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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 Harold J. Schaaff,
Asset Management Inc. and Morgan Stanley Jr.
Asset Management Limited; Managing VICE PRESIDENT
Director, Morgan Stanley & Co. Joseph P. Stadler
Incorporated VICE PRESIDENT
Michael F. Klein Valerie Y. Lewis
DIRECTOR AND PRESIDENT SECRETARY
Principal, Morgan Stanley Asset Management Karl O. Hartmann
Inc. and Morgan Stanley & Co. Incorporated ASSISTANT SECRETARY
John D. Barrett II Joanna M. Haigney
Chairman and Director, TREASURER
Barrett Associates, Inc. Rene J. Feuerman
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 Chief Executive
Officer,
Pinacle Trading L.L.C.
Fergus Reid
Chairman and Chief Executive Officer,
LumeLite Corporation
Frederick O. Robertshaw
Of Counsel, Copple, Chamberlin &
Boehm, P.C.
</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
3 Chase MetroTech Center
Brooklyn, NY 11245
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
THIRD QUARTER REPORT
SEPTEMBER 30, 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 nine month and one year periods ended September 30, 1997, the Portfolio
had total returns of 6.62% and 9.92%, respectively, for Class A shares and 6.61%
and 9.79%, respectively, for Class B shares compared to 6.52% and 9.71%,
respectively, for the Lehman Aggregate Bond Index (the "Index"). For the five
year period ended September 30, 1997, the average annual total return for Class
A shares was 7.00% compared to 6.92% for the Index. From inception on May 15,
1991 to September 30, 1997, the average annual total return
PERFORMANCE COMPARED TO THE LEHMAN AGGREGATE BOND INDEX(1)
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<TABLE>
<CAPTION>
TOTAL RETURNS(2)
--------------------------------------------------
AVERAGE
AVERAGE ANNUAL
ONE ANNUAL SINCE
YTD YEAR FIVE YEARS INCEPTION
----- --------- ----------- -------------
<S> <C> <C> <C> <C>
PORTFOLIO--CLASS A............. 6.62% 9.92% 7.00% 8.42%
PORTFOLIO--CLASS B............. 6.61 9.79 N/A 6.30
INDEX--CLASS A................. 6.52 9.71 6.92 8.38
INDEX--CLASS B................. 6.52 9.71 N/A 5.83
</TABLE>
1. The Lehman Aggregate Bond Index is an unmanaged index comprised 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.
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.
for Class A shares was 8.42% compared to 8.38% for the Index. From inception on
January 2, 1996 to September 30, 1997, the average annual total return for Class
B shares was 6.30% compared to 5.83% for the Index.
As of September 30, 1997, the Portfolio had an SEC 30-day yield of 6.24% for the
Class A shares and 6.10% for the Class B shares.
The fixed income markets produced another quarter of solid returns as bond
yields ended the quarter roughly 40 basis points lower than where they started.
The Lehman Aggregate Bond Index returned 3.32% and the Lehman
Government/Corporate Index returned 3.50% for the third quarter. Combined with
strong performance during the prior three months, these returns represent the
best consecutive quarterly returns for these indices since the first half of
1995. For the first nine months of 1997 the Aggregate Index returned 6.52% and
the Government/Corporate Index was up 6.34%.
The driving force behind these favorable bond market returns has been the
exceptional behavior of the major inflation measures. While economic growth has
been relatively strong, no evidence of inflation has been present.
Year-over-year changes in the core Consumer Price Index continued at 30-year
lows, while the Producer Price Index extended its string of negative monthly
readings to seven, before finally registering a positive change. The Federal
Reserve responded favorably to this inflation environment by holding monetary
policy steady at its July, August and September meetings. While the Fed
continues to express concerns about the pace of growth, its actions and
statements have reinforced the view in the marketplace that the Fed will not
tighten without a deterioration in inflation measures.
In response to this stable Fed policy low inflation environment, interest rates
fell substantially over the quarter. There was, however, considerable volatility
on a month-to-month basis. Long bond yields fell almost 50 basis points in July,
before rising 30 basis points in August, only to fall 20 basis points in
September. In contrast to
2
<PAGE>
several recent periods in which strong economic growth caused rates to rise
sharply, signs of strong growth in the third quarter had only a moderate and
temporary impact on rates. Long rates fell more than short rates over the third
quarter, with the yield curve flattening by roughly 10 basis points. Long rates
have been more responsive to declining inflation expectations, while short rates
are limited by the 5.5% Federal Funds rate.
From a sector standpoint, the non-Treasury sectors turned in a mixed performance
versus Treasuries. The corporate market provided a marginal return advantage
over Treasuries during the third quarter, but selected portions of the sector
performed quite poorly. Spreads in the Yankee sector widened particularly
sharply over the quarter due to pressures in Southeast Asia. The mortgage-backed
sector also started to exhibit signs of weakness during the third quarter. As
declining interest rates raised prepayment concerns, the sector underper-
formed substantially in July. Although it recovered fully in August and
September, tight spreads appear to leave the sector vulnerable to a further
market rally.
As was the case in the second quarter, foreign bond markets turned in a mixed
performance relative to the U.S. bond market during the third quarter. With the
exception of Italy and the United Kingdom, the major European bond markets
lagged the strong performance of the U.S. On the other hand, the Japanese and
Canadian bond markets outperformed the U.S. bond market by large amounts over
the quarter.
We maintained a long duration position of .3 to .4 years relative to our
benchmarks throughout the third quarter. As measured by real interest rates,
bond market valuation has been attractive and the interest rate trend has been
generally favorable. We have been underweighted in the prepayment sensitive
segment of the mortgage-backed market based on their rich historical valuations
and have limited our mortgage pass-through holdings to those segments of the
market with more favorable convexity characteristics such as discount and
seasoned mortgages and seven year balloons. In addition, we continued to add to
our asset-backed holdings, where we have been able to add securities with an
attractive combination of quality, yield spread and convexity. We also added a
small position in GNMA adjustable rate mortgages based on attractive valuation
characteristics. Our Portfolio remains overweighted in corporate bonds. While
there were no major changes to our holdings from the prior quarter, we did add a
number of putable corporate bonds that help enhance the convexity of our
Portfolio. Finally, we eliminated our holdings in hedged German bonds during the
quarter, as political developments related to the European Monetary Union
increased the risks of this position relative to the potential rewards.
We begin the fourth quarter about .4 years longer in duration than our
benchmark. We will likely maintain this duration exposure until either the
falling interest rate trend changes or market valuations become unfavorable. We
remain overweighted in yield advantaged sectors, primarily the corporate and
asset-backed sectors. While we would not anticipate major changes to our sector
allocation at current valuation levels, spread volatility has increased of late
and we are prepared to respond should spread pressures emerge. In particular, we
would view a further rally that resulted in wider mortgage spreads as an
opportunity to increase exposure to this sector.
Warren Ackerman, III
PORTFOLIO MANAGER
October 1997
3
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INVESTMENTS (UNAUDITED)
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SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------- ---------
<C> <S> <C>
FIXED INCOME SECURITIES (94.7%)
U.S. GOVERNMENT AND AGENCY OBLIGATIONS (59.5%)
U.S. TREASURY BONDS (3.2%)
$ 5,000 6.25%, 8/15/23 $ 4,854
---------
U.S. TREASURY NOTES (40.3%)
6,000 6.25%, 5/31/00 6,054
30,000 7.25%, 8/15/04 31,894
20,000 6.50%, 8/15/05 20,425
3,500 6.25%, 2/15/07 3,518
---------
61,891
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FEDERAL HOME LOAN MORTGAGE CORPORATION (1.3%)
9 13.00%, 9/01/10 10
2,131 6.00%, 3/01/11 2,089
---------
2,099
---------
FEDERAL NATIONAL MORTGAGE ASSOCIATION (12.4%)
4,089 6.00%, 9/01/10 4,014
5,202 6.00%, 2/01/11 5,088
1,533 6.00%, 5/01/11 1,500
8,666 6.50%, 4/01/24 8,483
---------
19,085
---------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION II ARM (2.3%)
3,500 6.00%, 7/20/27 3,531
---------
TOTAL U.S. GOVERNMENT AND AGENCY OBLIGATIONS 91,460
---------
FOREIGN GOVERNMENT AND AGENCY OBLIGATION (3.8%)
6,000 Republic of Poland, `Euro',
(Floating Rate), 6.9375%,
10/27/24 5,885
---------
CORPORATE BONDS AND NOTES (22.0%)
BROADCAST-RADIO & TELEVISION (1.0%)
1,500 News America Holdings, 7.75%,
12/01/45 1,460
---------
FINANCE (21.0%)
2,500 American General Institutional
Capital, Series A, 7.57%,
12/01/45 2,450
1,500 Banco Santiago, 7.00%, 7/18/07 1,503
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------- ---------
<C> <S> <C>
$ 2,000 BankAmerica (144A), 7.70%,
12/31/26 $ 1,982
2,500 BT Capital Trust, Series B1,
(144A), 7.90%, 1/15/27 2,523
2,250 EIBKOR Global Bond, 6.50%, 2/10/02 2,221
2,000 First Chicago, 7.75%, 12/01/26 1,978
2,500 General Motors Acceptance Corp.,
7.375%, 6/22/00 2,571
3,000 Goldman Sachs Group, 6.25%,
2/01/03 2,964
2,500 Hutchison Whampoa, Class B,
(144A), 7.45%, 8/01/17 2,482
1,300 Lehman Brothers Holdings, Inc.,
7.375%, 5/15/04 1,341
2,200 Lehman Brothers, Inc., 7.50%,
8/01/26 2,322
1,500 Liberty Mutual, 7.875%, 10/15/26 1,574
1,500 Lumbermens Mutual Casualty Co.,
(144A), 9.15%, 7/01/26 1,703
2,000 U.S. West Cap Funding, Inc.,
6.95%, 1/15/37 2,040
2,500 USF&G Capital Corp., I, (144A),
8.50%, 12/15/45 2,676
---------
32,330
---------
TOTAL CORPORATE BONDS AND NOTES 33,790
---------
ASSET BACKED SECURITIES (9.4%)
8 Federal National Mortgage
Association, REMIC, 92-59F,
(Floating Rate), 6.088%, 8/25/06 8
1,500 FPLUS 1997-2 M 1, 7.60%, 4/10/23 1,544
3,003 Mid-State Trust, Class A, 8.33%,
4/01/30 3,239
2,450 Resolution Trust Corp., Series
1991-M5, Class A, 9.00%, 3/25/17 2,474
4,000 Standard Credit Card Trust, 6.75%,
6/07/00 4,016
3,000 Team Fleet Financing Corp., 7.35%,
5/15/03 3,091
---------
TOTAL ASSET BACKED SECURITIES 14,372
---------
TOTAL FIXED INCOME SECURITIES (Cost $143,392) 145,507
---------
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
FACE
AMOUNT AMOUNT
(000) (000)
- --------------- ---------
<C> <S> <C>
SHORT-TERM INVESTMENT (4.2%)
REPURCHASE AGREEMENT (4.2%)
$ 6,437 Chase Securities, Inc. 5.75%,
dated 9/30/97, due 10/01/97, to
be repurchased at $6,438,
collateralized by U.S. Treasury
Notes, 6.25%, due 10/31/01,
valued at $6,571 (Cost $6,437) $ 6,437
---------
TOTAL INVESTMENTS (98.9%) (Cost $149,829) 151,944
---------
OTHER ASSETS AND LIABILITIES (1.1%)
Other Assets 1,867
Liabilities (196)
---------
1,671
---------
NET ASSETS (100%) $153,615
---------
---------
CLASS A:
NET ASSETS $150,231
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 13,868,404 outstanding $0.001 par
value shares (authorized 500,000,000 shares)
$10.83
---------
---------
CLASS B:
NET ASSETS $3,384
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 312,093 outstanding $0.001 par value
shares (authorized 500,000,000 shares)
$10.84
---------
---------
</TABLE>
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Floating Rate Security -- Interest rate changes on these instruments are based
on changes in a designated base rate. The rates shown are those in effect on
September 30, 1997.
REMIC -- Real Estate Mortgage Investment Conduit
5
