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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 Stanley VICE PRESIDENT
Asset Management Limited; Managing Harold J. Schaaff,
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 & Co. Karl O. Hartmann
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.
FIXED INCOME PORTFOLIO
FIRST QUARTER REPORT
MARCH 31, 1997
<PAGE>
LETTER TO SHAREHOLDERS
- -------
The Fixed Income Portfolio invests primarily in a diversified portfolio of U.S.
Government securities, corporate bonds (including competitively priced
Eurodollar bonds), mortgage-backed securities and other fixed income securities.
Targeted rates of return for the Portfolio are based on current and projected
market and economic conditions and on a conservative investment management
approach.
For the three months ended March 31, 1997, the Portfolio had a total return of
- -0.48% for the Class A shares and -0.43% for the Class B shares as compared to a
total return of -0.56% for the Lehman Aggregate Bond Index. The average annual
total return for the one year and five year periods ended March 31, 1997 and for
the period from inception on May 15, 1991 through March 31, 1997 was 5.79%,
7.38% and 7.90%, respectively, for the Class A shares as
PERFORMANCE COMPARED TO THE LEHMAN AGGREGATE BOND INDEX(1)
- ----------------------------------------------------
<TABLE>
<CAPTION>
TOTAL RETURNS(2)
----------------------------------------------------
AVERAGE AVERAGE
ANNUAL ANNUAL
ONE FIVE SINCE
YTD YEAR YEARS INCEPTION
--------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
PORTFOLIO--CLASS A....... -0.48% 5.79% 7.38% 7.90%
PORTFOLIO--CLASS B(3).... -0.43 5.68 NA 3.13
INDEX.................... -0.56 4.91 7.07 7.85
</TABLE>
1. The Lehman Aggregate Bond Index is an unmanaged index made up of the
Government/Corporate Index, the Mortgage-Backed Securities Index and the
Asset-Backed Securities Index.
2. Total returns for the Portfolio reflect expenses waived and reimbursed, if
applicable, by the Adviser. Without such waiver and reimbursement, total
returns would be lower.
3. The Portfolio began offering Class B shares on January 2, 1996.
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
- ------------------------------
THE PERFORMANCE RESULTS PROVIDED ARE FOR INFORMATIONAL PURPOSES ONLY AND SHOULD
NOT BE CONSTRUED AS A GUARANTEE OF THE PORTFOLIO'S FUTURE PERFORMANCE. PAST
PERFORMANCE SHOWN IS NOT PREDICTIVE OF FUTURE PERFORMANCE. INVESTMENT RETURN AND
PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY
BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. YIELDS WILL FLUCTUATE AS MARKET
CONDITIONS CHANGE.
compared to 4.91%, 7.07% and 7.85%, respectively, for the Index. As of March 31,
1997, the Portfolio had an SEC 30-day yield of 6.56% for the Class A shares and
6.39% for the Class B shares.
The fixed income markets began 1997 on a weak note, producing negative total
returns over the first quarter. With bond yields rising roughly 50 basis points
over the quarter, the Lehman Aggregate Bond Index returned -0.56% and the Lehman
Government/Corporate Index returned -0.86% for the quarter.
While not a pattern when viewed over larger periods of history, negative returns
in the first quarter of the year have been quite common recently, occurring in
three of the past four years and four of the past six years.
The bond market's performance over the first quarter can be divided into two
distinct periods. In the first part of the quarter, interest rates fluctuated
within a relatively narrow range as the market focused on the same growth versus
inflation issues that it had in 1996. While economic growth appeared to be
solid, there were virtually no signs of current inflation. Debate thus focused
on whether the classical view that full resource utilization in a rapidly
growing economy would eventually lead to inflation was still valid or whether
fundamental changes had taken place in the economy such that higher growth
levels could be achieved without raising inflationary pressures.
The pivotal event in reshaping this debate was Federal Reserve Chairman
Greenspan's Humphrey Hawkins testimony before Congress in late February. The Fed
Chairman made clear that the Federal Reserve would act preemptively in
tightening monetary policy if it perceived the risk of inflationary imbalances
developing in the economy, even if current inflation measures were favorable.
Given current levels of economic growth and resource utilization, the perception
of such risk was increasingly present and interest rates, which had been roughly
at the same level at which they started the quarter, began to rise sharply.
2
<PAGE>
The rise in interest rates was further supported by a series of strong economic
reports. Indicators of consumer demand such as retail sales and housing activity
were particularly strong. In response to the strength in the economy and the
concerns Chairman Greenspan had previously expressed, the Fed raised interest
rates at its scheduled meeting in late March. Overall, rates rose roughly 50
basis points over the quarter, with the yield curve flattening moderately in the
process. Market participants will now focus on whether the Fed tightening was a
one-time event that will prove sufficient in moderating the economy or merely
the first in a series of tightening moves. While the strength of the economy
will ultimately determine the outcome, history would support the latter view.
From a sector standpoint, despite some widening in spreads in March, the
non-Treasury sectors produced another quarter of relatively strong performance
as yield spreads tightened sharply in January and February. Strong investor
demand for yield spread product, which had been evident throughout 1996,
continued into early 1997. Solid broad-based credit fundamentals supported the
corporate bond sector while declining market volatility contributed to the
richening of mortgage-backed securities. While these fundamentals remained in
place in March, spreads began to widen as concern with Fed tightening increased
investor focus on duration decisions and reduced investor focus on the spread
sectors. In addition, because the Fed tightening in 1994 was temporarily
associated with wider spreads in a number of sectors, investors have become
somewhat more cautious about increasing their exposure to spread sectors at
present.
After strongly outperforming the U.S. bond market in 1996, foreign bond markets
turned in a more mixed performance relative to the U.S. market in the first
quarter. While most major foreign bond markets continued to outperform the U.S.
on a currency hedged basis (for example, ten-year German bond yields rose only
marginally on the quarter), there were several exceptions. Moreover, Japan was
the only country in which yields actually fell on the quarter.
FIRST QUARTER STRATEGY REVIEW
Our strategy emphasis during the first quarter remained one of identifying
attractive sector and security specific opportunities. Having added to our
corporate holdings in the fourth quarter of 1996, we maintained this
overweighting during the first quarter of 1997. Within the corporate sector, we
continued to find bank capital securities attractively valued relative to other
segments of the market. We also maintained an overweighting in mortgage-backed
securities. Our emphasis in this sector has been on segments of the market with
more favorable convexity characteristics such as discount and seasoned
mortgage-backed securities. In terms of interest rate risk, our durations were
slightly short of benchmark to start the quarter, but we viewed a neutral
position to be more appropriate as the quarter progressed. At quarter-end, our
durations were roughly equal to our benchmark. Finally, we maintained a
weighting in hedged foreign bonds with a position in German Government notes.
SECOND QUARTER OUTLOOK
We begin the second quarter basically neutral in duration to our benchmark.
While the interest rate trend continues to be one of rising rates, market
valuation in terms of real interest rates is too attractive to justify a short
duration position. We are not prepared to extend duration, however, until there
is a change in market trend. Sector opportunities thus continue to be our
primary focus. Our sector positions are little changed from earlier in the first
quarter. While we are not complacent, given the recent spread widening, history
suggests that the corporate sector only underperforms significantly during
periods of recession, a scenario that is not likely over the next six months. We
therefore view the recent weakness in spreads as potentially presenting some
opportunities to add attractive securities at favorable market levels. Finally,
we expect to continue our use of hedged foreign bonds at current valuation
levels.
Warren Ackerman, III
PORTFOLIO MANAGER
April 1997
3
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INVESTMENTS (UNAUDITED)
- ----------
MARCH 31, 1997
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------- ---------
<C> <S> <C>
FIXED INCOME SECURITIES (89.8%)
U.S. GOVERNMENT AND AGENCY OBLIGATIONS (51.2%)
U.S. TREASURY BOND (2.5%)
$ 3,000 8.125%, 8/15/19 $ 3,292
---------
U.S. TREASURY NOTES (13.2%)
10,000 6.25%, 5/31/00 9,887
7,500 7.25%, 8/15/04 7,649
---------
17,536
---------
FEDERAL HOME LOAN MORTGAGE CORPORATION (0.0%)
10 13.00%, 9/01/10 11
---------
FEDERAL NATIONAL MORTGAGE ASSOCIATION (24.1%)
4,545 6.00%, 9/01/10 4,293
5,478 6.00%, 2/01/11 5,174
3,722 7.00%, 3/01/11 3,664
3,810 6.00%, 5/01/11 3,598
7,000 6.50%, 4/01/12 6,731
9,065 6.50%, 4/01/24 8,514
---------
31,974
---------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (11.4%)
7,483 6.00%, 2/15/24 6,757
8,698 7.00%, 5/15/24 8,337
---------
15,094
---------
TOTAL U.S. GOVERNMENT AND AGENCY OBLIGATIONS 67,907
---------
FOREIGN GOVERNMENT AND AGENCY OBLIGATIONS (9.4%)
BONDS (9.4%)
DEM 11,000 Deutschland Republic, Series 1996,
6.00%, 2/16/06 6,650
$ 6,000 Republic of Poland, 'Euro',
(Floating Rate), 6.50%, 10/27/24 5,865
---------
TOTAL FOREIGN GOVERNMENT AND AGENCY OBLIGATIONS
12,515
---------
CORPORATE BONDS AND NOTES (23.8%)
BROADCAST-RADIO & TELEVISION (1.7%)
2,500 News America Holdings 7.75%,
12/01/45 2,242
---------
FINANCE (21.3%)
2,000 Bankers Trust Capital, Series A,
7.90%, 1/15/27 1,882
2,000 First Chicago 7.75%, 12/01/26 1,862
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------- ---------
<C> <S> <C>
$ 3,500 Ford Motor Credit Co. 6.25%,
11/08/00 $ 3,415
5,000 General Motors Acceptance Corp.
7.375%, 6/22/00 5,055
3,000 Goldman Sachs Group 6.25%, 2/01/03 2,850
2,000 Home Ownership Funding, Series 2,
1/01/01 1,927
3,000 Lehman Brothers Holdings, Inc.
7.25%, 4/15/03 2,940
2,000 Liberty Mutual 7.875%, 10/15/26 1,904
2,500 Lumbermens Mutual Casualty Co.,
Series AI, 9.15%, 7/01/26 2,608
1,500 Travelers Capital, Series III,
7.625%, 12/01/36 1,415
2,500 USF&G Capital Corp., Series 1,
8.50%, 12/15/45 2,467
---------
28,325
---------
MATERIALS (0.8%)
1,000 Reliance Industries Ltd. 10.25%,
1/15/69 1,007
---------
TOTAL CORPORATE BONDS AND NOTES 31,574
---------
ASSET BACKED SECURITIES (5.4%)
11 Federal National Mortgage
Association, 92-59F, REMIC,
(Floating Rate), 6.056%, 8/25/06 11
3,070 Resolution Trust Corp., Series
1991-M5, Class A, 9.00%, 3/25/17 3,086
4,000 Standard Credit Card Trust 6.75%,
6/07/00 4,015
---------
TOTAL ASSET BACKED SECURITIES 7,112
---------
TOTAL FIXED INCOME SECURITIES (Cost $120,239) 119,108
---------
SHORT-TERM INVESTMENT (14.0%)
REPURCHASE AGREEMENT (14.0%)
18,640 Chase Securities, Inc. 6.00%,
dated 3/31/97, due 4/01/97, to be
repurchased at $18,643,
collateralized by U.S. Treasury
Notes, 6.125%, due 8/31/98,
valued at $19,032 (Cost $18,640) 18,640
---------
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
VALUE
(000)
---------
<C> <S> <C>
TOTAL INVESTMENTS (103.8%) (Cost $138,879) $ 137,748
---------
OTHER ASSETS AND LIABILITIES (-3.8%)
Other Assets 8,799
Liabilities (13,861)
---------
(5,062)
---------
NET ASSETS (100%) $ 132,686
---------
---------
CLASS A:
NET ASSETS $131,229
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 12,597,307 outstanding $0.001 par
value shares (authorized 500,000,000 shares) $10.42
---------
---------
CLASS B:
NET ASSETS $1,457
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 139,718 outstanding $0.001 par value
shares (authorized 500,000,000 shares) $10.43
---------
---------
</TABLE>
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DEM -- Deutsche Mark
Floating Rate -- Interest rate changes on these instruments are based on changes
in a designated base rate. The rates shown are those in effect on March 31,
1997.
REMIC -- Real Estate Mortgage Investment Conduit
5
