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<TABLE>
<S> <C>
DIRECTORS OFFICERS
Barton M. Biggs James W. Grisham
CHAIRMAN OF THE BOARD VICE PRESIDENT
Chairman and Director, Morgan Stanley Michael F. Klein
Asset Management Inc. and Morgan VICE PRESIDENT
Stanley Asset Management Limited; Harold J. Schaaff,
Managing Director, Morgan Stanley & Co. Jr.
Incorporated; Director, Morgan Stanley VICE PRESIDENT
Group Inc. Joseph P. Stadler
Warren J. Olsen VICE PRESIDENT
DIRECTOR AND PRESIDENT Valerie Y. Lewis
Principal, Morgan Stanley Asset SECRETARY
Management Inc. and Morgan Stanley & Karl O. Hartmann
Co. Incorporated ASSISTANT SECRETARY
John D. Barrett II James R. Rooney
Chairman and Director, TREASURER
Barrett Associates, Inc. Joanna M. Haigney
Gerard E. Jones ASSISTANT TREASURER
Partner, Richards & O'Neil LLP
Andrew McNally IV
Chairman and Chief Executive Officer,
Rand McNally
Samuel T. Reeves
Chairman of the Board and CEO, Pinacle
L.L.C.
Fergus Reid
Chairman and Chief Executive Officer,
LumeLite Corporation
Frederick O. Robertshaw
Of Counsel, Bryan, Cave LLP
</TABLE>
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INVESTMENT ADVISER AND ADMINISTRATOR
Morgan Stanley Asset Management Inc.
1221 Avenue of the Americas
New York, New York 10020
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DISTRIBUTOR
Morgan Stanley & Co. Incorporated
1251 Avenue of the Americas
New York, New York 10020
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CUSTODIANS
The Chase Manhattan Bank
770 Broadway
New York, New York 10003
Morgan Stanley Trust Company
One Pierrepont Plaza
Brooklyn, New York 11210
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LEGAL COUNSEL
Morgan, Lewis & Bockius LLP
2000 One Logan Square
Philadelphia, Pennsylvania 19103
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INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York 10036
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For current performance, current net asset value, or for assistance with your
account, please contact the Fund at (800) 548-7786. This report is authorized
for distribution only when preceded or accompanied by prospectuses of the
Morgan Stanley Institutional Fund, Inc.
[LOGO] MORGAN STANLEY
INSTITUTIONAL FUND, INC.
P.O. Box 2798
Boston, MA 02208-2798
[LOGO] MORGAN STANLEY
INSTITUTIONAL FUND, INC.
INTERNATIONAL SMALL CAP PORTFOLIO
FIRST QUARTER REPORT
MARCH 31, 1997
<PAGE>
LETTER TO SHAREHOLDERS
- -------
The International Small Cap Portfolio seeks long-term capital appreciation by
investing primarily in the equity securities of non-U.S. issuers. The Portfolio
applies a disciplined bottom-up value approach to identify and invest in small
capitalization companies which are both attractive businesses and available at
cheap prices. A market capitalization cut-off of U.S. $1 billion is used as our
definition of "small."
For the three months ended March 31, 1997, the Portfolio had a total return of
3.62% as compared to a total return of -1.57% for the Morgan Stanley Capital
International (MSCI) EAFE Index. The average annual total return for the one
year ended March 31, 1997 and for the period from inception on December 15, 1992
through March 31, 1997 was 11.29% and 16.37%, respectively, for the Portfolio as
compared to 1.46% and 12.45%, respectively, for the Index.
PERFORMANCE COMPARED TO THE MORGAN STANLEY CAPITAL INTERNATIONAL (MSCI) EAFE
INDEX(1)
- ----------------------------------------------------
<TABLE>
<CAPTION>
TOTAL RETURNS(2)
---------------------------------------
ONE AVERAGE ANNUAL
YTD YEAR SINCE INCEPTION
--------- --------- -----------------
<S> <C> <C> <C>
PORTFOLIO....................... 3.62% 11.29% 16.37%
INDEX........................... -1.57 1.46 12.45
</TABLE>
1. The MSCI EAFE Index is an unmanaged index of common stocks and includes
Europe, Australasia and the Far East (includes dividends net of withholding
taxes).
2. Total returns for the Portfolio reflect expenses waived and reimbursed, if
applicable, by the Adviser. Without such waiver and reimbursement, total
returns would be lower.
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
- ------------------------------
THE COUNTRY SPECIFIC PERFORMANCE RESULTS PROVIDED ARE AS MEASURED BY THE MSCI
EAFE INDEX AND ARE FOR INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE CONSTRUED
AS A GUARANTEE OF THE PORTFOLIO'S FUTURE PERFORMANCE. PAST PERFORMANCE SHOWN IS
NOT PREDICTIVE OF FUTURE PERFORMANCE. INVESTMENT RETURN AND PRINCIPAL VALUE WILL
FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS
THAN THEIR ORIGINAL COST. PLEASE SEE THE PROSPECTUS FOR A DESCRIPTION OF CERTAIN
RISK CONSIDERATIONS ASSOCIATED WITH INTERNATIONAL INVESTING.
The Portfolio's outperformance reflected the Portfolio's underweighting in the
weak Japanese and South East Asian markets, together with strong stock selection
across almost all markets, but most notably in France and Japan. However, the
significant strength of the U.S. dollar against almost all the EAFE market
currencies bar the Japanese yen, negatively impacted performance as did poor
relative stock selection in Hong Kong and Germany.
The first quarter saw strong performance from the core European and Scandinavian
equity markets, driven by the strength of the export-related capital intensive
companies on the back of the U.S. dollar strength. The U.K. market saw more
modest gains given sterling strength relative to the other European currencies
and its negative impact on relative competitiveness.
In contrast, the Far Eastern markets were notably weak. Japan remained a
distinctly two tier market with the blue chip export stocks continuing to
benefit from yet further yen weakness, while domestic and particularly small cap
names were weak given concern over the impact of restrained public spending and
the likely negative impact of the increase in the consumption tax. Hong Kong was
also particularly weak, worried by the likely impact of a hike in U.S. interest
rates on the heated residential property market.
Portfolio activity was quite high as we sold Kuoni, in Switzerland, Pico Far
East in Hong Kong, Avonmore in Ireland, Berentzen in Germany and L'Espresso in
Italy-- all of which had reached our assessed fair value. The proceeds were
invested in a number of new positions.
Clondalkin in Ireland is an international manufacturer of a wide range of print
and packaging products with strong market shares in a host of niche areas.
Clandalkin is highly free cash generative and is set to continue to grow at a
mid-teens rate from a combination of strong organic growth and value enhancing
acquisitions. Purchased on 10 times cash flow and 12 times free cash flow, the
shares are cheap given these prospects.
Skilled Engineering, the leading skilled labor hire company in Australia, is
well placed to benefit from the significant trend to outsource both within the
private and public sectors and is clearly leveraged to a recovery
2
<PAGE>
in the Australian economy across a broadly diversified spread of industries.
What attracts us to the company is its extremely attractive cash flow dynamics
and growth prospects. On 11 times free cash flow, the shares offer attractive
value.
Devro is the world's leading manufacturer of edible and non-edible food casings
with dominant positions in Australia, New Zealand, the U.K. and U.S. Cash flow
generation is extremely strong due to high margins as a result of high
technological barriers to entry and management is extremely competent with a
clear vision for the future. Cash flow should grow steadily due to margin
improvement at the recently acquired Teepak operations combined with top line
growth from new markets and market share gains. Purchased on 10 times cash flow
the shares represent attractive value for a franchise of this quality.
ICS is a world leader in safety and control systems which has made a number of
acquisitions recently which are steadily being turned around. Importantly, ICS
is growing its recurrent revenues through customer services. Given the expected
growth in coming years, ICS is selling on an unjustified discount both to the
market and to recent transaction values in its industry.
Looking forward we expect only modest changes in the Portfolio's geographic mix.
Given the massive underpeformance of Japan's small cap sector we believe some
value is now emerging but we will remain cautious given the pressing need for
deregulation which will hurt the majority of Japanese companies. That said it is
worth noting that the negative impact of the rise in the consumption tax is
likely to be short-lived as workers are enjoying real income growth. Volume
demand is reasonable. Pricing is the real problem for corporate profits.
Elsewhere, we continue to find attractive value in the small cap sector. This is
particularly notable given the relative paucity of value in the large cap
sector. Although eyes remain glued to evidence of inflationary pressures in the
U.S. and thus further likely moves in U.S. interest rates, evidence of such
pressures across Europe are slim with the possible exceptions of the Netherlands
and U.K. Domestic demand in France and Germany remains weak given the squeeze on
public sector wages and widespread job insecurity as industry restructures.
Attractive value is particularly evident in the U.K. following a fairly
indiscriminate sell off of sterling-related stocks.
Margaret Naylor
PORTFOLIO MANAGER
January 1997
3
<PAGE>
INVESTMENTS (UNAUDITED)
- ----------
MARCH 31, 1997
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- --------------- -------
<C> <S> <C>
COMMON STOCKS (88.8%)
AUSTRALIA (10.4%)
122,830 Arnotts Ltd. $ 834
477,715 Auspine Ltd. 1,180
990,079 Bains Harding Ltd. 287
549,582 BRL Hardy Ltd. 1,379
856,800 Burswood Property Trust 934
2,458,218 Country Road Ltd. 3,199
4,422,291 E.R.G. Ltd. 5,963
475,450 Morgan & Banks Ltd. 2,646
6,311,180 Parbury Ltd. 3,958
950,000 Skilled Engineering Ltd. 2,517
1,721,500 Solution 6 Holdings Ltd. 985
699,748 W.D. & H.O. Wills Holdings Ltd. 1,125
-------
25,007
-------
DENMARK (1.7%)
6,750 Jyske Bank A/S (Registered) 540
76,230 SYD-Sonderjylland Holdings 3,683
-------
4,223
-------
FINLAND (5.8%)
39,880 Aamulehti Yhtymae Oy, Series II 1,297
125,000 Amer-Yhtymae Oy, Class A 2,600
54,500 KCI Konecranes International 2,146
48,100 Kone Oy, Class B 5,896
314,100 Oy Tamro AB 2,036
-------
13,975
-------
FRANCE (7.1%)
37,576 Dauphin O.T.A. 2,918
74,415 De Dietrich et Compagnie S.A. 3,605
59,575 Europeene d'Extincteurs 4,679
92,400 Legris Industries S.A. 4,266
78,857 Sediver S.A. 1,596
-------
17,064
-------
GERMANY (3.9%)
49,850 Duerr AG 1,889
107,600 Gerresheimer Glas AG 2,193
57,200 Marseille-Kliniken AG 1,252
11,303 Sinn AG 1,999
12,060 Varta AG 2,078
-------
9,411
-------
HONG KONG (2.3%)
1,754,000 Chen Hsong Holdings 951
1,097,000 Jardine International Motor
Holdings Ltd. 1,359
<CAPTION>
VALUE
SHARES (000)
- --------------- -------
<C> <S> <C>
1,106,000 Li & Fung Ltd. $ 913
6,542,000 Vitasoy International Holdings
Ltd. 2,301
-------
5,524
-------
IRELAND (2.6%)
246,024 Anglo Irish Bank Corp. plc 312
169,700 Clondalkin Group plc 1,627
955,274 Green Property plc 4,391
-------
6,330
-------
ITALY (1.9%)
580,000 Sogefi S.p.A. 1,304
787,000 Unicem Di Risp (NCS) 2,351
81,000 Vincenzo Zucchi S.p.A. 352
212,500 Vincenzo Zucchi S.p.A. (NCS) 529
-------
4,536
-------
JAPAN (9.8%)
15,000 Exedy Corp. 158
231,000 Foster Electric Co., Ltd. 859
463,000 Hankyu Realty 3,295
742,000 Japan Oil Transportation 2,503
213,000 Japan Vilene Co., Ltd. 794
134,000 Kansei Corp. 955
388,000 Kirin Beverage Corp. 5,021
136,000 Nifco, Inc. 1,177
446,250 Nissan Fire & Insurance Co. 1,740
45,000 Sangetsu Co., Ltd. 783
549,000 Toc Co. 5,329
170,000 Toyoda Gosei Co. 1,024
-------
23,638
-------
NETHERLANDS (6.7%)
38,380 Ahrend Groep N.V. 2,453
73,900 Apothekers Cooperatie OPG 2,266
31,040 Atag Holding N.V. 1,738
27,916 Hollandsche Beton Groep N.V. 6,371
53,730 Koninklijke Van Ommeren N.V. 2,349
8,802 Polynorm N.V. 751
4,122 Samas Groep N.V. 180
-------
16,108
-------
NEW ZEALAND (1.0%)
687,853 Fisher & Paykel Industries Ltd. 2,461
-------
NORWAY (2.5%)
73,850 Adelsten ASA, Class B 1,847
103,000 Kverneland ASA 3,412
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- --------------- -------
<C> <S> <C>
NORWAY (CONTINUED)
228,020 Oceanor $ 674
-------
5,933
-------
SINGAPORE (0.5%)
475,000 GP Batteries International Ltd. 1,297
-------
SPAIN (3.5%)
80,000 Bodegas y Bebidas S.A. 2,132
92,775 Empresa Nacional Hidroelectrica
del Ribagorzana S.A., Class B 2,210
39,700 Gas y Electricidad S.A. 2,068
48,550 Miquel y Costas & Miquel S.A. 1,935
-------
8,345
-------
SWEDEN (1.8%)
108,700 Marieberg Tidnings AB 2,974
71,100 Scandic Hotels AB 1,294
-------
4,268
-------
SWITZERLAND (8.9%)
2,600 Bobst AG (Bearer) 3,839
4,967 Bucher Holdings AG (Bearer) 4,245
9,800 Edipresse S.A. (Bearer) 2,254
2,750 LEM Holdings AG 587
4,575 Magazine Globus (Participating
Certificates) 2,003
4,450 Porst Holding AG (Bearer) 581
14,200 Publicitas Holding S.A.
(Registered) 2,560
2,865 Schweizerische Industrie-
Gesellschaft Holdings AG
(Registered) 3,543
2,550 Zellweger Luwa AG (Bearer) 1,905
-------
21,517
-------
UNITED KINGDOM (18.4%)
4,226,947 Anglo Irish Bank Corp. plc
(British Pound Shares) 5,354
1,211,900 Bluebird Toys plc 3,877
1,354,600 BSM Group plc 3,398
710,100 Corporate Services Group plc 2,354
612,800 Devro plc 3,054
2,540,850 Donelon Tyson plc --
1,782,600 GEI International plc 3,446
503,000 Industrial Control Services (ICS)
Group plc 1,117
426,289 International Business
Communications (Holdings) plc 2,254
1,584,212 John Mowlem & Co. plc 2,997
<CAPTION>
VALUE
SHARES (000)
- --------------- -------
<C> <S> <C>
33,795,100 Kendell plc $ 139
206,335 Mallett plc 297
2,682,000 Matthews (Bernard) plc 5,647
120,000 Northern Leisure plc 457
629,900 Oriflame International S.A. 5,285
2,659,393 Pentos plc --
667,000 Ricardo Group plc 1,498
1,895,000 Tandem Group plc 218
1,144,500 The 600 Group plc 2,429
541,700 Waterman Partnership Holdings plc 557
-------
44,378
-------
TOTAL COMMON STOCKS (Cost $199,210) 214,015
-------
PREFERRED STOCKS (5.1%)
GERMANY (5.1%)
10,923 Dyckerhoff AG 3,948
32,400 Hornbach Holding AG 2,127
8,550 STO AG-Vorzug 3,434
17,900 Spar Handels AG 259
16,000 Wuerttembergische
Metallwarenfabrik AG 2,475
-------
TOTAL PREFERRED STOCKS (Cost $11,647) 12,243
-------
<CAPTION>
NO. OF
WARRANTS
- ---------------
<C> <S> <C>
WARRANTS (0.0%)
SWITZERLAND (0.0%)
4,600 Zellweger Luwa AG, expiring
5/21/97, (Cost $0) 14
-------
<CAPTION>
FACE
AMOUNT
(000)
- ---------------
<C> <S> <C>
CONVERTIBLE DEBENTURE (0.2%)
ITALY (0.2%)
ITL 518,000 Mediobanca S.p.A. 5.50%, 1/01/00,
(Cost $328) 320
-------
TOTAL FOREIGN SECURITIES (94.1%) (Cost $211,185) 226,592
-------
FOREIGN CURRENCY (6.0%)
GBP 11 British Pound 18
DEM 23,713 Deutsche Mark 14,216
FIM 102 Finnish Markka 21
HKD 2,040 Hong Kong Dollar 263
ITL 22,143 Italian Lira 13
-------
TOTAL FOREIGN CURRENCY (Cost $14,465) 14,531
-------
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
VALUE
(000)
-------
<C> <S> <C>
TOTAL INVESTMENTS (100.1%) (Cost $225,650) $241,123
-------
OTHER ASSETS AND LIABILITIES (-0.1%)
Other Assets 18,819
Liabilities (18,991)
-------
(172)
-------
NET ASSETS (100%) $240,951
-------
-------
NET ASSET VALUE, OFFERING AND REDEMPTION PRICE PER
SHARE
Applicable to 13,819,318 outstanding $0.001 par
value shares (authorized 1,000,000,000 shares) $17.44
-------
-------
</TABLE>
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NCS -- Non Convertible Shares
6
