of the Internal Revenue Code
because you have underreported interest or dividends or you
were required to, but failed to, file a return which would
have included a reportable interest or dividend payment.
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D) PORTFOLIO AND For Purchase of the following
CLASS SECTION Portfolio(s): / / Class A Shares
(Class A shares minimum U.S. Equity Plus Portfolio $ / / Class B Shares $
$500,000 and Class B Total Initial Investment
shares minimum $100,000). $
Please indicate class and
amount.
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E) METHOD OF
INVESTMENT
Please indicate
portfolio, manner of
payment.
</TABLE>
Payment by:
/ / Check (MAKE CHECK PAYABLE TO MORGAN STANLEY INSTITUTIONAL FUND,
INC.--PORTFOLIO NAME)
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/ / Exchange $ From -- - - - - - - - - - -- - -
Name of Portfolio Account No.
/ / Account previously established by: / / Phone exchange / / Wire on -- - - - - - - - - - -- - -
Account No. (Check
(Previously assigned by the Fund) Digit)
Date
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F) DISTRIBUTION Income dividends and capital gains distributions (if any) to
OPTION be reinvested in additional shares unless either box below
is checked.
/ / Income dividends to be paid in cash, capital gains
distributions (if any) in shares.
/ / Income dividends and capital gains distributions (if
any) to be paid in cash.
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G) TELEPHONE / / I/we hereby authorize the Fund and
REDEMPTION its agents to honor any telephone Name of COMMERCIAL Bank (Not Savings
AND EXCHANGE requests to wire redemption proceeds to Bank)
OPTION the commercial bank indicated at right Bank Account No.
Please select at time of and/or mail redemption proceeds to the
initial application if you name and address in which my/our fund
wish to redeem or exchange account is registered if such requests Bank
shares by telephone. A are believed to be authentic. ABA
SIGNATURE GUARANTEE IS The Fund and the Fund's Transfer Agent No.
REQUIRED IF BANK ACCOUNT IS will employ reasonable procedures to
NOT REGISTERED IDENTICALLY TO confirm that instructions communicated Name(s) in which your Bank Account is
YOUR FUND ACCOUNT. by telephone are genuine. These Established
TELEPHONE REQUESTS FOR procedures include requiring the
REDEMPTIONS OR EXCHANGE WILL investor to provide certain personal Bank's Street
NOT BE HONORED UNLESS THE BOX identification information at the time Address
IS CHECKED. an account is opened and prior to
effecting each transaction requested by City State Zip
telephone. In addition, all telephone
transaction requests will be recorded
and investors may be required to provide
additional telecopied written
instructions of transaction requests.
Neither the Fund nor the Transfer Agent
will be responsible for any loss,
liability, cost or expense for following
instructions received by telephone that
it reasonably believes to be genuine.
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H) INTERESTED PARTY
OPTION Name
In addition to the
account statement sent to
my/our registered Address
address, I/we hereby
authorize the Fund to City State Zip Code
mail duplicate statements
to the name and address
provided at right.
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I) DEALER
INFORMATION
Representative Name Representative
No. Branch
No.
</TABLE>
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<C> <S> <C>
J) SIGNATURE OF
ALL HOLDERS
AND TAXPAYER
CERTIFICATION
Sign Here ,
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The undersigned certify that I/we have full authority and legal capacity to purchase and redeem shares
of the Fund and affirm that I/we have received a current Prospectus of the Morgan Stanley
Institutional Fund, Inc. and agree to be bound by its terms.
BY SIGNING THIS APPLICATION, I/WE HEREBY CERTIFY UNDER PENALTIES OF PERJURY THAT THE INFORMATION ON
THIS APPLICATION IS COMPLETE AND CORRECT AND THAT AS REQUIRED BY FEDERAL LAW (PLEASE CHECK APPLICABLE
BOXES BELOW):
/ / U.S. CITIZEN(S)/TAXPAYER(S):
/ / I/WE CERTIFY THAT (1) THE NUMBER(S) SHOWN ABOVE ON THIS FORM IS/ARE THE CORRECT SSN(S) OR
TIN(S) AND (2) I/WE ARE NOT SUBJECT TO ANY BACKUP WITHHOLDING EITHER BECAUSE (A) I/WE ARE
EXEMPT FROM BACKUP WITHHOLDING; (B) I/WE HAVE NOT BEEN NOTIFIED BY THE INTERNAL REVENUE
SERVICE ("IRS") THAT I/WE ARE SUBJECT TO BACKUP WITHHOLDING AS A RESULT OF A FAILURE TO
REPORT ALL INTEREST OR DIVIDENDS; OR (C) THE IRS HAS NOTIFIED ME/US THAT I AM/WE ARE NO
LONGER SUBJECT TO BACKUP WITHHOLDING.
/ / IF NO TIN(S) OR SSN(S) HAS/HAVE BEEN PROVIDED ABOVE, I/WE HAVE APPLIED, OR INTEND TO APPLY,
TO THE IRS OR THE SOCIAL SECURITY ADMINISTRATION FOR A TIN OR A SSN AND I/WE UNDERSTAND
THAT IF I/WE DO NOT PROVIDE EITHER NUMBER TO CHASE GLOBAL FUNDS SERVICES COMPANY ("CGFSC")
WITHIN 60 DAYS OF THE DATE OF THIS APPLICATION OR IF I/WE FAIL TO FURNISH MY/OUR CORRECT
SSN(S) OR TIN(S), I/WE MAY BE SUBJECT TO A PENALTY AND A 31% BACKUP WITHHOLDING ON
DISTRIBUTIONS AND REDEMPTION PROCEEDS. (PLEASE PROVIDE EITHER NUMBER ON IRS FORM W-9). YOU
MAY REQUEST SUCH FORM BY CALLING CGFSC AT 800-282-4404.
/ / NON-U.S. CITIZEN(S)/TAXPAYER(S)
UNDER PENALTIES OF PERJURY, I/WE CERTIFY THAT I/WE ARE NOT U.S. CITIZENS OR RESIDENTS AND I/WE ARE
EXEMPT FOREIGN PERSONS AS DEFINED BY THE INTERNAL REVENUE SERVICE.
THE INTERNAL REVENUE SERVICE DOES NOT REQUIRE YOUR CONSENT TO ANY PROVISION OF THIS DOCUMENT OTHER
THAN THE CERTIFICATIONS REQUIRED TO AVOID BACKUP WITHHOLDING.
(X) (X)
Signature Date Signature (if joint account, both must sign) Date
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<PAGE>
- -------------------------------------------
- -------------------------------------------
- -------------------------------------------
- -------------------------------------------
NO DEALER, SALES REPRESENTATIVE OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS, OTHER THAN THOSE CONTAINED
IN THIS PROSPECTUS, IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS AND, IF
GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON
AS HAVING BEEN AUTHORIZED BY THE FUND OR THE DISTRIBUTOR. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER BY THE FUND OR THE DISTRIBUTOR TO SELL OR A SOLICITATION
OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO
ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION IN SUCH
JURISDICTION.
--------------------------
TABLE OF CONTENTS
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PAGE
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Fund Expenses..................................... 2
Prospectus Summary................................ 4
Investment Objective and Policies................. 7
Additional Investment Information................. 8
Investment Limitations............................ 10
Management of the Fund............................ 10
Purchase of Shares................................ 12
Redemption of Shares.............................. 16
Shareholder Services.............................. 18
Valuation of Shares............................... 19
Performance Information........................... 20
Dividends and Capital Gains Distributions......... 20
Taxes............................................. 21
Portfolio Transactions............................ 22
General Information............................... 22
Account Registration Form
</TABLE>
U.S. EQUITY PLUS PORTFOLIO
A PORTFOLIO OF THE
MORGAN STANLEY
INSTITUTIONAL FUND, INC.
Common Stock
($.001 PAR VALUE)
-------------
PROSPECTUS
-------------
Investment Adviser
Morgan Stanley
Asset Management Inc.
Distributor
Morgan Stanley & Co.
INCORPORATED
MORGAN STANLEY INSTITUTIONAL FUND, INC.
P.O. BOX 2798, BOSTON, MA 02208-2798
- -------------------------------------------
- -------------------------------------------
- -------------------------------------------
- -------------------------------------------
<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 thirty 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"). 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 (except that the
International Small Cap Portfolio may impose a transaction fee). This Statement
of Additional Information addresses information of the Fund applicable to all of
the Fund's Portfolios, except the Technology Portfolio.
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
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PAGE
----
INVESTMENT OBJECTIVES AND POLICIES...... 2
TAXES................................... 17
GENERAL REGULATED INVESTMENT COMPANY
QUALIFICATIONS........................ 17
GENERAL TAX TREATMENT OF QUALIFYING RICS
AND SHAREHOLDERS...................... 18
SPECIAL TAX CONSIDERATIONS RELATING TO
MUNICIPAL BOND AND MUNICIPAL MONEY
MARKET PORTFOLIOS..................... 19
SPECIAL TAX CONSIDERATIONS RELATING TO
FOREIGN INVESTMENTS................... 20
TAXES AND FOREIGN SHAREHOLDERS.......... 20
PURCHASE OF SHARES...................... 21
REDEMPTION OF SHARES.................... 21
SHAREHOLDER SERVICES.................... 21
INVESTMENT LIMITATIONS.................. 22
DETERMINING MATURITIES OF CERTAIN
INSTRUMENTS........................... 24
MANAGEMENT OF THE FUND.................. 24
NET ASSET VALUE FOR MONEY MARKET
PORTFOLIOS............................ 34
PERFORMANCE INFORMATION................. 34
GENERAL INFORMATION..................... 40
DESCRIPTION OF RATINGS.................. 41
FINANCIAL STATEMENTS.................... 42
</TABLE>
STATEMENT OF ADDITIONAL INFORMATION DATED MAY 1, 1997 AS AMENDED JULY 21, 1997
Prospectus for the U.S. Equity Plus Portfolio dated July 21, 1997
Prospectus for the International Magnum Portfolio, dated May 1, 1997
Prospectus for the U.S. Real Estate Portfolio, dated May 1, 1997
Prospectus for the Fixed Income Portfolio, Municipal Bond Portfolio,
Mortgage-Backed Securities Portfolio, Money Market Portfolio and Municipal
Money Market Portfolio, dated May 1, 1997
Prospectus for the Equity Growth Portfolio, Emerging Growth Portfolio,
MicroCap Portfolio and Aggressive Equity Portfolio, dated May 1, 1997
Prospectus for the Small Cap Value Equity Portfolio, Value Equity Portfolio,
Balanced Portfolio, Global Fixed Income Portfolio and High Yield Portfolio,
dated May 1, 1997
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, 1997
Prospectus for the Emerging Markets Portfolio and Emerging Markets Debt
Portfolio, dated May 1, 1997
Prospectus for the Active Country Allocation Portfolio, dated May 1, 1997
Prospectus for the Gold Portfolio, dated May 1, 1997
Prospectus for the China Growth Portfolio, dated May 1, 1995
1
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
The following policies supplement the investment objectives and policies set
forth in the Fund's Prospectuses:
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-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.
EMERGING COUNTRY EQUITY AND DEBT SECURITIES
GENERAL. Each of the Active Country Allocation, Latin American,
International Magnum, Active Country Allocation, Global Equity, International
Equity, International Small Cap, Asian Equity, European Equity, Emerging Markets
and Emerging Markets Debt Portfolios' 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. 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 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 principally reflects 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,
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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 be unable or unwilling
to repay the principal and/or interest when due in accordance with the terms of
such debt. As a result of the foregoing, a government obligor may default on its
obligations. If such an event occurs, the 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.
EQUITY-LINKED SECURITIES
The Aggressive Equity Portfolio may invest in equity-linked securities,
including, among others, PERCS, ELKS or LYONs, which are securities that are
convertible into or the value of which is based upon the value of, equity
securities upon certain terms and conditions. The amount received by an investor
at maturity of such securities is not fixed but is based on the price of the
underlying common stock. It is impossible to predict whether the price of the
underlying common stock will rise or fall. Trading prices of the underlying
common stock will be influenced by the issuer's operational results, by complex,
interrelated political, economic, financial, or other factors affecting the
capital markets, the stock exchanges on which the underlying common stock is
traded and the market segment of which the issuer is a part. In addition, it is
not possible to predict how equity-linked securities will trade in the secondary
market, which is fairly developed and liquid. The market for such securities may
be shallow, however, and high volume trades may be possible only with
discounting. In addition to the foregoing risks, the return on such securities
depends on the creditworthiness of the issuer of the securities, which may be
the issuer of the underlying securities or a third party investment banker or
other lender. The creditworthiness of such third party issuer of equity-linked
securities may, and often does, exceed the creditworthiness of the issuer of the
underlying securities. The advantage of using equity-linked securities over
traditional equity and debt securities is that the former are income producing
vehicles that may provide a higher income than the dividend income on the
underlying equity securities while allowing some participation in the capital
appreciation of the underlying equity securities. Another advantage of using
equity-linked securities is that they may be used for hedging to reduce the risk
of investing in the generally more volatile underlying equity securities.
The following are three examples of equity-linked securities. The Portfolio
may invest in the securities described below or other similar equity-linked
securities.
PERCS. Preferred Equity Redemption Cumulative Stock ("PERCS") technically
is preferred stock with some characteristics of common stock. PERCS are
mandatorily convertible into common stock after a period of time, usually three
years, during which the investors' capital gains are capped, usually at 30%.
Commonly, PERCS may be redeemed by the issuer at any time or if the issuer's
common stock is trading at a specified price level or better. The redemption
price starts at the beginning of the PERCS duration period at a price that is
above the cap by the amount of the extra dividends the PERCS holder is entitled
to receive relative to the common stock over the duration of the PERCS and
declines to the cap price shortly before maturity of the PERCS. In exchange for
having the cap on capital gains and giving the issuer the option to redeem the
PERCS at any time or at the specified common stock price level, the Portfolio
may be compensated with a substantially higher dividend yield than that on the
underlying common stock. Investors, such as the Portfolio, that seek current
income find PERCS attractive because PERCS provide a higher dividend income than
that paid with respect to a company's common stock.
ELKS. Equity-Linked Securities ("ELKS") differ from ordinary debt
securities, in that the principal amount received at maturity is not fixed but
is based on the price of the issuer's common stock. ELKS are debt securities
commonly issued in fully registered form for a term of three years under an
indenture trust. At maturity, the holder of ELKS will be entitled to receive a
principal amount equal to the lesser of a cap amount, commonly in the range of
30% to 55% greater than the current price of the issuer's common stock, or the
average closing price per share of the issuer's common stock, subject to
adjustment as a result of certain dilution events, for the 10 trading days
immediately prior to maturity. Unlike PERCS, ELKS are commonly not subject to
redemption prior to maturity. ELKS usually bear interest during the three-year
term at a substantially higher rate than the dividend yield on the underlying
common stock. In exchange for having the cap on the return that might have been
received as capital gains on the underlying common stock, the Portfolio may be
compensated with the higher yield, contingent on how well the underlying common
stock does. Investors, such as the Portfolio, that seek current income, find
ELKS attractive because ELKS provide a higher dividend income than that paid
with respect to a company's common stock.
LYONS. Liquid Yield Option Notes ("LYONs") differ from ordinary debt
securities, in that the amount received prior to maturity is not fixed but is
based on the price of the issuer's common stock. LYONs are zero-coupon notes
that sell at a large discount from face value. For an investment in LYONs, the
Portfolio will not receive any interest payments until the notes mature,
typically in 15 to 20 years, when the notes are redeemed at face, or par, value.
The yield on LYONs, typically, is lower-than-market rate for debt securities of
the same maturity, due in part to the fact that the LYONs are convertible into
common stock of the issuer at any time at the option of the holder of the LYONs.
Commonly, the LYONs are redeemable by the issuer at any time after an initial
period or if the issuer's common stock is trading at a specified price level or
better or, at the option
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of the holder, upon certain fixed dates. The redemption price typically is the
purchase price of the LYONs plus accrued original issue discount to the date of
redemption, which amounts to the lower-than-market yield. The Portfolio will
receive only the lower-than-market yield unless the underlying common stock
increases in value at a substantial rate. LYONs are attractive to investors like
the Portfolio when it appears that they will increase in value due to the rise
in value of the underlying common stock.
FOREIGN CURRENCY FORWARD 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 Equity Growth, 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 foreign currency forward contract
involves an obligation to purchase or sell a specific currency at a future date,
which may be any fixed number of days from the date of the contract agreed upon
by the parties, at a price set at the time of the contract. These contracts are
traded in the interbank market conducted directly between currency traders
(usually large commercial banks) and their customers. 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 on Futures Contracts" below.
The Portfolios may enter into foreign currency forward 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 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 Investment Company Act of 1940 (the
"1940 Act") or the rules adopted thereunder, the Fund's Custodian will place
cash or liquid 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
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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. For a discussion of the
special risks associated with foreign currency transactions, see "Risks
Associated with Foreign Currency Transactions," below in this SAI.
RISKS ASSOCIATED WITH FOREIGN CURRENCY TRANSACTIONS
Transactions in foreign currency forward contracts, foreign currency futures
contracts and options thereon, 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.
Settlement of over-the-counter ("OTC") forward contracts or 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, OTC options
on foreign currencies and foreign currency forward contracts are not traded on
contract markets or national securities exchanges regulated by the Commodity
Futures Trading Commission ("CFTC") or the Securities and Exchange Commission
(the "Commission"), respectively. In an OTC trading environment, many of the
protections associated with transactions on exchanges will not be available.
For example, there are no daily price fluctuation limits, and adverse market
movements could therefore continue to an unlimited extent over a period of time.
Although the purchaser of an option cannot lose more than the amount of the
premium plus related transaction costs, this entire amount could be lost.
Moreover, an option writer could lose amounts substantially in excess of its
initial investment due to the margin and collateral requirements associated with
such option positions. Similarly, there is no limit on the amount of potential
losses on forward contracts to which a Portfolio is a party.
In addition, OTC 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 OTC
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, OTC 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 OTC transactions only with parties whose
creditworthiness has been reviewed and found satisfactory by the Adviser.
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OTC options on foreign currencies 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 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 Portfolios. 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 OTC 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.
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, Aggressive Equity 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 "Foreign Currency Forward 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 United States. 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.
FUTURES CONTRACTS
The Portfolios, except the Money Market and Municipal Money Market
Portfolios, may enter into futures contracts and options on futures contracts.
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.
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Futures exchanges and trading are regulated under the Commodity Exchange Act
by the CFTC.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities or currencies, in most cases the
contracts are closed out before the settlement date without the making or taking
of delivery. Closing out an open futures position is done by taking an opposite
position ("buying" a contract which has previously been "sold" or "selling" a
contract previously "purchased") in an identical contract to terminate the
position. Brokerage commissions are incurred when a futures contract is bought
or sold.
Futures contracts on securities indices or other indices do not require the
physical delivery of securities, but merely provide for profits and losses
resulting from changes in the market value of a contract to be credited or
debited at the close of each trading day to the respective accounts of the
parties to the contract. On the contract's expiration date a final cash
settlement occurs and the futures position is simply closed out. Changes in the
market value of a particular futures contract reflect changes in the level of
the index on which the futures contract is based.
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements which are higher than the exchange
minimums. Futures contracts are customarily purchased and sold for prices that
may range upward from less than 5% of the value of the contract being traded.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent that
the margin on deposit does not satisfy margin requirements, payment of an
additional "variation" margin will be required. Conversely, a change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The 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.
Portfolios may purchase and write call and put options on futures contracts
which are traded on a U.S. Exchange or 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 futures position by the writer of the option to the holder of
the option will be accompanied by 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 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, each Portfolio will limit
its use of derivative instruments, including futures contracts, to 33 1/3% of
its total assets measured by the aggregate notional amount of outstanding
derivative instruments.
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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 generally entering into futures which are traded on
recognized international or national futures exchanges and for which there
appears to be a liquid secondary market, however the Portfolios may enter into
over-the-counter futures transactions to the extent permitted by applicable law.
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. For a discussion of the special risks associated
with foreign currency transactions, see "Risks Associated with Foreign Currency
Transactions" in this SAI.
LOAN PARTICIPATIONS AND ASSIGNMENTS
The Emerging Markets and 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 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
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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.
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
weighing 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 domiciled in EAFE countries (defined below). 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 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.
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, 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 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 Mortgage Assets. As part of the process of creating
more predictable cash flows on certain tranches of a CMO, one or more tranches
generally must be created that absorb most of the changes in the cash flows on
the underlying Mortgage Assets. The yields on these tranches are generally
higher than prevailing market yields on 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.
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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. Federal
National Mortgage Association ("FNMA" or "Fannie Mae") and Federal Home Loan
Mortgage Corporation ("FHLMC" or "Freddie Mac") obligations are not backed by
the full faith and credit of the U.S. government as Government National Mortgage
Association ("GNMA" or "Ginnie Mae") certificates are, but FNMA and FHLMC
securities are supported by the instrumentalities' right to borrow from the U.S.
Treasury. Each of GNMA, FNMA and FHLMC guarantees timely distributions of
interest to certificate holders. 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 issues 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 U.S. 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 U.S. 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
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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.
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.
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 may 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.
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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.
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.
OPTIONS TRANSACTIONS
GENERAL INFORMATION. The Portfolios, except the Money Market and Municipal
Money Market Portfolios, may purchase and sell options on portfolio securities
and 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.
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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 or other liquid securities 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 may 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. 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.
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 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 or
liquid securities with its custodian in an amount at least equal to the market
or 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 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 or liquid securities in an amount equal
to the amount the Portfolio would be required to pay upon exercise of the put.
RISK FACTORS IN OPTIONS TRANSACTIONS. The use of options also involves
additional risks. Compared to the purchase or sale of futures contracts, the
purchase of call or put options involves less potential risk to a Portfolio
because the maximum amount of risk is the premium paid for the option. The
writing of a call option generates a premium which may partially offset a
decline in the value of a Portfolio's portfolio assets. By writing a call
option, the Portfolio becomes obligated to sell the underlying instrument, which
may have a value higher than the exercise price. Conversely, the writing of a
put option generates a premium, but the Portfolio becomes obligated to purchase
the underlying instrument, which may have a value lower than the exercise price.
Thus, the loss incurred by a Portfolio in writing options may exceed the amount
of the premium received.
The effective use of options strategies is dependent, among other things, on
a Portfolio's ability to terminate options positions at a time when the
portfolio manager deems it desirable to do so. Although a Portfolio will enter
into options
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positions only if the portfolio manager believes that a liquid secondary market
exists for such options, there is no assurance that the Portfolio will be able
to effect closing transactions at any particular time or at an acceptable price.
A Portfolio's purchase or sale of put or call options will be based upon
predictions as to anticipated market trends and/or interest rate movements by
the portfolio manager, which could prove to be inaccurate. Even if the
expectations of the portfolio manager are correct, there may be an imperfect
correlation between the change in the value of the options and of the
Portfolio's portfolio securities.
The writer of an option may have no control over when the underlying
securities must be sold, in the case of a call option, or purchased, in the case
of a put option; the writer may be assigned an exercise notice at any time prior
to the termination of the obligation. Whether or not an option expires
unexercised, the writer retains the amount of the premium. This amount, of
course, may, in the case of a covered call option, be offset by a decline in the
market value of the underlying security during the option period. If a call
option is exercised, the writer experiences a profit or loss from the sale of
the underlying security. If a put option is exercised, the writer must fulfill
the obligation to purchase the underlying security at the exercise price which
will usually exceed the then market value of the underlying security.
The writer of an option that wishes to terminate its obligation may effect a
"closing purchase transaction." This is accomplished by buying an option of the
same series as the option previously written. The effect of the purchase is that
the writer's position will be canceled by the clearing corporation. However, a
writer may not effect a closing purchase transaction after being notified of the
exercise of an option. Likewise, an investor who is the holder of an option may
liquidate its position by effecting a "closing sale transaction." This is
accomplished by selling an option of the same series as the option previously
purchased. There is no guarantee that either a closing purchase or a closing
sale transaction can be effected.
Effecting a closing transaction in the case of a written call option will
permit the Portfolio to write another call option on the underlying security
with either a different exercise price or expiration date or both, in the case
of a written put option, will permit the Portfolio to write another put option
to the extent that the exercise price thereof is secured by depositing liquid
assets. Also, effecting a closing transaction will permit the cash or proceeds
from the concurrent sale of any securities subject to the option to be used for
other Portfolio investments. If the Portfolio desires to sell a particular
security from its portfolio on which it has written a call option, it will
effect a closing transaction prior to or concurrent with the sale of the
security.
A Portfolio will realize a profit from a closing transaction if the price of
the transaction is less than the premium received from writing the option or is
more than the premium paid to purchase the option; the Portfolio will realize a
loss from a closing transaction if the price of the transaction is more than the
premium received from writing the option or is less than the premium paid to
purchase the option. Because increases in the market price of a call option will
generally reflect increases in the market price of the underlying security, any
loss resulting from the repurchase of a call option is likely to be offset in
whole or in part by appreciation of the underlying security owned by the
Portfolio.
An options position may be closed out only where there exists a secondary
market for an option of the same series. If a secondary market does not exist,
it might be possible to effect a closing transaction in particular options with
the result that the Portfolio would have to exercise the options in order to
realize any profit. If the Portfolio is unable to effect a closing purchase
transaction in a secondary market, it will not be able to sell the underlying
security until the option expires or it delivers the underlying security upon
exercise. Reasons for the absence of a liquid secondary market include the
following: (1) there may be insufficient trading interest in certain options,
(2) restrictions may be imposed by an exchange on opening transactions or
closing transactions, or both, (3) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or series of
options or underlying securities, (4) unusual or unforeseen circumstances may
interrupt normal operation on an exchange, (5) the facilities of an exchange or
OCC may not at all times be adequate to handle current trading volume, or (6)
one or more exchange could, for economic or other reasons, decide or be
compelled at some future date to discontinue the trading of options (or a
particular class or series of options), in which event the secondary market on
that Exchange (or in that class or series of options) would cease to exist,
although outstanding options on that exchange that had been issued by OCC as a
result of trades on that exchange would continue to be exercisable in accordance
with their terms.
The Portfolios may purchase put options to hedge against a decline in the
value of their portfolios. By using put options in this way, the Portfolios will
reduce any profit they might otherwise have realized in the underlying security
by the amount of the premium paid for the put option and by transaction costs.
The Portfolios may purchase call options to hedge against an increase in the
price of securities that the Portfolios anticipate purchasing in the future. The
premium paid for the call option plus any transaction costs will reduce the
benefit, if any, realized by a Portfolio upon exercise of the option, and,
unless the price of the underlying security rises sufficiently, the option may
expire worthless.
Options may also be traded OTC ("OTC Options"). In an OTC trading
environment, many of the protections afforded to exchange participants will not
be available. For example, there are no daily price fluctuation limits, and
adverse market movements could therefore continue to an unlimited extent over a
period of time. The Portfolios may purchase or write OTC Options deemed
creditworthy by the Adviser. OTC Options are illiquid and it may not be possible
for the Portfolios to dispose of such options they have purchased or terminate
their obligations under an option they have written at a time when the Adviser
and portfolio manager believe it would be advantageous to do so. Accordingly,
OTC Options are subject to the
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Portfolios' limitation that a maximum of 15% of its net assets be invested in
illiquid securities. In the event of the bankruptcy of the writer of an OTC
Option, the Portfolios could experience a loss of all or part of the value of
the option.
For a discussion regarding the special risks of foreign currency options,
see "Risks Associated with Foreign Currency Transactions," in this SAI.
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 metals
("precious metals futures") 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").
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, liquid assets 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.
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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 1940 Act, or the Rules and Regulations or
interpretations of 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 Adviser
or Sub-Adviser to be of good standing and when, in the judgment of the Adviser
or Sub-Adviser, 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.
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 at present the Portfolios do 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 or liquid securities. 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 or liquid securities
equal to the difference, if any, between the market value of the securities sold
short and any cash or liquid securities deposited as collateral with the broker
in connection with the short sale. Until it replaces the borrowed securities,
the Portfolio will maintain the segregated account daily at a level so that the
amount deposited in the account plus the amount deposited with the broker will
equal the current market value of the securities 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.
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 GNMA, are, in effect, backed by the full faith and credit of the United
States through provisions in their charters that they may make "indefinite and
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unlimited" drawings on the Treasury, if needed to service debt. Debt from
certain other agencies and instrumentalities, including the Federal Home Loan
Bank and FNMA, 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 FHLMC, are
federally chartered institutions under Government supervision, but their debt
securities are backed only by the creditworthiness of those institutions, not
the U.S. Government.
Some of the U.S. Government agencies that issue or guarantee securities
include the Export-Import Bank of the United States, Farmers Home
Administration, Federal Housing Administration, Maritime Administration, Small
Business Administration, and the Tennessee Valley Authority.
An instrumentality of the U.S. Government is a Government agency organized
under Federal charter with Government supervision. Instrumentalities issuing or
guaranteeing securities include, among others, Federal Home Loan Banks, the
Federal Land Banks, Central Bank for Cooperatives, Federal Immediate Credit
Banks, and the FNMA.
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 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.
GENERAL REGULATED INVESTMENT COMPANY QUALIFICATIONS
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, for each tax
year, if any, to its 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.
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GENERAL TAX TREATMENT OF QUALIFYING RICS AND 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.
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.
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.
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.
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
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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.
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.
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
19
<PAGE>
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.
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.
20
<PAGE>
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 Federal Funds are received. The International Small Cap
Portfolio may impose a 1% transaction fee on share purchases. For each Portfolio
of the Fund other then the Money Market or Municipal Money 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, Martin Luther King, Jr.'s Birthday,
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 and the Emerging Markets Portfolios are currently closed to
new investors with the exception of certain Morgan Stanley customers, employees
of Morgan Stanley, certain tax-qualified retirement plans and other investment
companies advised by Morgan Stanley Asset Management Inc. and its affiliates.
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.
No charge is made by any Portfolio for redemptions except for the 1%
transaction fee that may be 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.
An "eligible guarantor institution" guarantor may include a bank, a trust
company, a credit union or savings and loan association, 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.
The Fund has made an election with the Commission pursuant to Rule 18f-1
under the 1940 Act to pay in cash all redemptions requested by any shareholder
of record limited in amount during any 90-day period to the lesser of $250,000
or 1% of the net assets of a Portfolio at the beginning of such period. Such
commitment is irrevocable without the prior approval of the Commission.
Redemptions in excess of the above limits may be paid in whole or in part in
investment securities or in cash, as the Board of Directors may deem advisable
as being in the best interests of the Fund. If redemptions are paid in
investment securities, such securities will be valued as set forth in the Fund's
Prospectus under "Valuation of Shares" and a redeeming shareholder would
normally incur brokerage expenses in converting these securities to cash.
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
21
<PAGE>
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 sales 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.
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
22
<PAGE>
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 Portfolio, except the
Money Market and Municipal Money Market Portfolios may enter into option
transactions and futures contracts as described in its Prospectus, and (iii) as
specified above in fundamental restriction no. (1) above;
(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;
(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 as
permitted by the 1940 Act or the rules, regulations, interpretations or orders
of the SEC and its staff thereunder;
(6) 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;
(7) 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;
(8) borrow money, except from banks for extraordinary or emergency
purposes, and then only in amounts up to 10% of the value of the Portfolio's
total assets, taken at cost at the time of borrowing, or purchase securities
while borrowings exceed 5% of its total assets, except that the Latin American
and Emerging Markets Debt Portfolios may borrow in accordance with Fundamental
Restriction No. (5) above;
(9) invest in fixed time deposits with a duration of over seven calendar
days or invest in fixed time deposits with a duration of from two business days
to seven calendar days if more than 10% of the Portfolio's total assets would be
invested in these deposits.
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; and (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).
With respect to Fundamental Restriction No. (7), the Fund will determine
industry concentration in accordance with the classifications of industries
based on the Industry Numbers from the Standard Industrial Classification Manual
as prepared by the Office of Management and Budget, except that, with respect to
the Money Market and Municipal Money Market Portfolios, (i) financial service
companies will be classified according to the end users of their services, for
example, automobile finance, bank finance and diversified finance will each be
considered a separate industry; and (ii) asset-backed securities will be
classified according to the underlying assets securing such securities.
In accordance with Fundamental Restriction No. (7), the Latin American
Portfolio will only invest more than 25% of its total assets in companies
involved in the telecommunications industry or financial services industry if
the Board of Directors determines that the Latin American markets are dominated
by securities of issuers in such industries and that, in light of the
23
<PAGE>
anticipated return, investment quality, availability and liquidity of the
issuers in such industries, the Portfolio's ability to achieve its investment
objective would, in light of the investment policies and limitations, be
materially adversely affected if the Portfolio was not able to invest greater
than 25% of its total assets in such industries.
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
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. Two 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 MSAM 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:
<TABLE>
<CAPTION>
NAME, ADDRESS AND DATE OF BIRTH POSITION WITH FUND PRINCIPAL OCCUPATION DURING PAST FIVE YEARS
- --------------------------------------- ---------------------- --------------------------------------------------
<S> <C> <C>
Barton M. Biggs* Chairman and Director Chairman and Director of Morgan Stanley Asset
1221 Avenue of the Americas Management Inc. and Morgan Stanley Asset
New York, NY 10020 Management Limited; Managing Director of Morgan
11/26/32 Stanley & Co. Incorporated; Member of
International Advisory Counsel of the Thailand
Fund; Director of Rand McNally Company; Member
of the Yale Development Board; Chairman and
Director of 16 U.S. registered investment
companies managed by Morgan Stanley Asset
Management Inc.
Michael F. Klein* Director and President Principal of Morgan Stanley Asset Management Inc;
1221 Avenue of the Americas President and Director of three investment
New York, NY 10020 companies and Officer of various other
12/12/58 investment companies managed by Morgan Stanley
Asset Management Inc.; Previously practiced law
with the New York firm of Rogers & Wells.
John D. Barrett, II Director Chairman and Director of Barrett Associates, Inc.
521 Fifth Avenue (investment counseling); Director of the
New York, NY 10135 Ashforth Company (real estate); Director of the
8/21/35 Morgan Stanley Universal Funds, Inc.
Gerard E. Jones Director Partner in Richards & O'Neil LLP (law firm);
43 Arch Street Director of the Morgan Stanley Universal Funds,
Greenwich, CT 06830 Inc.
1/23/37
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
NAME, ADDRESS AND DATE OF BIRTH POSITION WITH FUND PRINCIPAL OCCUPATION DURING PAST FIVE YEARS
- --------------------------------------- ---------------------- --------------------------------------------------
<S> <C> <C>
Andrew McNally IV Director Chairman and Chief Executive Officer of Rand
8255 North Central Park Avenue McNally (publication); Director of Allendale
Skokie, IL 60076 Insurance Co., Mercury Finance (consumer
11/11/39 finance); Zenith Electronics, Hubbell, Inc.
(industrial electronics); Director of the Morgan
Stanley Universal Funds, Inc.
Samuel T. Reeves Director Chairman of the Board and CEO, Pinacle L.L.C.
8211 North Fresno Street (investment firm); Director, Pacific Gas and
Fresno, CA 93720 Electric and PG&E Enterprises (utilities);
7/28/34 Director of the Morgan Stanley Universal Funds,
Inc.
Fergus Reid Director Chairman and Chief Executive Officer of LumeLite
85 Charles Colman Blvd Corporation (injection molding firm); Trustee
Pawling, NY 12564 and Director of Vista Mutual Fund Group;
8/12/32 Director of the Morgan Stanley Universal Funds,
Inc.
Frederick O. Robertshaw Director Of Counsel, Copple, Chamberlin Boehm, P.C.;
2800 North Central Avenue Formerly of Counsel, Bryan, Cave LLP; (law
Phoenix, AZ 85004 firms); Director of the Morgan Stanley Universal
1/24/34 Funds, Inc.
James W. Grisham* Vice President Principal of Morgan Stanley & Co. Incorporated and
1221 Avenue of the Americas of Morgan Stanley Asset Management Inc.; Vice
New York, NY 10020 President of 16 U.S. registered investment
10/24/41 companies managed by Morgan Stanley Asset
Management Inc.
Harold J. Schaaff, Jr.* Vice President Principal of Morgan Stanley & Co. Incorporated and
1221 Avenue of the Americas of Morgan Stanley Asset Management Inc.; General
New York, NY 10020 Counsel and Secretary of Morgan Stanley Asset
6/10/60 Management Inc.; Vice President of 16 U.S.
registered investment companies managed by
Morgan Stanley Asset Management Inc.
Joseph P. Stadler* Vice President Vice President of Morgan Stanley & Co.
1221 Avenue of the Americas Incorporated and Morgan Stanley Asset Management
New York, NY 10020 Inc.; Previously with Price Waterhouse LLP
6/7/54 (accounting); Vice President of 16 U.S.
registered investment companies managed by
Morgan Stanley Asset Management Inc.
Valerie Y. Lewis* Secretary Vice President of Morgan Stanley & Co.
1221 Avenue of the Americas Incorporated and Morgan Stanley Asset Management
New York, NY 10020 Inc.; Previously with Citicorp (banking);
3/26/56 Secretary of 16 U.S. registered investment
companies managed by Morgan Stanley Asset
Management Inc.
Karl O. Hartmann Assistant Secretary Senior Vice President, Secretary and General
73 Tremont Street Counsel of Chase Global Funds Services Company;
Boston, MA 02108-3913 Previously, Leland, O'Brien, Rubinstein
3/7/55 Associates, Inc. (investments).
Joanna Haigney Treasurer Assistant Vice President, Senior Manager of Fund
73 Tremont Street Administration and Compliance Services, Chase
Boston, MA 02108-3913 Global Funds Services Company; Officer of
10/10/66 various investment companies managed by Morgan
Stanley Asset Management Inc. Previously with
Coopers & Lybrand LLP.
Rene J. Feuerman Assistant Treasurer Manager of Fund Administration and Compliance
73 Tremont Street Services, Chase Global Funds Services Company.
Boston, MA 02108-3913 Previously Fund Administrator and Senior Fund
1/25/67 Accountant, Chase Global Funds Services Company.
</TABLE>
- --------------
* "Interested Person" within the meaning of the 1940 Act.
25
<PAGE>
REMUNERATION OF DIRECTORS AND OFFICERS
Effective June 28, 1995, the Open-end Fund Complex managed by MSAM will pay
each of the 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 funds in the Open-end Fund Complex in direct proportion to their
respective average net assets. For the fiscal year ended December 31, 1996, the
Fund paid approximately $389,000 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 July 16, 1997, 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: 2.0% Asian
Equity Portfolio - Class A shares and 2.1% Latin American Portfolio - Class A
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, 1996.
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; and (ii) are acquired for investment and not for resale.
COMPENSATION TABLE
<TABLE>
<CAPTION>
(4)
(2) (3) ESTIMATED (5)
AGGREGATE PENSION OR RETIREMENT ANNUAL TOTAL COMPENSATION
COMPENSATION BENEFITS ACCRUED BENEFITS FROM REGISTRANT
(1) FROM AS PART OF FUND UPON AND FUND COMPLEX
NAME OF PERSON, POSITION REGISTRANT EXPENSES RETIREMENT PAID TO DIRECTORS
- -------------------------------------------------- ------------- --------------------- ------------- ------------------
<S> <C> <C> <C> <C>
Barton M. Biggs,
Director and Chairman of the Board............... N/A N/A N/A N/A
Warren J. Olsen,*
Director and President........................... N/A N/A N/A N/A
Michael F. Klein,**
Director and President........................... N/A N/A N/A N/A
John D. Barrett, II
Director......................................... 59,485 N/A N/A 68,777
Gerard E. Jones,
Director......................................... 59,485 N/A N/A 75,877
Andrew McNally, IV
Director......................................... 55,023 N/A N/A 63,195
Samuel T. Reeves,
Director......................................... 53,287 N/A N/A 61,331
Fergus Reid,
Director......................................... 67,434 N/A N/A 77,220
Frederick O. Robertshaw,
Director......................................... 50,834 N/A N/A 58,777
Frederick B. Whittemore,***
Director......................................... N/A N/A N/A N/A
</TABLE>
- ------------------
* As of May 31, 1997, Mr. Olsen resigned from the Board of Directors.
** Mr. Klein was appointed to the Board of Directors effective May 31, 1997.
*** As of March 14, 1997, Mr. Whittemore resigned from the Board of Directors.
INVESTMENT ADVISORY AND ADMINISTRATIVE AGREEMENTS
Morgan Stanley Asset Management Inc. ("MSAM" or the "Adviser") is a
wholly-owned subsidiary of Morgan Stanley, Dean Witter, Discover & Co. The
principal offices of Morgan Stanley, Dean Witter, Discover & Co. are located at
1585 Broadway, New York, NY 10036, and the principal offices of MSAM are located
at 1221 Avenue of the Americas, New York, NY 10020. As compensation for advisory
services for the fiscal years ended December 31, 1994, December 31, 1995 and
December 31, 1996, the Adviser earned fees of approximately $34,338,000,
$40,534,000 and $55,465,000, respectively, and from such fees voluntarily waived
fees of $2,640,000, $3,526,000 and $4,340,000, respectively. For the fiscal
years ended December 31, 1994, December 31, 1995 and December 31, 1996, the Fund
paid brokerage commissions of approximately $7,287,293, $10,317,515 and
$17,014,335, respectively. For the fiscal years ended December 31, 1994,
December 31, 1995 and December 31, 1996, the Fund paid in the aggregate
$796,000, $377,000 and $826,686, respectively, as brokerage commissions to
Morgan Stanley & Co. Incorporated, an affiliated broker-dealer, which
represented 11%, 4%, and 5% of the total amount of brokerage commissions paid in
each respective period. For the fiscal years ended December 31, 1994, December
31, 1995
26
<PAGE>
and December 31, 1996, the Fund paid administrative fees to MSAM of
approximately $4,458,000, $5,238,000 and
$7,298,531, 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, December 31, 1995 and December 31,
1996, the Sub-Adviser earned fees of approximately $76,000, $73,000 and
$110,000, respectively, and from such fees voluntarily waived fees of $36,000,
$37,000 and $52,000, respectively. For the fiscal years ended December 31, 1994,
December 31, 1995 and December 31, 1996, the Fund paid $8,000, $450 and $0,
respectively, as brokerage commissions to Sun Valley Gold Trading, Inc., a
broker-dealer affiliated with the Sub-Adviser.
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
("Chase"), Chase Global Funds Services Company ("CGFSC," a corporate affiliate
of Chase) provides certain administrative services to the Fund. CGFSC provides
operational and administrative services to investment companies with
approximately $69 billion in assets and having approximately 215,930 shareholder
accounts as of December 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, Dean Witter, Discover & Co., 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 Money Market, Municipal Money Market and International Small Cap Portfolios
which do 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
February 13, 1997.
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. For the fiscal year ended December 31, 1996, the Fund paid to the
Distributor fees of approximately $178,205 pursuant to the Distribution Plan in
accordance with Rule 12b-1 under the 1940 Act. The U.S. Equity Plus,
Mortgage-Backed Securities, China Growth and MicroCap Portfolios were not in
operation in the fiscal year ended December 31, 1996.
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
27
<PAGE>
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 July 16, 1997 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: The Trustees of Columbia University in
the City of New York, 475 Riverside Drive, Suite 401, New York, NY 10115, owned
22% of such Portfolio's total outstanding Class A shares.
Oglebay Norton Company, 1100 Superior Avenue, Cleveland, OH 44114-2598,
owned 16% of such Portfolio's total outstanding Class A shares.
Boatmen's Trust Co. Pension Plan, P.O. Bos 14737, St. Louis, MO 63178-4737
owned 10% of such Portfolio's total outstanding Class A shares.
The Flinn Foundation, Northern Trust Co., Master Trust Dept., 7th Floor,
P.O. Box 92984, Chicago, IL 60675, owned 9% of such Portfolio's total
outstanding Class A shares.
Sahara Enterprises, Inc., 3 First National Plaza, Suite 2000, Chicago, IL
60602-4260, owned 9% of such Portfolio's total outstanding Class A shares.
Wallace Global Fund, 1990 M Street, Suite 250, Washington, D.C. 20036, owned
5% of such Portfolio's total outstanding Class A shares.
David M. & Sharon M. Platter, 9 Palmer Lane, Riverside, CT 06878, owned 97%
of such Portfolio's total outstanding Class B shares.
AGGRESSIVE EQUITY PORTFOLIO: Ministers and Missionaries Benefit Board of
the American Baptist Churches, Attn: Morgan Stanley Asset Management, 1221
Avenue of the Americas, New York, NY 10020, owned 10% of such Portfolio's total
outstanding Class A shares.
Northern Trust Company Trustee, FBO Morgan Stanley Profit Sharing Plan, P.O.
Box 92956, Chicago, IL 60675-2956, owned 10% of such Portfolio's total
outstanding Class A shares.
Bank Morgan Stanley AG, Bahnogstrasse 92, Zurich CH-8023, Switzerland owned
7% 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 6% 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 5% of such Portfolio's total outstanding
Class A shares.
ASIAN EQUITY PORTFOLIO: Association De Bienfsaissance Et De Retraite Des
Pollciers De La Communaute Urbaine De Montreal, 480 Gilford Street, Montreal,
Quebec H2J1N3, owned 10% of such Portfolio's total outstanding Class A shares.
Northern Trust Company Trustee, FBO Morgan Stanley Profit Sharing Plan, P.O.
Box 92956, Chicago, IL 60675-2956, owned 7% of such Portfolio's total
outstanding Class A shares.
James L. & Sarah M. Barksdale, Trustees of Jim & Sally Barksdale, 800
Woodlands Parkway, Suite 118, Ridgeland, MS 39157-5216 owned 6% of such
Portfolio's total outstanding Class B shares.
Thomas J. Holce, 109 N. Lotus Beach Drive, Portland, OR 97217-8021, owned 6%
of such Portfolio's total outstanding Class B shares.
Steve & Julie Gerhardt, 6030 Quail Hill Drive, Cincinnati, OH 45233, owned
5% of such Portfolio's total outstanding Class B shares.
BALANCED PORTFOLIO: Kinney Printing Co-Employees, 4801 So. Lawndale,
Chicago, IL 60632-3018, owned 17% of such Portfolio's total outstanding Class A
shares.
H. Conrad & Sarah Meyer, One Woodland Avenue, Bronxville, NY 10708, owned
13% of such Portfolio's total outstanding Class A shares.
28
<PAGE>
Guarantee & Trust Company, IRA Rollover, One Woodland Avenue, Bronxville, NY
10708, owned 8% of such Portfolio's total outstanding Class A shares.
The Arthur J. Gallagher Foundation, Attn: Luann Hudgins, The Gallagher
Center, Two Pierre Place, Itasca, IL 60143-1203, owned 5% of such Portfolio's
total outstanding Class A shares.
Jeffery R. Holzschuh, 21 Kenilworth Terrace, Greenwich, CT 06830, owned 5%
of such Portfolio's total outstanding Class A shares.
William Guthrie, IRA Rollover, 435 Sheridan Road, Winnetka, IL 60093-2626,
owned 32% of such Portfolio's total outstanding Class B shares.
Ramakrishna Kothalanka M.D., Profit Sharing Plan, MSTC Custodian, 126
Bentley Avenue, Jersey City, NJ 07304-1702, owned 17% of such Portfolio's total
outstanding Class B shares.
Sam G. Pitroda Custodian for Rajal Pitroda, 1480 Goldenbell Court, Downers
Grove, IL 60515-1301, owned 8% of such Portfolio's total outstanding Class B
shares.
Sam G. Pitroda Custodian for Salil Pitroda, 1480 Goldenbell Court, Downers
Grove, IL 60515-1301, owned 8% of such Portfolio's total outstanding Class B
shares.
Phyllis M. Mott IRA, MSTC Custodian, 120 West State Street, Suite 400,
Rockford, IL 61101, owned 8% 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 48%
of such Portfolio's total outstanding Class A shares.
Allendale Mutual Insurance Co., P.O. Box 7500, Johnston, RI 02919-0750,
owned 17% 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 8% of such Portfolio's total outstanding Class
A shares.
South Trust Estate & Trust Company of Georgia, Trustee U/A Southern
Engineering Company Retirement Plan, P.O. Box 1001, Atlanta, GA 30301, owned 7%
of such Portfolio's total outstanding Class A shares.
HVA Limited Partnership, C/O H L Van Arnem, 1301 W. Newport Center Drive,
Deerfield Beach, FL 33442-7734, owned 12% of such Portfolio's total outstanding
Class B shares.
Anne W. Rohrbach, c/o Gleacher Avenue, 660 Madison Avenue, 19th Floor, New
York, NY 10021, owned 11% of such Portfolio's total outstanding Class B shares.
Lawrence M. Howell, Howell Capital, One Maritime Plaza, Suite 1700, San
Francisco, CA 94101, owned 8% of such Portfolio's total outstanding Class B
shares.
Julian Eisner, 871 Oak Lane, North Woodmere, NY 11581, owned 7% of such
Portfolio's total outstanding Class B shares.
H. Conrad & Sarah Meyer, One Woodland Avenue, Bronxville, NY 10708, owned 7%
of such Portfolio's total outstanding Class B shares.
Bruce S. Ives, 163 Gallows Hill Road, West Redding, CT 06896, owned 6% of
such Portfolio's total outstanding Class B shares.
William B. O'Connor, 18 Montfort Road, Port Washington, NY 11050, owned 6%
of such Portfolio's total outstanding Class B shares.
James F. & Marlene Connors, 205 E. Joppa Road, Towson, MD 21286, 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 6% of
such Portfolio's total outstanding Class A shares.
Ewing Marion Kauffman Foundation, 4900 Oak Street, Kansas City, MO 64112,
owned 6% of such Portfolio's total outstanding Class A shares.
EMERGING MARKETS DEBT PORTFOLIO: Northwestern University, 633 Clark Street,
Evanston, IL 60208-1122, owned 21% 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>
Morgan Stanley & Co. Pension Fund, C/O Northern Trust Co., 770 Broadway, New
York, NY 10003, owned 7% of such Portfolio's total outstanding Class A shares.
Northern Trust Company Trustee, FBO Morgan Stanley Profit Sharing Plan, P.O.
Box 92956, Chicago, IL 60675-2956, owned 6% of such Portfolio's total
outstanding Class A shares.
Alice H. & Paul D. Bartlett, 4800 Main Street, Kansas City, MO 64112, owned
10% of such Portfolio's total outstanding Class B shares.
Dr. Russell Warren, IRA MSTC Custodian, 215 John Street, Greenwich, CT
06831-2516, owned 7% of such Portfolio's total outstanding Class B shares.
Daniel E. Winters, 1319 Mirror Terrace, NW, Winter Haven, FL 33881, owned 7%
of such Portfolio's total outstanding Class B shares.
Bruce A. Drummond, 1847 Onaway SE, Grand Rapids, MI 49506, owned 6% of such
Portfolio's total outstanding Class B shares.
Rodriguez Living Trust, Javier & Gloria Rodriguez Trustees, 210 Saint
Katherine Drive, La Canada, CA 91011, owned 6% of such Portfolio's total
outstanding Class B shares.
David Brooks Gendron, 2 Montpelier Place, London SW7 1HJ England, UK, owned
5% of such Portfolio's total outstanding Class B shares.
EQUITY GROWTH PORTFOLIO: Fidelity Management Trust Company as Trustee for
GTE Master Savings Trust, 82 Devonshire Street, Boston, MA 02109, owned 23% of
such Portfolio's total outstanding Class A shares.
Northern Trust Company Trustee, FBO Morgan Stanley Profit Sharing Plan, P.O.
Box 92956, Chicago, IL 60675, owned 17% of such Portfolio's total outstanding
Class A shares.
Fidelity Investments Institutional Operations Company, Agent for Certain
Employee Benefit Plans, 100 Magellan Way, Covington, KY 41015, owned 9% of such
Portfolio's total outstanding Class A shares.
St. Raymonds Cemetery Reserve Fund, P.O. Box 92800, Rochester, NY 14692,
owned 5% of such Portfolio's total outstanding Class A shares.
FMB Nominee Co., c/o First Commonwealth Trust, 614 Philadelphia Street,
Indiana, PA 15701, owned 35% of such Portfolio's total outstanding Class B
shares.
EUROPEAN EQUITY PORTFOLIO: R. Douglas Spedding, Trustee of R. Douglas
Spedding 1996 Trust, c/o 4380 E. Alameda, Glendale, CO 80222, 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 30% of such
Portfolio's total outstanding Class A shares.
Mitra & Co., 1000 N. Water Street, 14th floor, Milwaukee, WI 53202, owned 8%
of such Portfolio's outstanding Class A shares.
Brooks School, C/O Mr. Frank Marino, North Andover, MA 01845, owned 6% of
such Portfolio's total outstanding Class A shares.
Burton P. Cohen, 3912 Zenith Avenue South, Minneapolis, MN 55410-1169, owned
11% of such Portfolio's total outstanding Class B shares.
Michael S. Virgil, FBO Mary Ann Young Brownsey Trust, 135 S. LaSalle Street,
Chicago, IL 60603, owned 11% of such Portfolio's total outstanding Class B
shares.
Joan M. Hunt, MSTC Custodian, 8627 Madison Drive, Niles, IL 60648, owned 10%
of such portfolio's total outstanding Class B shares.
Catholic Medical Center of Brooklyn & Queens, Inc., Deferred Compensation
Plan, 88-25 153rd Street, Apt. 1-H, Jamaica, NY 11432-3748, owned 8% of such
Portfolio's total outstanding Class B shares.
Laverne M. Brownsey Trust UA, (Bonnie's Portion), 135 S. LaSalle Street,
Chicago, IL 60603, owned 6% of such Portfolio's total outstanding Class B
shares.
Laverne M. Brownsey Trust UA, (Gale's Portion), 135 S. LaSalle Street,
Chicago, IL 60603, owned 5% of such Portfolio's total outstanding Class B
shares.
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.
30
<PAGE>
JM Kaplan Fund, Inc., 880 Third Avenue, 3rd floor, New York, NY 10022, owned
13% of such Portfolio's total outstanding Class A shares.
Kaplan, Choate Value Partners, L.P., 880 Third Avenue, New York, NY
10022-4730, owned 8% of such Portfolio's total outstanding Class A shares.
Gooss & Company, C/O Chase Manhattan Bank, 1211 6th Avenue, New York, NY
10036, owned 7% 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 2558, Houston, TX 77252, owned 7% of such Portfolio's total outstanding
Class A shares.
Fidelity Investments Institutional Operations as Agent for Certain Employee
Benefit Plans, 100 Magellan Way, Covington, KY 41015, owned 25% of such
Portfolio's total outstanding Class B shares.
Edward J. Prostic, 2225 Stratford Road, Mission Hills, KS 66208, owned 8% of
such Portfolio's total outstanding Class B shares.
Eduardo Abad Trustee, Abad Charitable Remainder Trust 1, 277 North
Deepspring, Orange, CA 92669-6505, owned 8% of such Portfolio's total
outstanding Class B shares.
V. Marc Droppert IRA, MSTC Custodian, 13106 184th NE, Redmond, WA 98052,
owned 7% of such Portfolio's total outstanding Class B shares.
Leslie E. Tiffany IRA, MSTC, 14312 173rd Place NE, Redmond, WA 98052, owned
6% 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 20% 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 16% of such Portfolio's total outstanding Class A
shares.
Northern Trust Company as Custodian FBO The LBD Foundation, P.O. Box 92956,
Chicago, IL 60675, owned 6% of such Portfolio's total outstanding Class A
shares.
The Northern Trust Co. FBO Christel Dehaan Trust, P.O. Box 92956, Chicago,
IL 60675-2956, owned 6% of such Portfolio's total outstanding Class A shares.
Lakeview Holdings Ltd., Coutts & Co. (Bahamas) Ltd., P.O. Box N7788, West
Bay St., Nassau Bahamas owned 5% of such Portfolio's total outstanding Class A
shares.
National Bank of Commerce Trustee FBO National Bank of Commerce Pension
Plan, Attn: June Taylor, c/o NBC Trust Dept., One Commerce Square, Memphis, TN
38150, owned 5% of such Portfolio's total outstanding Class A shares.
Radiology Associates PA Employee Benefit Plan, 500 South University, Suite
604, Little Rock, AR 72205, owned 5% of such Portfolio's total outstanding Class
A shares.
David Brooks Gendron, 2 Montpelier Place, London SW7 1HJ, England, UK, owned
52% of such Portfolio's total outstanding Class B shares.
George N. & Susan P. Fugelsang, 17 Calhoun Drive, Greenwich, CT 06831, owned
15% of such Portfolio's total outstanding Class B shares.
George & Claudine Boutros, 11007 Branbrook, Houston, TX 77042, owned 11% of
such Portfolio's total outstanding Class B shares.
Paul E. & H. Anthony Hellmers, 4 Colonial Lane, Larchmont, NY 10538, owned
10% of such Portfolio's total outstanding Class B shares.
Anthony F. & Colette H. Rowland, C/O Cambrian Management, 1114 Avenue of the
Americas, New York, NY 10036, owned 9% of such Portfolio's total outstanding
Class B shares.
GOLD PORTFOLIO: Marshall & Ilsley Trust Company, C/F John Morey, 1000 N.
Water Street, Milwaukee, WI 53202, owned 21% of such Portfolio's total
outstanding Class B shares.
Merrill Lynch Trust Co., Trustee FBO Qualified Retirement Plans, 285
Davidson Avenue, 4th floor, Somerset, NJ 08873, owned 20% of such Portfolio's
total outstanding Class B shares.
Barlett and Company, Profit Sharing Plan and Trust, 4800 Main Street, Kansas
City, MO 64112, owned 16% of such Portfolio's total outstanding Class B shares.
31
<PAGE>
Chicago Methodist Episcopal Church Aid Society, C/O Gordon Worley, 4401 Gulf
Shore Boulevard North, Monaco Beach Club, Naples, FL 33940, owned 15% of such
Portfolio's total outstanding Class B shares.
Steven C. Olson, 505 Knollwood Road, Ridgewood, NJ 07450, owned 13% of such
Portfolio's total outstanding Class B shares.
Priscilla & John Privat, Community Property, 8852 N.E. 24th Street,
Bellevue, WA 98004, owned 5% 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 21% 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 10% of such Portfolio's total
outstanding Class A shares.
Adeliade L. Hinckley, C/O Jim Bell, Morgan Stanley/IIS Department, 1251
Avenue of the Americas, New York, NY 10020, owned 6% of such Portfolio's total
outstanding Class B shares.
INTERNATIONAL EQUITY PORTFOLIO: Fleet Bank, Trustee for Third Presbyterian
Church, P.O. Box 92800, Rochester, NY 14692, owned 14% of such Portfolio's total
outstanding Class B shares.
Vanguard Fiduciary Trust Company FBO Ball Corp. Plan 91324, The Vanguard
Group, P.O. Box 2600 VM421, Valley Forge, PA 19462, owned 10% 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 42% of such Portfolio's total outstanding
Class A shares.
Southwest Guaranty Trust Co., 2121 Sage Road, Suite 150, Houston, TX 77056,
owned 7% of such Portfolio's total outstanding Class A shares.
Connelly Foundation, Attn: Lawrence Mangan, One Tower Bridge, Suite 1450,
West Conshohocken, PA 19428, owned 5% of such Portfolio's total outstanding
Class A shares.
Fidelity Investments Institutional Operations Company, Agent for Certain
Employee Benefit Plans, 100 Magellan Way, Covington, KY 41015, owned 81% 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 10% of such Portfolio's total
outstanding Class A shares.
Trustees of Boston College Attn: Paul Haran Associate 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 6% of such Portfolio's total
outstanding Class A shares.
The Skillman Foundation, Attn: Jean E. Gregory, 600 Renaissance Center,
Suite 1700, Detroit, MI 48243, owned 5% of such Portfolio's total outstanding
Class A shares.
JAPANESE EQUITY PORTFOLIO: 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.
Adase Partners, 106 Laurel Way, Beverly Hills, CA 90210, owned 9% of such
Portfolio's total outstanding Class B shares.
Paul M. & Shirley F. Mathews, 25 W. 706 Jerome Avenue, Wheaton, IL 60187,
owned 7% of such Portfolio's total outstanding Class B shares.
William & Brenda Castonguay, 9101 Hometown Drive, Raleigh, NC 27615, owned
6% of such Portfolio's total outstanding Class B shares.
Wayne Gretzky Trustee of the Gretzky Trust of 1989, 9100 Wilshire Boulevard,
Beverly Hills, CA 90210, owned 6% of such Portfolio's total outstanding Class B
shares.
Douglas E. Ebert, Trustee and Successor in Trust, 326 Vailwood Court,
Bloomfield Hills, MI 48302, owned 5% of such Portfolio's total outstanding Class
B shares.
LATIN AMERICAN PORTFOLIO: Investors Bank & Trust Co., Financial Product
Services, P.O. Box 1537, Boston, MA 02205, owned 6% of such Portfolio's total
outstanding Class A shares.
Walter Graves, Jr. and Evelyn Myers Revocable Trust, Walter Graves, Jr.
Trustee, 5301 Bryant Irvin Road, Apt. 130, Fort Worth, TX 76132-4019, owned 16%
of such Portfolio's total outstanding Class B shares.
32
<PAGE>
Marc Andreessen, Trustee FBO Marc Andreessen 1996 Living Trust, 16615 Lark
Avenue, Apt. 101, Los Gatos, CA 95030, owned 11% of such Portfolio's total
outstanding Class B shares.
Pinnacle Trading, LLC, P.O. Box 28918, Fresno, CA 93729-8918, owned 9% of
such Portfolio's total outstanding Class B shares.
Robert M. & Anne D. Buxton, 888 Park Avenue, Apt. 8C, New York, NY 10021,
owned 8% of such Portfolio's total outstanding Class B shares.
Joseph M. Haggar, Jr., 16800 Dallas Parkway, Suite 120, Dallas, TX 75248,
owned 6% of such Portfolio's total outstanding Class B shares.
Horizon Cons Ltd. Profit Sharing Plan, Horizon Cons Ltd. Money Purchase
Plan, 615 Colonial Park Drive, #201, Roswell, GA 30075, owned 6% 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 60305-1205, owned 6% of such Portfolio's total
outstanding Class B shares.
MUNICIPAL BOND PORTFOLIO: Daniel F. and Maria J. McDonald, 8550 Old
Dominion Drive, McLean, VA 22102, owned 10% 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 7% of such Portfolio's total outstanding Class A
shares.
Arnold E. and Jill I. Bellowe Trustees, 915 Park Lane, Montecito, CA
93108-1421, owned 7% of such Portfolio's total outstanding Class A shares.
Donna Karan, C/O Stephan Weiss, The Donna Karan Company, 550 Seventh Avenue,
New York, NY 10018, owned 6% of such Portfolio's total outstanding Class A
shares.
Sevenson Environmental Services, P.O. Box 396, 2749 Lockport Road, Niagra
Falls, NY 14305, owned 6% of such Portfolio's total outstanding Class A shares.
SMALL CAP VALUE EQUITY PORTFOLIO: Barlett and Company, Profit Sharing Plan
and Trust, 4800 Main Street, Kansas City, MO 64112, owned 9% of such Portfolio's
total outstanding Class B shares.
TECHNOLOGY PORTFOLIO: Valassis Enterprises-Equity, c/o Franklin
Enterprises, 520 Lake Cook Road, Suite 380, Deerfield, IL 60015, owned 24% of
such Portfolio's total outstanding Class A shares.
Goolock Associates, C/O Oppenheimer & Co. Inc., 200 Liberty Street, New
York, NY 10281, owned 15% of such Portfolio's total outstanding Class A shares.
Robert J. Weinstein M.D., & Lois Weinstein, 875 N. Michigan Avenue, Chicago,
IL 60611, owned 9% of such Portfolio's total outstanding Class B shares.
Martha Tredgett, 312 Bleeker Street, New York, NY 10014-3425, owned 7% of
such Portfolio's total outstanding Class B shares.
Paul Krieger, 23 Fairview Avenue, Great Neck, NY 11023, owned 7% of such
Portfolio's total outstanding Class B shares.
Jonathan J. Williams, IRA Rollover MSTC Custodian, 132 Ready Road, Walnut
Creek, CA 94598-2329, owned 6% of such Portfolio's total outstanding Class B
shares.
U.S. REAL ESTATE PORTFOLIO: Northern Trust Company Trustee, FBO Anderson
Worldwide Profit Sharing 401k Retirement Trust, P.O. Box 92956DV, Chicago, IL
60675, owned 13% of such Portfolios total outstanding Class A Shares.
Northwestern University, Attn: Investment Department, 633 Clark Street,
Evanston, IL 60208, owned 8% of such Portfolio's total outstanding Class A
shares.
Morgan Stanley & Co. Pension Fund, C/O Northern Trust Company Cust, 770
Broadway, New York, NY 10003, owned 7% of such Portfolio's total outstanding
Class A shares.
Charles Schwab & Co. Inc., 101 Montgomery Street, San Francisco, CA 94104,
owned 6% of such Portfolio's total outstanding Class A Shares.
European Patent Organization Pension Reserve Fund, Erhardt Strasse 27,
Munich, 80331 Germany, owned 5% of such Portfolio's total outstanding Class A
shares.
Merrill Lynch Trust Co., Trustee of FBO Qualified Retirement Plans, 265
Davidson Avenue, 4th floor, Somerset, NJ 08873, owned 38% of such Portfolio's
total outstanding Class B shares.
33
<PAGE>
VALUE EQUITY PORTFOLIO: Alice H. & Paul D. Bartlett, Trustees, 4800 Main
Street, Kansas City, MO 64112, owned 19% of such Portfolio's total outstanding
Class B shares.
Paul D. Bartlett Jr., 4800 Main Street, Kansas City, MO 64112, owned 12% of
such Portfolio's total outstanding Class B shares.
R. Douglas Spedding, Trustee of R. Douglas Spedding 1996 Trust, c/o 4380 E.
Alameda, Glendale, CO 80222, owned 10% of such Portfolio's total outstanding
Class B shares.
David Brooks Gendron, 2 Montpelier Place, London SW7 1HJ England, UK, owned
8% of such Portfolio's total outstanding Class B shares.
First United Methodist Church of Chicago - Endowment Fund, 77 West
Washington, Chicago, IL 60602, owned 6% of such Portfolio's total outstanding
Class B shares.
George N. & Susan P. Fugelsang, 17 Calhoun Drive, Greenwich, CT 06831, owned
6% of such Portfolio's total outstanding Class B shares.
Laverne M. Brownsey Trust, 135 S. LaSalle St., Chicago, IL 60603 owned 6% of
such Portfolio's total outstanding Class B shares.
Cascino Investment Co., 820 Burgess Hill, Naperville, IL 60565, owned 5% of
such Portfolio's total outstanding Class B shares.
Joan M. Hunt Trust, 8627 Madison Drive, Niles, IL 60648-2321, 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.
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
34
<PAGE>
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,
1996 and for the period from inception through December 31, 1996 are as follows:
<TABLE>
<CAPTION>
AVERAGE ANNUAL
INCEPTION ONE AVERAGE ANNUAL SINCE
NAME OF PORTFOLIO DATE YEAR FIVE YEAR INCEPTION
- -------------------------------------------------- --------- --------- -------------- --------------
<S> <C> <C> <C> <C>
Active Country Allocation
Class A......................................... 1/17/92 9.71% N/A 8.71%
Class B......................................... 1/02/96 9.22% N/A N/A
Aggressive Equity
Class A......................................... 3/08/95 40.90% N/A 45.98%
Class B......................................... 1/02/96 39.72% N/A N/A
Asian Equity
Class A......................................... 7/01/91 3.49% 19.35% 18.28%
Class B......................................... 1/02/96 2.92% N/A N/A
Balanced
Class A......................................... 2/20/90 10.93% 10.15% 10.39%
Class B......................................... 1/02/96 10.24% N/A N/A
Emerging Growth
Class A......................................... 11/01/89 3.72% 4.10% 11.96%
Class B......................................... 1/02/96 3.58% N/A N/A
Emerging Markets
Class A......................................... 9/25/92 12.19% N/A 12.93%
Class B......................................... 1/02/96 11.04% N/A N/A
Emerging Markets Debt
Class A......................................... 2/01/94 50.52% N/A 18.94%
Class B......................................... 1/02/96 48.52% N/A N/A
Equity Growth
Class A......................................... 4/02/91 30.97% 16.99% 17.06%
Class B......................................... 1/02/96 29.92% N/A N/A
European Equity
Class A......................................... 4/02/93 22.29% N/A 19.62%
Class B......................................... 1/02/96 20.76% N/A N/A
Fixed Income
Class A......................................... 5/15/91 4.61% 7.00% 8.35%
Class B......................................... 1/02/96 4.35% N/A N/A
Global Equity
Class A......................................... 7/15/92 22.83% N/A 19.22%
Class B......................................... 1/02/96 22.04% N/A N/A
Global Fixed Income
Class A......................................... 5/01/91 6.44% 7.17% 8.50%
Class B......................................... 1/02/96 6.12% N/A N/A
Gold
Class A......................................... 2/01/94 16.94% N/A 6.80%
Class B......................................... 1/02/96 13.21% N/A N/A
High Yield
Class A......................................... 9/28/92 15.01% N/A 12.91%
Class B......................................... 1/02/96 14.37% N/A N/A
International Equity
Class A......................................... 8/04/89 19.64% 16.41% 11.96%
Class B......................................... 1/02/96 18.58% N/A N/A
</TABLE>
35
<PAGE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL
INCEPTION ONE AVERAGE ANNUAL SINCE
NAME OF PORTFOLIO DATE YEAR FIVE YEAR INCEPTION
- -------------------------------------------------- --------- --------- -------------- --------------
<S> <C> <C> <C> <C>
International Magnum
Class A......................................... 3/15/96 8.25%* N/A N/A
Class B......................................... 3/15/96 7.90%* N/A N/A
International Small Cap
Class A......................................... 12/15/92 16.82% N/A 16.42%
Japanese Equity
Class A......................................... 4/25/94 -1.40% N/A -2.51%
Class B......................................... 1/02/96 -1.67% N/A N/A
Latin American
Class A......................................... 1/18/95 48.77% N/A 16.98%
Class B......................................... 1/02/96 42.44% N/A N/A
Municipal Bond
Class A......................................... 1/18/95 3.67% N/A 6.36%
Class B......................................... 1/02/96 3.55% N/A N/A
Small Cap Value Equity
Class A......................................... 12/17/92 22.99% N/A 14.32%
Class B......................................... 1/02/96 22.33% N/A N/A
U.S. Real Estate
Class A......................................... 2/24/95 39.56% N/A 32.73%
Class B......................................... 1/02/96 38.23% N/A N/A
Value Equity
Class A......................................... 1/31/90 19.73% 14.92% 12.95%
Class B......................................... 1/02/96 18.57% N/A N/A
</TABLE>
- ------------------
* Cumulative (unannualized) total return since inception of the Portfolio.
These figures were calculated according to the following formula:
<TABLE>
<C> <C> <S>
P(1+T)n = ERV
</TABLE>
where:
<TABLE>
<C> <C> <S>
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of hypothetical $1,000 payment made at the beginning
of the 1-, 5-, or 10-year periods at the end of the 1-, 5-, or 10-year
periods (or fractional portion thereof).
</TABLE>
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 current yields for certain of the Fund's Portfolios for the
30-day period ended December 31, 1996 were as follows:
<TABLE>
<CAPTION>
CLASS A
PORTFOLIO NAME SHARES CLASS B SHARES
- -------------------------------------------------- --------- --------------
<S> <C> <C>
Emerging Markets Debt............................. 10.46% 10.16%
Fixed Income...................................... 6.39% 6.27%
Global Fixed Income............................... 4.91% 4.76%
High Yield........................................ 9.31% 9.05%
Municipal Bond.................................... 4.35% 4.11%
</TABLE>
36
<PAGE>
These figures were obtained using the following formula:
<TABLE>
<S> <C> <C>
Yield = 2[(a - b + 1)(6) - 1]
-------------------
cd
</TABLE>
where:
<TABLE>
<S> <C> <C>
a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the
period that were entitled to receive income distributions
d = the maximum offering price per share on the last day of the
period.
</TABLE>
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, 1996 were 4.99%
and 3.38%, 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, 1996 were 5.11% and 3.43%, respectively.
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:
<TABLE>
<C> <C> <S>
Tax Free Yield
- ------------------- = Your Taxable Equivalent
1 - Your Tax Bracket Yield
</TABLE>
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 1996 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 FEDERAL
TAXABLE INCOME INCOME TAXABLE EQUIVALENT RATES BASED ON TAX-EXEMPT YIELD OF:
- ------------------------------------ TAX ------------------------------------------------------------------
JOINT RETURN SINGLE RETURN BRACKETS 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 1996 Federal Income Tax after deductions and exemptions,
not indexed for 1996 income tax rates.
The taxable equivalent yields for the Municipal Money Market and Municipal
Bond Portfolios for the seven days ended December 31, 1996 assuming a Federal
income tax rate of 39.6% (maximum rate), were 5.60% and 6.44%, respectively. The
taxable equivalent effective yields for the Municipal Money Market and Municipal
Bond Portfolios for the seven days ended December 31, 1996, assuming the same
tax rate, were 5.68% and 6.57%, respectively.
37
<PAGE>
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.
(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) CS First Boston High Yield Index -- generally includes over 180 issues
with an average maturity range of seven to ten years with a minimum
capitalization of $100 million. All issues are individually trader-priced
monthly.
(f) CS First Boston Upper/Middle Tier High Yield Index -- an unmanaged index
of bonds rated B to BBB.
(g) 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.
(h) 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).
(i) Indata Balanced-Median Index -- an unmanaged index and includes an asset
allocation of 2.5% cash, 38.2% bonds and 59.3% equity based on $52.6 billion in
assets among 579 portfolios for the year ended December 31, 1996 (assumes
dividends reinvested).
(j) Indata Equity-Median Stock Index -- an unmanaged index which includes an
average asset allocation of 7.4% cash and 92.6% equity based on $464.9 billion
in assets among 1,277 portfolios for the year ended December 31, 1996.
(k) 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.
(l) J.P. Morgan Emerging Markets Bond Index Plus -- expanding on the J.P.
Morgan Emerging Markets Bond Index, which only trades Brady Bonds, this index
reflects total returns for external debt instruments which have been traded in
emerging markets. Brady Bonds are included amoung such instruments, as well as
Eurobonds, loans and U.S. dollar
38
<PAGE>
denominated local market instruments. Countries included in the index are
Argentina, Brazil, Bulgaria, Ecuador, Mexico, Morocco, Nigeria, Panama, Peru,
the Phillipines, Poland, Russia, South Africa 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 China Free
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
America 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.
(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 2000 Growth Index -- comprised of those Russell 2000 Securities
with an above-average growth orientation. Here, securities tend to exhibit
higher price-to-book and price-earnings ratios, lower divided yeilds and higher
forecasted growth than the Value universe.
(ee) 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.
(ff) Salomon Brothers GNMA Index -- includes pools of mortgages originated
by private lenders and guaranteed by the mortgage pools of the Government
National Association.
(gg) 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.
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(hh) 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.
(ii) 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.
(jj) 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.
(kk) 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 PERFORMANCE INFORMATION
Each Portfolio's performance will fluctuate, unlike bank deposits or other
investments which pay a fixed yield for a stated period of time. Past
performance is not necessarily indicative of future return. Actual performance
will depend on such variables as portfolio quality, average portfolio maturity,
the type of portfolio instruments acquired, changes in interest rates, portfolio
expenses and other factors. Performance is one basis investors may use to
analyze a Portfolio as compared to other funds and other investment vehicles.
However, performance of other funds and other investment vehicles may not be
comparable because of the foregoing variables, and differences in the methods
used in valuing their portfolio instruments, computing net asset value and
determining performance.
From time to time, a Portfolio's performance may be compared to other mutual
funds tracked by financial or business publications and periodicals. For
example, a Portfolio may quote Morningstar, Inc. in its advertising materials.
Morningstar, Inc. is a mutual fund rating service that rates mutual funds on the
basis of risk-adjusted performance. Rankings that compare the performance of the
Funds to one another in appropriate categories over specific periods of time may
also be quoted in advertising.
Portfolio advertising may include data on historical returns of the capital
markets in the United States compiled or published by Ibbotson Associates of
Chicago, Illinois ("Ibbotson"), including returns on common stocks, small
capitalization stocks, long-term corporate bonds, intermediate-term government
bonds, long-term government bonds, Treasury bills, the U.S. rate of inflation
(based on the Consumer Price Index), and combinations of various capital
markets. The performance of these capital markets is based on the returns of
different indices. The Portfolios may use the performance of these capital
markets in order to demonstrate general risk-versus-reward investment scenarios.
Performance comparisons may also include the value of a hypothetical investment
in any of these capital markets. The risks associated with the security types in
any capital market may or may not correspond directly to those of the
Portfolios. The Portfolios may also compare their performance to that of other
compilations or indices that may be developed and made available in the future.
The Portfolios may include in advertisements, charts, graphs or drawings
which illustrate the potential risks and rewards of investment in various
investment vehicles, including but not limited to, foreign securities, stocks,
bonds, treasury bills and shares of a Portfolio. In addition, advertisements may
include a discussion of certain attributes or benefits to be derived by an
investment in a Portfolio and/or other mutual funds, shareholder profiles and
hypothetical investor scenarios, timely information on financial management, tax
and retirement planning and various investment alternatives. Advertisements may
include lists of representative Morgan Stanley clients. The Portfolios may also
from time to time include discussions or illustrations of the effects of
compounding in advertisements. "Compounding" refers to the fact that, if
dividends or other distributions on a Portfolio investment are reinvested by
being paid in additional Portfolio shares, any future income or capital
appreciation of a Portfolio would increase the value, not only of the original
investment in the Portfolio, but also of the additional Portfolio shares
received through reinvestment.
The Portfolios may include in its advertisements, discussions or
illustrations of the potential investment goals of a prospective investor
(including materials that describe general principles of investing, such as
asset allocation, diversification, risk tolerance, goal setting, questionnaires
designed to help create a personal financial profile, worksheets used to project
savings needs based on assumed rates of inflation and hypothetical rates of
return and action plans offering investment alternatives), investment management
techniques, policies or investment suitability of a Portfolio (such as value
investing, market timing, dollar cost averaging, asset allocation, constant
ratio transfer, automatic account rebalancing, the advantages and disadvantages
of investing in tax-deferred and taxable investments). Advertisements and sales
materials relating to a Portfolio may include information regarding the
background and experience of its portfolio managers; the resources, expertise
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and support made available to the portfolio managers by Morgan Stanley; and the
portfolio manager's goals, strategies and investment techniques.
The Portfolios' advertisements may discuss economic and political conditions
of the United States and foreign countries, the relationship between sectors of
the U.S., a foreign, or the global economy and the U.S., a foreign, or the
global economy as a whole and the effects of inflation. The Portfolios may
include discussions and illustrations of the growth potential of various global
markets including, but not limited to, Africa, Asia, Europe, Latin America,
North America, South America, Emerging Markets and individual countries. These
discussions may include the past performance of the various markets or market
sectors; forecasts of population, gross national product and market performance;
and the underlying data which supports such forecasts. From time to time,
advertisements, sales literature, communications to shareholders or other
materials may summarize the substance of information contained in the
Portfolios' shareholder reports (including the investment composition of a
Portfolio), as well as the views of Morgan Stanley as to current market,
economic, trade and interest rate trends, legislative, regulatory and monetary
developments, investment strategies and related matters believed to be of
relevance to a Portfolio.
The Portfolios may quote various measures of volatility and benchmark
correlation in advertising. The Portfolios may compare these measures to those
of other funds. Measures of volatility seek to compare the historical share
price fluctuations or total returns to those of a benchmark. Measures of
benchmark correlation indicate how valid a comparative benchmark may be.
Measures of volatility and correlation may be calculated using averages of
historical data. A Portfolio may also advertise its current interest rate
sensitivity, duration, weighted average maturity or similar maturity
characteristics.
The Portfolio may advertise examples of the effects of periodic investment
plans, including the principle of dollar cost averaging. In such a program, an
investor invests a fixed dollar amount in a Portfolio at periodic intervals,
thereby purchasing fewer shares when prices are high and more shares when prices
are low. While such a strategy does not assure a profit or guard against loss in
a declining market, the investor's average cost per share can be lower than if
fixed numbers of shares are purchased at the same intervals. In evaluating such
a plan, investors should consider their ability to continue purchasing shares
during periods of low price levels.
GENERAL INFORMATION
DESCRIPTION OF SHARES AND VOTING RIGHTS
The Fund's Articles of Incorporation, as amended and restated, permit the
Directors to issue 36 billion shares of common stock, par value $.001 per share,
from an unlimited number of classes ("Portfolios") of shares. Currently the Fund
consists of shares of thirty Portfolios (the China Growth, Mortgage-Backed
Securities and MicroCap 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 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.
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CUSTODY ARRANGEMENTS
Chase is the Fund's custodian for domestic and certain foreign assets. 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.
ADVISER'S USE OF COMPANIES COMPRISING THE S&P 500 INDEX
The Adviser uses the 500 companies included in the S&P 500 Index as the
universe of potential investments for the U.S. Equity Plus Portfolio. The U.S.
Equity Plus Portfolio is not sponsored, endorsed, sold or promoted by Standard &
Poor's, a division of The McGraw-Hill Companies, Inc. ("S&P"). S&P makes no
representation or warranty, express or implied, to investors in the U.S. Equity
Plus Portfolio or any member of the public regarding the advisability of
investing in the U.S. Equity Plus Portfolio or the ability of the S&P 500 Index
to track general stock market performance. S&P's only relationship to the
Adviser is the licensing of certain trademarks and trade names of S&P and of the
S&P 500 Index which is determined, composed and calculated by S&P without regard
to the Adviser or the U.S. Equity Plus Portfolio. S&P has no obligation to take
the needs of the Adviser or the investors in the U.S. Equity Plus Portfolio into
consideration in determining, composing or calculating the S&P 500 Index. S&P is
not responsible for, does not participate in and has no obligation or liability
in connection with the management, administration or marketing of the U.S.
Equity Plus Portfolio.
S&P DOES NOT GUARANTEE THE ACCURACY AND/OR COMPLETENESS OF THE S&P 500 INDEX
OR ANY DATA INCLUDED THEREIN AND S&P SHALL HAVE NO LIABILITY FOR ANY ERRORS,
OMISSIONS OR INTERRUPTIONS THEREIN. S&P MAKES NO WARRANTY, EXPRESS OR IMPLIED,
AS TO THE PERFORMANCE OF THE ADVISER OR THE U.S. EQUITY PLUS PORTFOLIO, AND
EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A
PARTICULAR PURPOSE OR USE WITH RESPECT TO THE S&P 500 INDEX OR ANY DATA
INCLCUDED THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL S&P
HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES
(INCLUDING LOST PROFITS) ARISING OUT OF ANY USE OF THE S&P 500 INDEX OR ANY DATA
INCLUDED THEREIN, EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.
DESCRIPTION OF RATINGS
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 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.
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EXCERPTS FROM S&P'S 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.
FINANCIAL STATEMENTS
The Fund's financial statements for the fiscal year ended December 31, 1996,
including notes thereto and the report of Price Waterhouse LLP are herein
incorporated by reference from the Fund's Annual report. A copy of the Fund's
Annual Report to Shareholders must accompany the delivery of this Statement of
Additional Information.
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