<PAGE>
SUPPLEMENT DATED SEPTEMBER 26, 1997
TO PROSPECTUS DATED MAY 1, 1997
SMALL CAP VALUE EQUITY PORTFOLIO
VALUE EQUITY PORTFOLIO
BALANCED PORTFOLIO
GLOBAL FIXED INCOME PORTFOLIO
HIGH YIELD PORTFOLIO
PORTFOLIOS OF THE
MORGAN STANLEY INSTITUTIONAL FUND, INC. (THE "FUND")
P.O. BOX 2798
BOSTON, MASSACHUSETTS
02208-2798
-------------
The Prospectus is being amended and supplemented to: (i) reflect changes to
the parent of the investment adviser, administrator and the distributor; (ii)
reflect changes in the portfolio managers of the Small Cap Value Equity and
Global Fixed Income Portfolios; (iii) to reflect a clarification of the market
capitalizations of the issuers in which the Small Cap Value Equity Portfolio
primarily intends to invest; (iv) detail the Portfolios' revised investment
policies with respect to certain derivative instruments; (v) reflect a change in
the definition of high yield securities with respect to the High Yield
Portfolio; (vi) reflect changes to the High Yield Portfolio's investment policy
with respect to investment in the securities of foreign issuers; and (vii)
reflect changes to the High Yield Portfolio's investment policy with respect to
liquid Restricted Securities. The Prospectus is amended and supplemented as
follows:
--------------
On May 31, 1997, Morgan Stanley Group Inc. and Dean Witter, Discover & Co.
merged to form Morgan Stanley, Dean Witter, Discover & Co. Prior thereto, Morgan
Stanley Group Inc. was the direct parent of Morgan Stanley Asset Management Inc.
(the "Adviser") and Morgan Stanley & Co. Incorporated ("Morgan Stanley"). The
Adviser and Morgan Stanley are now subsidiaries of Morgan Stanley, Dean Witter,
Discover & Co.
--------------
J. David Germany, Michael B. Kushma, Paul F. O'Brien, Robert M. Smith and
Richard B. Worley now share primary responsibility for managing the assets of
the Global Fixed Income Portfolio. Accordingly, the fourth full paragraph on
page 26 is deleted and replaced with the following:
GLOBAL FIXED INCOME PORTFOLIO -- J. DAVID GERMANY, MICHAEL B.
KUSHMA, PAUL F. O'BRIEN, ROBERT M. SMITH AND RICHARD B. WORLEY. J.
David Germany shares primary responsibility for managing the Portfolio's
assets. He joined the Adviser in 1996 and has been a portfolio manager
with the Adviser's affiliate, Miller Anderson & Sherrerd, LLP ("MAS")
since 1991. He was Vice President & Senior Economist for Morgan Stanley
from 1989 to 1991. He assumed responsibility for the Global Fixed Income
and International Fixed Income Portfolios of the MAS-advised MAS Funds
in 1993 and the MAS Fund's Multi-Asset-Class Portfolio in 1994. Mr.
Germany was Senior Staff Economist (International Finance and
Macroeconomics) to the Council of Economic Advisers -- Executive Office
of the President from 1986 through 1987 and an Economist with the Board
of
<PAGE>
Governors of the Federal Reserve System -- Division of International
Finance from 1983 through 1987. He holds an A.B. degree (Valedictorian)
from Princeton University and a Ph.D. in Economics from the
Massachusetts Institute of Technology. Michael B. Kushma, a Principal at
Morgan Stanley, joined the firm in 1987. He shares primary
responsibility for managing the Portfolio's assets. He was a member of
Morgan Stanley's global fixed income strategy group in the fixed income
division from 1987-1995 where he became the division's senior government
bond strategist. He joined the Adviser in 1995 where he took
responsibility for the global fixed income bond strategist. Mr. Kushma
received an A.B. in economics from Princeton University in 1979, and M.
Sc. in economics from Columbia University in 1983. Paul F. O'Brien
shares primary responsibility for managing the Portfolio's assets. He
joined the Adviser and MAS in 1996. He was head of European Economics
from 1993 through 1995 for JP Morgan and as Principal Administrator from
1991 through 1992 for the Organization for Economic Cooperation and
Development. He assumed responsibility for the MAS-advised MAS Funds'
Global Fixed Income and International Fixed Income Portfolios in 1996.
Mr. O'Brien holds a B.S. degree from the Massachusetts Institute of
Technology and a Ph.D. in Economics from the University of Minnesota.
Robert Smith, a Principal of Morgan Stanley, joined the Adviser in June
1994. Prior to joining the Adviser, he spent eight years as Senior
Portfolio Manager -- Fixed Income at the State of Florida Pension Fund.
Mr. Smith's responsibilities included active total rate-of-return
management of long term portfolios and supervision of other fixed income
managers. A graduate of Florida State University with a B.S. in
Business, Mr. Smith also received an M.B.A. -- Finance from Florida
State and holds a Chartered Financial Analyst (CFA) designation. Richard
B. Worley, a Managing Director of Morgan Stanley, joined MAS in 1978. He
assumed responsibility for the MAS Funds Fixed Income Portfolio in 1984,
the MAS Funds Domestic Fixed Income Portfolio in 1987, the MAS Funds
Fixed Income Portfolio II in 1990, the MAS Funds Balanced and Special
Purpose Fixed Income Portfolios in 1992, the MAS Funds Global Fixed
Income and International Fixed Income Portfolios in 1993 and the MAS
Funds Multi-Asset-Class Portfolio in 1994. Mr. Worley received a B.A. in
Economics from University of Tennessee and attended the Graduate School
of Economics at University of Texas.
--------------
Gary D. Haubold no longer serves as portfolio manager for the Small Cap
Value Equity Portfolio. William B. Gerlach and Gary G. Schlarbaum now share
primary responsibility for managing the assets of the Small Cap Value Equity
Portfolio. Accordingly, the second full paragraph on Page 26 of the Prospectus
is deleted and replaced with the following paragraph:
SMALL CAP VALUE EQUITY PORTFOLIO -- WILLIAM B. GERLACH AND GARY G.
SCHLARBAUM. Mr. Gerlach joined the Adviser in July 1996 and has worked
with the Adviser's affiliate, Miller Anderson & Sherrerd, LLP ("MAS")
since 1991. Previously, he was with Alphametrics Corporation and Wharton
Econometric Forecasting Associates. Mr. Gerlach received a B.A. in
Economics from Haverford College. Gary G. Schlarbaum, a Managing
Director of Morgan Stanley, joined MAS in 1987. He assumed
responsibility for the MAS Funds Equity and Small Cap Value Portfolios
in 1987, the MAS Funds Balanced Portfolio in 1992 and the MAS Funds
Multi-Asset-Class and Mid Cap Value Portfolios in 1994. Mr. Schlarbaum
also is a Director of MAS Fund Distribution, Inc. Previously, he was
with First Chicago Investment Advisers and was a Professor at the
Krannert Graduate School at Purdue University. Mr. Schlarbaum holds a
B.A. in Economics from Coe College and a Ph.D. in Applied Economics from
University of Pennsylvania. Mr. Gerlach and Mr. Schlarbaum have had
primary responsibility for managing the Small Cap Value Equity Portfolio
since June 1997.
--------------
<PAGE>
The second, third and fourth sentences under "THE SMALL CAP VALUE EQUITY
PORTFOLIO" on page 14, are hereby deleted and replaced with the following:
The Fund invests primarily in corporations domiciled in the United
States with equity market capitalizations in the range of the companies
represented in the Russell 2500 Small Company Index, but may invest in
similar sized foreign companies. Such range is currently $70 million to
$1.3 billion, but the range fluctuates over time with the equity market.
Under normal circumstances, the Fund will invest at least 65% of the
value of its total assets in equity securities of issuers whose market
capitalizations are within the range represented in the Index.
--------------
The section entitled "FUTURES CONTRACTS AND OPTIONS OF FUTURES CONTRACTS" on
pages 21-22 is deleted.
The section entitled "OPTIONS TRANSACTIONS" on page 23 is deleted.
After the section entitled "WHEN-ISSUED AND DELAYED DELIVERY SECURITIES" on
page 24, the following sections are inserted:
DERIVATIVE INSTRUMENTS
The Portfolios are permitted to invest in various derivative
instruments for both hedging and non-hedging purposes. Derivatives
instruments include options, futures and options on futures, structured
investments and structured notes, caps, floors, collars and swaps.
Additionally, the Portfolios may invest in other derivative instruments
that are developed over time if their use would be consistent with the
objectives of the Portfolios. Each Portfolio will limit its use of
derivative instruments to 33 1/3% of its total assets measured by the
aggregate notional amount of outstanding derivative instruments. The
Portfolios' investments in forward foreign currency contracts and
derivatives used for hedging purposes are not subject to the limit
described above.
The Portfolios may use derivative instruments under a number of
different circumstances to further their investment objectives. The
Portfolios may use derivatives when doing so provides more liquidity
than the direct purchase of the securities underlying such derivatives.
For example, a Portfolio may purchase derivatives to quickly gain
exposure to a market in response to changes in the Portfolio's
investment policy or upon the inflow of investable cash or when the
derivative provides greater liquidity than the underlying securities
market. A Portfolio may also use derivatives when it is restricted from
directly owning the underlying securities due to foreign investment
restrictions or other reasons or when doing so provides a price
advantage over purchasing the underlying securities directly, either
because of a pricing differential between the derivatives and securities
markets or because of lower transaction costs associated with the
derivatives transaction. Derivatives may also be used by a Portfolio for
hedging purposes and in other circumstances when a Portfolio's portfolio
managers believe it advantageous to do so consistent with the
Portfolio's investment objective. The Portfolios will not, however, use
derivatives in a manner that creates leverage, except to the extent that
the use of leverage is expressly permitted by a particular Portfolio's
investment policies, and then only in a manner consistent with such
policies.
Some of the derivative instruments in which the Portfolios may
invest and the risks related thereto are described in more detail below.
<PAGE>
CAPS, FLOORS AND COLLARS
The Portfolios may invest in caps, floors and collars, which are
instruments analogous to options. In particular, a cap is the right to
receive the excess of a reference rate over a given rate and is
analogous to a put option. A floor is the right to receive the excess of
a given rate over a reference rate and is analogous to a call option.
Finally, a collar is an instrument that combines a cap and a floor. That
is, the buyer of a collar buys a cap and writes a floor, and the writer
of a collar writes a cap and buys a floor. The risks associated with
caps, floors and collars are similar to those associated with options.
In addition, caps, floors and collars are subject to risk of default by
the counterparty because they are privately negotiated instruments.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
The Portfolios may purchase and sell futures contracts and options
on futures contracts, including but not limited to securities index
futures, foreign currency exchange futures, interest rate futures
contracts and other financial futures. Futures contracts provide for the
sale by one party and purchase by another party of a specified amount of
a specific security, instrument or basket thereof, at a specific future
date and at a specified price. An option on a futures contract is a
legal contract that gives the holder the right to buy or sell a
specified amount of futures contracts at a fixed or determinable price
upon the exercise of the option.
The Portfolios may sell securities index futures contracts and/or
options thereon in anticipation of or during a market decline to attempt
to offset the decrease in market value of investments in its portfolio,
or purchase securities index futures in order to gain market exposure.
Subject to applicable laws, the Portfolios may engage in transactions in
securities index futures contracts (and options thereon) which are
traded on a recognized securities or futures exchange, or may purchase
or sell such instruments in the over-the-counter market. There currently
are limited securities index futures and options on such futures in many
countries, particularly emerging countries. The nature of the strategies
adopted by the Adviser, and the extent to which those strategies are
used, may depend on the development of such markets.
The Portfolios may engage in transactions involving foreign currency
exchange futures contracts. Such contracts involve an obligation to
purchase or sell a specific currency at a specified future date and at a
specified price. The Portfolios may engage in such transactions to hedge
their respective holdings and commitments against changes in the level
of future currency rates or to adjust their exposure to a particular
currency.
The Portfolios may engage in transactions in interest rate futures
transactions. Interest rate futures contracts involve an obligation to
purchase or sell a specific debt security, instrument or basket thereof
at a specified future date at a specified price. The value of the
contract rises and falls inversely with changes in interest rates. The
Portfolios may engage in such transactions to hedge their holdings of
debt instruments against future changes in interest rates.
Financial futures are futures contracts relating to financial
instruments, such as U.S. Government securities, foreign currencies, and
certificates of deposit. Such contracts involve an obligation to
purchase or sell a specific security, instrument or basket thereof at a
specified future date at a specified price. Like interest rate futures
contracts, the value of financial futures contracts rises and falls
inversely with changes in interest rates. The Portfolios may engage in
financial futures contracts for hedging and non-hedging purposes.
<PAGE>
Under rules adopted by the Commodity Futures Trading Commission,
each Portfolio may enter into futures contracts and options thereon for
both hedging and non-hedging purposes, provided that not more than 5% of
such 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.
Gains and losses on futures contracts and options thereon 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 and options are (i) imperfect
correlation between the change in market value of investments held by a
Portfolio and the prices of futures and options 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 a Portfolio will be unable to
close out a futures position or options contract will be minimized by
only entering into futures contracts or options transactions 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 both to the low margin deposits required and the
extremely high degree of leverage involved in futures pricing.
OPTIONS TRANSACTIONS
The Portfolios may seek to increase their returns or may hedge their
portfolio investments through options transactions with respect to
securities, instruments, indices or baskets thereof in which such
Portfolios may invest, as well as with respect to foreign currency.
Purchasing a put option gives a Portfolio the right to sell a specified
security, currency or basket of securities or currencies at the exercise
price until the expiration of the option. Purchasing a call option gives
a Portfolio the right to purchase a specified security, currency or
basket of securities or currencies at the exercise price until the
expiration of the option.
Each Portfolio also may write (i.e., sell) put and call options on
investments held in its portfolio, as well as with respect to foreign
currency. A Portfolio that has written an option receives a premium,
which increases the Portfolio's return on the underlying security or
instrument in the event the option expires unexercised or is closed out
at a profit. However, by writing a call option, a Portfolio will limit
its opportunity to profit from an increase in the market value of the
underlying security or instrument above the exercise price of the option
for as long as the Portfolio's obligation as writer of the option
continues. The Portfolios may only write options that are "covered." A
covered call option means that so long as the Portfolio is obligated as
the writer of the option, it will earmark or segregate sufficient liquid
assets to cover its obligations under the option or own (i) the
underlying security or instrument subject to the option, (ii) securities
or instruments convertible or exchangeable without the payment of any
consideration into the security or instrument subject to the option, or
(iii) a call option on the same underlying security with a strike price
no higher than the price at which the underlying instrument was sold
pursuant to a short option position.
By writing (or selling) a put option, a Portfolio incurs an
obligation to buy the security or instrument 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. The Portfolios
may also write options that may be exercised by the purchaser only on a
specific date. A Portfolio that has written a put option will earmark or
segregate sufficient liquid assets to cover its obligations under the
option or will own a put option on the same underlying security with an
equal or higher strike price.
<PAGE>
The Portfolios may engage in transactions in options which are
traded on recognized exchanges or over-the-counter. There currently are
limited options markets in many countries, particularly emerging
countries such as Latin American countries, and the nature of the
strategies adopted by the Adviser and the extent to which those
strategies are used will depend on the development of such options
markets. The primary risks associated with the use of options are (i)
imperfect correlation between the change in market value of investments
held, purchased or sold by a Portfolio and the prices of options
relating to such investments, and (ii) possible lack of a liquid
secondary market for an option.
STRUCTURED NOTES
Structured Notes are derivatives on which the amount of principal
repayment and/or interest payments is based upon the movement of one or
more factors. These factors include, but are not limited to, currency
exchange rates, interest rates (such as the prime lending rate and
LIBOR) and stock indices such as the S&P 500 Index. In some cases, the
impact of the movements of these factors may increase or decrease
through the use of multipliers or deflators. The Portfolios may use
structured notes to tailor their investments to the specific risks and
returns the Adviser wishes to accept while avoiding or reducing certain
other risks.
SWAPS -- SWAP CONTRACTS
Swaps and Swap Contracts are derivatives in the form of a contract
or other similar instrument in which two parties agree to exchange the
returns generated by a security, instrument, basket or index thereof for
the returns generated by another security, instrument, basket thereof or
index. The payment streams are calculated by reference to a specific
security, index or instrument and an agreed upon notional amount. The
relevant indices include but are not limited to, currencies, fixed
interest rates, prices and total return on interest rate indices, fixed
income indices, stock indices and commodity indices (as well as amounts
derived from arithmetic operations on these indices). For example, a
Portfolio may agree to swap the return generated by a fixed income index
for the return generated by a second fixed income index. The currency
swaps in which the Portfolios may enter will generally involve an
agreement to pay interest streams in one currency based on a specified
index in exchange for receiving interest streams denominated in another
currency. Such swaps may involve initial and final exchanges that
correspond to the agreed upon notional amount.
A Portfolio will usually enter into swaps on a net basis, i.e., the
two return streams are netted out in a cash settlement on the payment
date or dates specified in the instrument, with a Portfolio receiving or
paying, as the case may be, only the net amount of the two returns. A
Portfolio's obligations under a swap agreement will be accrued daily
(offset against any amounts owing to the Portfolio) and any accrued, but
unpaid, net amounts owed to a swap counterparty will be covered by the
maintenance of a segregated account consisting of cash or liquid
securities. A Portfolio will not enter into any swap agreement unless
the counterparty meets the rating requirements set forth in guidelines
established by the Fund's Board of Directors.
Interest rate and total rate of return swaps do not involve the
delivery of securities, other underlying assets, or principal.
Accordingly, the risk of loss with respect to interest rate and total
rate of return swaps is limited to the net amount of payments that a
Portfolio is contractually obligated to make. If the other party to an
interest rate or total rate of return swap defaults, a Portfolio's risk
of loss consists of the net amount of payments that a Portfolio is
contractually entitled to receive. In contrast,
<PAGE>
currency swaps may involve the delivery of the entire principal value of
one designated currency in exchange for the other designated currency.
Therefore, the entire principal value of a currency swap may be subject
to the risk that the other party to the swap will default on its
contractual delivery obligations. If there is a default by the
counterparty, a Portfolio may have contractual remedies pursuant to the
agreements related to the transaction. The swaps market has grown
substantially in recent years with a large number of banks and
investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. As a result, the swaps market
has become relatively liquid. Swaps that include caps, floors and
collars are more recent innovations for which standardized documentation
has not yet been fully developed and, accordingly, they are less liquid
than "traditional" swaps.
The use of swaps is a highly specialized activity which involves
investment techniques and risks different from those associated with
ordinary portfolio securities transactions. If the Adviser is incorrect
in its forecasts of market values, interest rates, and currency exchange
rates, the investment performance of the Portfolios would be less
favorable than it would have been if this investment technique were not
used.
--------------
The fifth bullet point under the heading "THE FUND" on page 10 of the
Prospectus is deleted and replaced with the following:
- 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 third sentence in the third paragraph under "THE HIGH YIELD PORTFOLIO"
on page 17, is hereby deleted.
--------------
Under the heading "NON-PUBLICLY TRADED SECURITIES, PRIVATE PLACEMENTS AND
RESTRICTED SECURITIES" on page 22, the second paragraph is deleted and replaced
with the following:
As a general matter, the Portfolio may not invest more than 15% of
its net assets in illiquid securities, including securities for which
there is no readily available secondary market. Nor, as a general
matter, may the Portfolio invest more than 10% of its total assets in
securities that are restricted from sale to the public without
registration ("Restricted Securities") under the Securities Act of 1933,
as amended (the "1933 Act"). However, the Portfolio may invest without
limit in liquid Restricted Securities that can be offered and sold to
qualified institutional buyers under Rule 144A under the 1933 Act ("Rule
144A Securities"). The Board of Directors has adopted guidelines and
delegated to the Adviser, subject to the supervision of the Board of
Directors, the daily function of determining and monitoring the
liquidity of Rule 144A Securities. Rule 144A Securities may become
illiquid if qualified institutional buyers are not interested in
acquiring the securities.
--------------
PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE
<PAGE>
SUPPLEMENT DATED SEPTEMBER 26, 1997
TO PROSPECTUS DATED MAY 1, 1997
FIXED INCOME PORTFOLIO
MUNICIPAL BOND PORTFOLIO
MORTGAGE-BACKED SECURITIES PORTFOLIO
MONEY MARKET PORTFOLIO
MUNICIPAL MONEY MARKET PORTFOLIO
PORTFOLIOS OF THE
MORGAN STANLEY INSTITUTIONAL FUND, INC. (THE "FUND")
P.O. BOX 2798
BOSTON, MASSACHUSETTS
02208-2798
-------------
The Prospectus is being amended and supplemented to: (i) reflect changes to
the parent of the investment adviser, administrator and the distributor; (ii)
detail the Portfolios' revised investment policies with respect to certain
derivative instruments; (iii) reflect a change in the portfolio managers of the
Money Market Portfolio; and (iv) reflect a change in the definition of high
yield securities with respect to the High Yield Portfolio. The Prospectus is
amended and supplemented as follows:
--------------
On May 31, 1997, Morgan Stanley Group Inc. and Dean Witter, Discover & Co.
merged to form Morgan Stanley, Dean Witter, Discover & Co. Prior thereto, Morgan
Stanley Group Inc. was the direct parent of Morgan Stanley Asset Management Inc.
(the "Adviser") and Morgan Stanley & Co. Incorporated ("Morgan Stanley"). The
Adviser and Morgan Stanley are now subsidiaries of Morgan Stanley, Dean Witter,
Discover & Co.
--------------
The section entitled "FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS" on
pages 19-20 is deleted.
The section entitled "OPTIONS TRANSACTIONS" on page 21 is deleted.
After the section entitled "WHEN-ISSUED AND DELAYED DELIVERY SECURITIES" on
pages 22-23, the following sections are inserted:
DERIVATIVE INSTRUMENTS
The Portfolios are permitted to invest in various derivative
instruments for both hedging and non-hedging purposes. Derivatives
instruments include options, futures and options on futures, structured
investments and structured notes, caps, floors, collars and swaps.
Additionally, the Portfolios may invest in other derivative instruments
that are developed over time if their use would be consistent with the
objectives of the Portfolios. Each Portfolio will limit its use of
derivative instruments to 33 1/3% of its total assets measured by the
aggregate notional amount of outstanding derivative instruments. The
Portfolios' investments in forward foreign currency contracts and
derivatives used for hedging purposes are not subject to the limit
described above.
The Portfolios may use derivative instruments under a number of
different circumstances to further their investment objectives. The
Portfolios may use derivatives when doing so provides more
<PAGE>
liquidity than the direct purchase of the securities underlying such
derivatives. For example, a Portfolio may purchase derivatives to
quickly gain exposure to a market in response to changes in the
Portfolio's investment policy or upon the inflow of investable cash or
when the derivative provides greater liquidity than the underlying
securities market. A Portfolio may also use derivatives when it is
restricted from directly owning the underlying securities due to foreign
investment restrictions or other reasons or when doing so provides a
price advantage over purchasing the underlying securities directly,
either because of a pricing differential between the derivatives and
securities markets or because of lower transaction costs associated with
the derivatives transaction. Derivatives may also be used by a Portfolio
for hedging purposes and in other circumstances when a Portfolio's
portfolio managers believe it advantageous to do so consistent with the
Portfolio's investment objective. The Portfolios will not, however, use
derivatives in a manner that creates leverage, except to the extent that
the use of leverage is expressly permitted by a particular Portfolio's
investment policies, and then only in a manner consistent with such
policies.
Some of the derivative instruments in which the Portfolios may
invest and the risks related thereto are described in more detail below.
CAPS, FLOORS AND COLLARS
The Portfolios may invest in caps, floors and collars, which are
instruments analogous to options. In particular, a cap is the right to
receive the excess of a reference rate over a given rate and is
analogous to a put option. A floor is the right to receive the excess of
a given rate over a reference rate and is analogous to a call option.
Finally, a collar is an instrument that combines a cap and a floor. That
is, the buyer of a collar buys a cap and writes a floor, and the writer
of a collar writes a cap and buys a floor. The risks associated with
caps, floors and collars are similar to those associated with options.
In addition, caps, floors and collars are subject to risk of default by
the counterparty because they are privately negotiated instruments.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
The Non-Money Portfolios may purchase and sell futures contracts and
options on futures contracts, including but not limited to securities
index futures, foreign currency exchange futures, interest rate futures
contracts and other financial futures. Futures contracts provide for the
sale by one party and purchase by another party of a specified amount of
a specific security, instrument or basket thereof, at a specific future
date and at a specified price. An option on a futures contract is a
legal contract that gives the holder the right to buy or sell a
specified amount of futures contracts at a fixed or determinable price
upon the exercise of the option.
The Non-Money Portfolios may sell securities index futures contracts
and/or options thereon in anticipation of or during a market decline to
attempt to offset the decrease in market value of investments in its
portfolio, or purchase securities index futures in order to gain market
exposure. Subject to applicable laws, the Portfolios may engage in
transactions in securities index futures contracts (and options thereon)
which are traded on a recognized securities or futures exchange, or may
purchase or sell such instruments in the over-the-counter market. There
currently are limited securities index futures and options on such
futures in many countries, particularly emerging countries. The nature
of the strategies adopted by the Adviser, and the extent to which those
strategies are used, may depend on the development of such markets.
<PAGE>
The Non-Money Portfolios may engage in transactions involving
foreign currency exchange futures contracts. Such contracts involve an
obligation to purchase or sell a specific currency at a specified future
date and at a specified price. The Portfolios may engage in such
transactions to hedge their respective holdings and commitments against
changes in the level of future currency rates or to adjust their
exposure to a particular currency.
The Non-Money Portfolios may engage in transactions in interest rate
futures transactions. Interest rate futures contracts involve an
obligation to purchase or sell a specific debt security, instrument or
basket thereof at a specified future date at a specified price. The
value of the contract rises and falls inversely with changes in interest
rates. The Portfolios may engage in such transactions to hedge their
holdings of debt instruments against future changes in interest rates.
Financial futures are futures contracts relating to financial
instruments, such as U.S. Government securities, foreign currencies, and
certificates of deposit. Such contracts involve an obligation to
purchase or sell a specific security, instrument or basket thereof at a
specified future date at a specified price. Like interest rate futures
contracts, the value of financial futures contracts rises and falls
inversely with changes in interest rates. The Non-Money Portfolios may
engage in financial futures contracts for hedging and non-hedging
purposes.
Under rules adopted by the Commodity Futures Trading Commission,
each Non-Money Portfolio may enter into futures contracts and options
thereon for both hedging and non-hedging purposes, provided that not
more than 5% of such 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.
Gains and losses on futures contracts and options thereon 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 and options are (i) imperfect
correlation between the change in market value of investments held by a
Non-Money Portfolio and the prices of futures and options 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 a Portfolio will be
unable to close out a futures position or options contract will be
minimized by only entering into futures contracts or options
transactions 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 both to the low margin deposits
required and the extremely high degree of leverage involved in futures
pricing.
OPTIONS TRANSACTIONS
The Non-Money Portfolios may seek to increase their returns or may
hedge their portfolio investments through options transactions with
respect to securities, instruments, indices or baskets thereof in which
such Portfolios may invest, as well as with respect to foreign currency.
Purchasing a put option gives a Portfolio the right to sell a specified
security, currency or basket of securities or currencies at the exercise
price until the expiration of the option. Purchasing a call option gives
a Portfolio the right to purchase a specified security, currency or
basket of securities or currencies at the exercise price until the
expiration of the option.
Each Non-Money Portfolio also may write (i.e., sell) put and call
options on investments held in its portfolio, as well as with respect to
foreign currency. A Portfolio that has written an option receives a
<PAGE>
premium, which increases the Portfolio's return on the underlying
security or instrument in the event the option expires unexercised or is
closed out at a profit. However, by writing a call option, a Portfolio
will limit its opportunity to profit from an increase in the market
value of the underlying security or instrument above the exercise price
of the option for as long as the Portfolio's obligation as writer of the
option continues. The Portfolios may only write options that are
"covered." A covered call option means that so long as the Portfolio is
obligated as the writer of the option, it will earmark or segregate
sufficient liquid assets to cover its obligations under the option or
own (i) the underlying security or instrument subject to the option,
(ii) securities or instruments convertible or exchangeable without the
payment of any consideration into the security or instrument subject to
the option, or (iii) a call option on the same underlying security with
a strike price no higher than the price at which the underlying
instrument was sold pursuant to a short option position.
By writing (or selling) a put option, a Non-Money Portfolio incurs
an obligation to buy the security or instrument 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. The Portfolios
may also write options that may be exercised by the purchaser only on a
specific date. A Portfolio that has written a put option will earmark or
segregate sufficient liquid assets to cover its obligations under the
option or will own a put option on the same underlying security with an
equal or higher strike price.
The Non-Money Portfolios may engage in transactions in options which
are traded on recognized exchanges or over-the-counter. There currently
are limited options markets in many countries, particularly emerging
countries such as Latin American countries, and the nature of the
strategies adopted by the Adviser and the extent to which those
strategies are used will depend on the development of such options
markets. The primary risks associated with the use of options are (i)
imperfect correlation between the change in market value of investments
held, purchased or sold by a Portfolio and the prices of options
relating to such investments, and (ii) possible lack of a liquid
secondary market for an option.
STRUCTURED NOTES
Structured Notes are derivatives on which the amount of principal
repayment and/or interest payments is based upon the movement of one or
more factors. These factors include, but are not limited to, currency
exchange rates, interest rates (such as the prime lending rate and
LIBOR) and stock indices such as the S&P 500 Index. In some cases, the
impact of the movements of these factors may increase or decrease
through the use of multipliers or deflators. The Non-Money Portfolios
may use structured notes to tailor their investments to the specific
risks and returns the Adviser wishes to accept while avoiding or
reducing certain other risks.
SWAPS -- SWAP CONTRACTS
Swaps and Swap Contracts are derivatives in the form of a contract
or other similar instrument in which two parties agree to exchange the
returns generated by a security, instrument, basket or index thereof for
the returns generated by another security, instrument, basket thereof or
index. The payment streams are calculated by reference to a specific
security, index or instrument and an agreed upon notional amount. The
relevant indices include but are not limited to, currencies, fixed
interest rates, prices and total return on interest rate indices, fixed
income indices, stock indices and commodity indices (as well as amounts
derived from arithmetic operations on these indices). For example, a
Non-Money Portfolio may agree to swap the return generated by a fixed
income index for
<PAGE>
the return generated by a second fixed income index. The currency swaps
in which the Portfolios may enter will generally involve an agreement to
pay interest streams in one currency based on a specified index in
exchange for receiving interest streams denominated in another currency.
Such swaps may involve initial and final exchanges that correspond to
the agreed upon notional amount.
A Non-Money Portfolio will usually enter into swaps on a net basis,
i.e., the two return streams are netted out in a cash settlement on the
payment date or dates specified in the instrument, with a Portfolio
receiving or paying, as the case may be, only the net amount of the two
returns. A Portfolio's obligations under a swap agreement will be
accrued daily (offset against any amounts owing to the Portfolio) and
any accrued, but unpaid, net amounts owed to a swap counterparty will be
covered by the maintenance of a segregated account consisting of cash or
liquid securities. A Portfolio will not enter into any swap agreement
unless the counterparty meets the rating requirements set forth in
guidelines established by the Fund's Board of Directors.
Interest rate and total rate of return swaps do not involve the
delivery of securities, other underlying assets, or principal.
Accordingly, the risk of loss with respect to interest rate and total
rate of return swaps is limited to the net amount of payments that a
Non-Money Portfolio is contractually obligated to make. If the other
party to an interest rate or total rate of return swap defaults, a
Portfolio's risk of loss consists of the net amount of payments that a
Portfolio is contractually entitled to receive. In contrast, currency
swaps may involve the delivery of the entire principal value of one
designated currency in exchange for the other designated currency.
Therefore, the entire principal value of a currency swap may be subject
to the risk that the other party to the swap will default on its
contractual delivery obligations. If there is a default by the
counterparty, a Portfolio may have contractual remedies pursuant to the
agreements related to the transaction. The swaps market has grown
substantially in recent years with a large number of banks and
investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. As a result, the swaps market
has become relatively liquid. Swaps that include caps, floors and
collars are more recent innovations for which standardized documentation
has not yet been fully developed and, accordingly, they are less liquid
than "traditional" swaps.
The use of swaps is a highly specialized activity which involves
investment techniques and risks different from those associated with
ordinary portfolio securities transactions. If the Adviser is incorrect
in its forecasts of market values, interest rates, and currency exchange
rates, the investment performance of the Non-Money Portfolios would be
less favorable than it would have been if this investment technique were
not used.
--------------
Kenneth R. Holley no longer serves as a portfolio manager for the Money
Market Portfolio. Abigail Jones Feder, Daniel M. Niland, Ellen D. Harvey,
Christian G. Roth and Scott F. Richard now share primary responsibility for
managing the assets of the Money Market Portfolio. Accordingly, the last
paragraph on page 24 is deleted and replaced with the following:
MONEY MARKET PORTFOLIO -- ABIGAIL JONES FEDER, DANIEL M. NILAND,
ELLEN D. HARVEY, CHRISTIAN G. ROTH, AND SCOTT F. RICHARD. Abigail Jones
Feder is a Principal of Morgan Stanley and shares responsibility for
managing short-term taxable and tax-exempt portfolios. Ms. Feder joined
Morgan Stanley's Corporate Finance Department in 1985. In 1987 she
joined the Adviser as a Marketing Analyst and was promoted to a
Marketing Director in 1988. She joined the Fixed Income Group as a
Portfolio Manager in 1989 and she became a Vice President in 1992. Ms.
Feder holds a B.A. from Vassar College. Ms. Feder has had primary
responsibility for managing the Portfolio's assets since its
<PAGE>
inception. Daniel M. Niland joined the Adviser in July 1997 as a Vice
President and shares responsibility for managing short-term taxable
portfolios. Prior to joining the Adviser, Mr. Niland managed liquidity
and short duration fixed income portfolios for institutional and private
accounts at Citibank Global Asset Management. Before joining Citibank,
Mr. Niland worked at J.P. Morgan as a portfolio manager investing $20
billion in short-term securities for that firm's securities lending
program. Mr. Niland holds a B.A. from Iona College and an M.B.A. from
Fordham University. Mr. Niland has shared primary responsibility for
managing the Portfolio's assets since July 1997. Ellen D. Harvey joined
the Adviser in 1996 and has been a portfolio manager with Miller
Anderson & Sherrerd, LLP ("MAS"), an affiliate of the Adviser, since
1984. She assumed responsibility for the MAS-advised Cash Reserves
Portfolio in 1990, the Limited Duration Portfolio in 1992 and the
Intermediate Duration Portfolio in 1994. Ms. Harvey holds an A.B. in
economics from Princeton University and an M.A. in economics from George
Washington University. Christian G. Roth joined the Adviser in 1996 and
has been a portfolio manager with MAS since 1991. He served as Senior
Associate, Dean Witter Capital Corporation from 1987 to 1991. He assumed
responsibility for the MAS-advised Limited Duration and Intermediate
Duration Portfolios in 1994. Mr. Roth holds a B.S. from The Wharton
School of the University of Pennsylvania. Scott F. Richard joined the
Adviser in 1996 and has been a portfolio manager with MAS since 1992. He
served as Vice President, Head of Fixed Income Research & Model
Development for Goldman, Sachs & Co. from 1987 to 1991 and as Head of
Mortgage Research in 1992. He assumed responsibility for the MAS-advised
Mortgage-Backed Securities Portfolio in 1992 and the Limited Duration,
Intermediate Duration, Municipal and PA Municipal Portfolios in 1994.
Mr. Richard holds a B.S. from Massachusetts Institute of Technology and
a D.B.A. from Harvard Graduate School of Business Administration. Ms.
Harvey, Mr. Roth and Mr. Richard have shared primary responsibility for
managing the Portfolio's assets since January 1996.
--------------
The third bullet point under the heading "FIXED INCOME:" on page 11 of the
Prospectus is deleted and replaced with the following:
- 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.
--------------
PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE
<PAGE>
SUPPLEMENT DATED SEPTEMBER 26, 1997
TO PROSPECTUS DATED MAY 1, 1997
INTERNATIONAL MAGNUM PORTFOLIO
A PORTFOLIO OF THE
MORGAN STANLEY INSTITUTIONAL FUND, INC. (THE "FUND")
P.O. BOX 2798
BOSTON, MASSACHUSETTS
02208-2798
-------------
The Prospectus is being amended and supplemented to: (i) reflect changes to
the parent of the investment adviser, administrator and the distributor; (ii)
detail the Portfolio's revised investment policies with respect to certain
derivative instruments; (iii) reflect a change in the Portfolio's policy
concerning investment in securities of issuers not domiciled in an EAFE country
(defined below); and (iv) reflect a change in the definition of high yield
securities with respect to the High Yield Portfolio. The Prospectus is amended
and supplemented as follows:
--------------
On May 31, 1997, Morgan Stanley Group Inc. and Dean Witter, Discover & Co.
merged to form Morgan Stanley, Dean Witter, Discover & Co. Prior thereto, Morgan
Stanley Group Inc. was the direct parent of Morgan Stanley Asset Management Inc.
(the "Adviser") and Morgan Stanley & Co. Incorporated ("Morgan Stanley"). The
Adviser and Morgan Stanley are now subsidiaries of Morgan Stanley, Dean Witter,
Discover & Co.
--------------
The section entitled "FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS" on
pages 11-13 is deleted.
The section entitled "OPTIONS TRANSACTIONS" on pages 14-15 is deleted.
After the section entitled "WHEN-ISSUED AND DELAYED DELIVERY SECURITIES" on
pages 15-16, the following sections are inserted:
DERIVATIVE INSTRUMENTS
The Portfolio is permitted to invest in various derivative
instruments for both hedging and non-hedging purposes. Derivatives
instruments include options, futures and options on futures, structured
investments and structured notes, caps, floors, collars and swaps.
Additionally, the Portfolio may invest in other derivative instruments
that are developed over time if their use would be consistent with the
objectives of the Portfolio. The Portfolio will limit its use of
derivative instruments to 33 1/3% of its total assets measured by the
aggregate notional amount of outstanding derivative instruments. The
Portfolio's investments in forward foreign currency contracts and
derivatives used for hedging purposes are not subject to the limit
described above.
The Portfolio may use derivative instruments under a number of
different circumstances to further its investment objectives. The
Portfolio may use derivatives when doing so provides more liquidity than
the direct purchase of the securities underlying such derivatives. For
example, the Portfolio may purchase derivatives to quickly gain exposure
to a market in response to changes in the Portfolio's investment policy
or upon the inflow of investable cash or when the derivative provides
<PAGE>
greater liquidity than the underlying securities market. The Portfolio
may also use derivatives when it is restricted from directly owning the
underlying securities due to foreign investment restrictions or other
reasons or when doing so provides a price advantage over purchasing the
underlying securities directly, either because of a pricing differential
between the derivatives and securities markets or because of lower
transaction costs associated with the derivatives transaction.
Derivatives may also be used by the Portfolio for hedging purposes and
in other circumstances when the Portfolio's portfolio managers believe
it advantageous to do so consistent with the Portfolio's investment
objective. The Portfolio will not, however, use derivatives in a manner
that creates leverage, except to the extent that the use of leverage is
expressly permitted by the Portfolio's investment policies, and then
only in a manner consistent with such policies.
Some of the derivative instruments in which the Portfolio may invest
and the risks related thereto are described in more detail below.
CAPS, FLOORS AND COLLARS
The Portfolio may invest in caps, floors and collars, which are
instruments analogous to options. In particular, a cap is the right to
receive the excess of a reference rate over a given rate and is
analogous to a put option. A floor is the right to receive the excess of
a given rate over a reference rate and is analogous to a call option.
Finally, a collar is an instrument that combines a cap and a floor. That
is, the buyer of a collar buys a cap and writes a floor, and the writer
of a collar writes a cap and buys a floor. The risks associated with
caps, floors and collars are similar to those associated with options.
In addition, caps, floors and collars are subject to risk of default by
the counterparty because they are privately negotiated instruments.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
The Portfolio may purchase and sell futures contracts and options on
futures contracts, including but not limited to securities index
futures, foreign currency exchange futures, interest rate futures
contracts and other financial futures. Futures contracts provide for the
sale by one party and purchase by another party of a specified amount of
a specific security, instrument or basket thereof, at a specific future
date and at a specified price. An option on a futures contract is a
legal contract that gives the holder the right to buy or sell a
specified amount of futures contracts at a fixed or determinable price
upon the exercise of the option.
The Portfolio may sell securities index futures contracts and/or
options thereon in anticipation of or during a market decline to attempt
to offset the decrease in market value of investments in its portfolio,
or purchase securities index futures in order to gain market exposure.
Subject to applicable laws, the Portfolio may engage in transactions in
securities index futures contracts (and options thereon) which are
traded on a recognized securities or futures exchange, or may purchase
or sell such instruments in the over-the-counter market. There currently
are limited securities index futures and options on such futures in many
countries, particularly emerging countries. The nature of the strategies
adopted by the Adviser, and the extent to which those strategies are
used, may depend on the development of such markets.
The Portfolio may engage in transactions involving foreign currency
exchange futures contracts. Such contracts involve an obligation to
purchase or sell a specific currency at a specified future date and at a
specified price. The Portfolio may engage in such transactions to hedge
their respective
<PAGE>
holdings and commitments against changes in the level of future currency
rates or to adjust their exposure to a particular currency.
The Portfolio may engage in transactions in interest rate futures
transactions. Interest rate futures contracts involve an obligation to
purchase or sell a specific debt security, instrument or basket thereof
at a specified future date at a specified price. The value of the
contract rises and falls inversely with changes in interest rates. The
Portfolio may engage in such transactions to hedge its holdings of debt
instruments against future changes in interest rates.
Financial futures are futures contracts relating to financial
instruments, such as U.S. Government securities, foreign currencies, and
certificates of deposit. Such contracts involve an obligation to
purchase or sell a specific security, instrument or basket thereof at a
specified future date at a specified price. Like interest rate futures
contracts, the value of financial futures contracts rises and falls
inversely with changes in interest rates. The Portfolio may engage in
financial futures contracts for hedging and non-hedging purposes.
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.
Gains and losses on futures contracts and options thereon 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 and options are (i) imperfect
correlation between the change in market value of investments held by
the Portfolio and the prices of futures and options 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 or options contract will be
minimized by only entering into futures contracts or options
transactions 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 both to the low margin deposits
required and the extremely high degree of leverage involved in futures
pricing.
OPTIONS TRANSACTIONS
The Portfolio may seek to increase its return or may hedge its
portfolio investments through options transactions with respect to
securities, instruments, indices or baskets thereof in which the
Portfolio may invest, as well as with respect to foreign currency.
Purchasing a put option gives the Portfolio the right to sell a
specified security, currency or basket of securities or currencies at
the exercise price until the expiration of the option. Purchasing a call
option gives the Portfolio the right to purchase a specified security,
currency or basket of securities or currencies at the exercise price
until the expiration of the option.
The Portfolio also may write (i.e., sell) put and call options on
investments held in its portfolio, as well as with respect to foreign
currency. When the Portfolio has written an option, it receives a
premium, which increases the Portfolio's return on the underlying
security or instrument in the event the option expires unexercised or is
closed out at a profit. However, by writing a call option, the Portfolio
will limit its opportunity to profit from an increase in the market
value of the underlying
<PAGE>
security or instrument above the exercise price of the option for as
long as the Portfolio's obligation as writer of the option continues.
The Portfolio may only write options that are "covered." A covered call
option means that so long as the Portfolio is obligated as the writer of
the option, it will earmark or segregate sufficient liquid assets to
cover its obligations under the option or own (i) the underlying
security or instrument subject to the option, (ii) securities or
instruments convertible or exchangeable without the payment of any
consideration into the security or instrument subject to the option, or
(iii) a call option on the same underlying security with a strike price
no higher than the price at which the underlying instrument was sold
pursuant to a short option position.
By writing (or selling) a put option, the Portfolio incurs an
obligation to buy the security or instrument 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. The Portfolio may
also write options that may be exercised by the purchaser only on a
specific date. The Portfolio that has written a put option will earmark
or segregate sufficient liquid assets to cover its obligations under the
option or will own a put option on the same underlying security with an
equal or higher strike price.
The Portfolio may engage in transactions in options which are traded
on recognized exchanges or over-the-counter. There currently are limited
options markets in many countries, particularly emerging countries such
as Latin American countries, and the nature of the strategies adopted by
the Adviser and the extent to which those strategies are used will
depend on the development of such options markets. The primary risks
associated with the use of options are (i) imperfect correlation between
the change in market value of investments held, purchased or sold by the
Portfolio and the prices of options relating to such investments, and
(ii) possible lack of a liquid secondary market for an option.
STRUCTURED NOTES
Structured Notes are derivatives on which the amount of principal
repayment and/or interest payments is based upon the movement of one or
more factors. These factors include, but are not limited to, currency
exchange rates, interest rates (such as the prime lending rate and
LIBOR) and stock indices such as the S&P 500 Index. In some cases, the
impact of the movements of these factors may increase or decrease
through the use of multipliers or deflators. The Portfolio may use
structured notes to tailor its investments to the specific risks and
returns the Adviser wishes to accept while avoiding or reducing certain
other risks.
SWAPS -- SWAP CONTRACTS
Swaps and Swap Contracts are derivatives in the form of a contract
or other similar instrument in which two parties agree to exchange the
returns generated by a security, instrument, basket or index thereof for
the returns generated by another security, instrument, basket thereof or
index. The payment streams are calculated by reference to a specific
security, index or instrument and an agreed upon notional amount. The
relevant indices include but are not limited to, currencies, fixed
interest rates, prices and total return on interest rate indices, fixed
income indices, stock indices and commodity indices (as well as amounts
derived from arithmetic operations on these indices). For example, the
Portfolio may agree to swap the return generated by a fixed income index
for the return generated by a second fixed income index. The currency
swaps in which the Portfolio may enter will generally involve an
agreement to pay interest streams in one currency based on a specified
index in
<PAGE>
exchange for receiving interest streams denominated in another currency.
Such swaps may involve initial and final exchanges that correspond to
the agreed upon notional amount.
The Portfolio will usually enter into swaps on a net basis, i.e.,
the two return streams are netted out in a cash settlement on the
payment date or dates specified in the instrument, with the Portfolio
receiving or paying, as the case may be, only the net amount of the two
returns. The Portfolio's obligations under a swap agreement will be
accrued daily (offset against any amounts owing to the Portfolio) and
any accrued, but unpaid, net amounts owed to a swap counterparty will be
covered by the maintenance of a segregated account consisting of cash or
liquid securities. The Portfolio will not enter into any swap agreement
unless the counterparty meets the rating requirements set forth in
guidelines established by the Fund's Board of Directors.
Interest rate and total rate of return swaps do not involve the
delivery of securities, other underlying assets, or principal.
Accordingly, the risk of loss with respect to interest rate and total
rate of return swaps is limited to the net amount of payments that the
Portfolio is contractually obligated to make. If the other party to an
interest rate or total rate of return swap defaults, the Portfolio's
risk of loss consists of the net amount of payments that the Portfolio
is contractually entitled to receive. In contrast, currency swaps may
involve the delivery of the entire principal value of one designated
currency in exchange for the other designated currency. Therefore, the
entire principal value of a currency swap may be subject to the risk
that the other party to the swap will default on its contractual
delivery obligations. If there is a default by the counterparty, the
Portfolio may have contractual remedies pursuant to the agreements
related to the transaction. The swaps market has grown substantially in
recent years with a large number of banks and investment banking firms
acting both as principals and as agents utilizing standardized swap
documentation. As a result, the swaps market has become relatively
liquid. Swaps that include caps, floors and collars are more recent
innovations for which standardized documentation has not yet been fully
developed and, accordingly, they are less liquid than "traditional"
swaps.
The use of swaps is a highly specialized activity which involves
investment techniques and risks different from those associated with
ordinary portfolio securities transactions. If the Adviser is incorrect
in its forecasts of market values, interest rates, and currency exchange
rates, the investment performance of the Portfolio would be less
favorable than it would have been if this investment technique were not
used.
--------------
Under the heading "INVESTMENT OBJECTIVE AND POLICIES" on page 10, the first
paragraph is deleted and replaced with the following:
The investment objective of the Portfolio is to provide long-term capital
appreciation. The production of any current income is incidental to this
objective. The Portfolio seeks to achieve its objective by investing primarily
in equity securities of non-U.S. issuers domiciled in the EAFE countries
(defined below). The countries in which the Portfolio will invest are those
comprising the Morgan Stanley Capital International EAFE Index (the "Index"),
which includes Australia, Japan, New Zealand, most nations located in Western
Europe and certain developed countries in Asia, such as Hong Kong and Singapore
(each an "EAFE country," and collectively the "EAFE countries"). At least 65% of
the total assets of the Portfolio will be invested in equity securities of
issuers in at least three different EAFE countries under normal circumstances.
The Portfolio may also invest up to 5% of its total assets in the securities of
issuers domiciled in countries which do not comprise part of the Index. The
Portfolio's investment objective is a fundamental policy which may not be
changed
<PAGE>
without the approval of a majority of the Portfolio's outstanding voting
securities. There is no assurance that the Portfolio will attain its objective.
--------------
The first sentence on page 11 is deleted and replaced with the following:
Although the Portfolio anticipates being fully invested in the equity
securities described above, the Portfolio may invest, under normal circumstances
for cash management purposes, up to 35% of its total 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 fourth bullet point under the heading "FIXED INCOME:" on page 7 of the
Prospectus is deleted and replaced with the following:
- 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.
--------------
PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE
<PAGE>
SUPPLEMENT DATED SEPTEMBER 26, 1997
TO PROSPECTUS DATED MAY 1, 1997
GOLD PORTFOLIO
A PORTFOLIO OF THE
MORGAN STANLEY INSTITUTIONAL FUND, INC. (THE "FUND")
P.O. BOX 2798
BOSTON, MASSACHUSETTS
02208-2798
-------------
The Prospectus is being amended and supplemented to: (i) reflect changes to
the parent of the investment adviser, administrator and the distributor; (ii)
detail the Portfolio's revised investment policies with respect to certain
derivative instruments; and (iii) reflect a change in the definition of high
yield securities with respect to the High Yield Portfolio. The Prospectus is
amended and supplemented as follows:
--------------
On May 31, 1997, Morgan Stanley Group Inc. and Dean Witter, Discover & Co.
merged to form Morgan Stanley, Dean Witter, Discover & Co. Prior thereto, Morgan
Stanley Group Inc. was the direct parent of Morgan Stanley Asset Management Inc.
(the "Adviser") and Morgan Stanley & Co. Incorporated ("Morgan Stanley"). The
Adviser and Morgan Stanley are now subsidiaries of Morgan Stanley, Dean Witter,
Discover & Co.
--------------
The section entitled "FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS" on
pages 13-14 is deleted.
The section entitled "OPTIONS TRANSACTIONS" on page 15 is deleted.
After the section entitled "WHEN-ISSUED AND DELAYED DELIVERY SECURITIES" on
page 17, the following sections are inserted:
DERIVATIVE INSTRUMENTS
The Portfolio is permitted to invest in various derivative
instruments for both hedging and non-hedging purposes. Derivatives
instruments include options, futures and options on futures, structured
investments and structured notes, caps, floors, collars and swaps.
Additionally, the Portfolio may invest in other derivative instruments
that are developed over time if their use would be consistent with the
objectives of the Portfolio. The Portfolio will limit its use of
derivative instruments to 33 1/3% of its total assets measured by the
aggregate notional amount of outstanding derivative instruments. The
Portfolio's investments in forward foreign currency contracts and
derivatives used for hedging purposes are not subject to the limit
described above.
The Portfolio may use derivative instruments under a number of
different circumstances to further its investment objectives. The
Portfolio may use derivatives when doing so provides more liquidity than
the direct purchase of the securities underlying such derivatives. For
example, the Portfolio may purchase derivatives to quickly gain exposure
to a market in response to changes in the Portfolio's investment policy
or upon the inflow of investable cash or when the derivative provides
<PAGE>
greater liquidity than the underlying securities market. The Portfolio
may also use derivatives when it is restricted from directly owning the
underlying securities due to foreign investment restrictions or other
reasons or when doing so provides a price advantage over purchasing the
underlying securities directly, either because of a pricing differential
between the derivatives and securities markets or because of lower
transaction costs associated with the derivatives transaction.
Derivatives may also be used by the Portfolio for hedging purposes and
in other circumstances when the Portfolio's portfolio managers believe
it advantageous to do so consistent with the Portfolio's investment
objective. The Portfolio will not, however, use derivatives in a manner
that creates leverage, except to the extent that the use of leverage is
expressly permitted by the Portfolio's investment policies, and then
only in a manner consistent with such policies.
Some of the derivative instruments in which the Portfolio may invest
and the risks related thereto are described in more detail below.
CAPS, FLOORS AND COLLARS
The Portfolio may invest in caps, floors and collars, which are
instruments analogous to options. In particular, a cap is the right to
receive the excess of a reference rate over a given rate and is
analogous to a put option. A floor is the right to receive the excess of
a given rate over a reference rate and is analogous to a call option.
Finally, a collar is an instrument that combines a cap and a floor. That
is, the buyer of a collar buys a cap and writes a floor, and the writer
of a collar writes a cap and buys a floor. The risks associated with
caps, floors and collars are similar to those associated with options.
In addition, caps, floors and collars are subject to risk of default by
the counterparty because they are privately negotiated instruments.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
The Portfolio may purchase and sell futures contracts and options on
futures contracts, including but not limited to securities index
futures, foreign currency exchange futures, interest rate futures
contracts and other financial futures. Futures contracts provide for the
sale by one party and purchase by another party of a specified amount of
a specific security, instrument or basket thereof, at a specific future
date and at a specified price. An option on a futures contract is a
legal contract that gives the holder the right to buy or sell a
specified amount of futures contracts at a fixed or determinable price
upon the exercise of the option.
The Portfolio may sell securities index futures contracts and/or
options thereon in anticipation of or during a market decline to attempt
to offset the decrease in market value of investments in its portfolio,
or purchase securities index futures in order to gain market exposure.
Subject to applicable laws, the Portfolio may engage in transactions in
securities index futures contracts (and options thereon) which are
traded on a recognized securities or futures exchange, or may purchase
or sell such instruments in the over-the-counter market. There currently
are limited securities index futures and options on such futures in many
countries, particularly emerging countries. The nature of the strategies
adopted by the Adviser, and the extent to which those strategies are
used, may depend on the development of such markets.
The Portfolio may engage in transactions involving foreign currency
exchange futures contracts. Such contracts involve an obligation to
purchase or sell a specific currency at a specified future date and at a
specified price. The Portfolio may engage in such transactions to hedge
their respective
<PAGE>
holdings and commitments against changes in the level of future currency
rates or to adjust their exposure to a particular currency.
The Portfolio may engage in transactions in interest rate futures
transactions. Interest rate futures contracts involve an obligation to
purchase or sell a specific debt security, instrument or basket thereof
at a specified future date at a specified price. The value of the
contract rises and falls inversely with changes in interest rates. The
Portfolio may engage in such transactions to hedge its holdings of debt
instruments against future changes in interest rates.
Financial futures are futures contracts relating to financial
instruments, such as U.S. Government securities, foreign currencies, and
certificates of deposit. Such contracts involve an obligation to
purchase or sell a specific security, instrument or basket thereof at a
specified future date at a specified price. Like interest rate futures
contracts, the value of financial futures contracts rises and falls
inversely with changes in interest rates. The Portfolio may engage in
financial futures contracts for hedging and non-hedging purposes.
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.
Gains and losses on futures contracts and options thereon 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 and options are (i) imperfect
correlation between the change in market value of investments held by
the Portfolio and the prices of futures and options 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 or options contract will be
minimized by only entering into futures contracts or options
transactions 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 both to the low margin deposits
required and the extremely high degree of leverage involved in futures
pricing.
OPTIONS TRANSACTIONS
The Portfolio may seek to increase its return or may hedge its
portfolio investments through options transactions with respect to
securities, instruments, indices or baskets thereof in which the
Portfolio may invest, as well as with respect to foreign currency.
Purchasing a put option gives the Portfolio the right to sell a
specified security, currency or basket of securities or currencies at
the exercise price until the expiration of the option. Purchasing a call
option gives the Portfolio the right to purchase a specified security,
currency or basket of securities or currencies at the exercise price
until the expiration of the option.
The Portfolio also may write (i.e., sell) put and call options on
investments held in its portfolio, as well as with respect to foreign
currency. When the Portfolio has written an option, it receives a
premium, which increases the Portfolio's return on the underlying
security or instrument in the event the option expires unexercised or is
closed out at a profit. However, by writing a call option, the Portfolio
will limit its opportunity to profit from an increase in the market
value of the underlying
<PAGE>
security or instrument above the exercise price of the option for as
long as the Portfolio's obligation as writer of the option continues.
The Portfolio may only write options that are "covered". A covered call
option means that so long as the Portfolio is obligated as the writer of
the option, it will earmark or segregate sufficient liquid assets to
cover its obligations under the option or own (i) the underlying
security or instrument subject to the option, (ii) securities or
instruments convertible or exchangeable without the payment of any
consideration into the security or instrument subject to the option, or
(iii) a call option on the same underlying security with a strike price
no higher than the price at which the underlying instrument was sold
pursuant to a short option position.
By writing (or selling) a put option, the Portfolio incurs an
obligation to buy the security or instrument 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. The Portfolio may
also write options that may be exercised by the purchaser only on a
specific date. The Portfolio that has written a put option will earmark
or segregate sufficient liquid assets to cover its obligations under the
option or will own a put option on the same underlying security with an
equal or higher strike price.
The Portfolio may engage in transactions in options which are traded
on recognized exchanges or over-the-counter. There currently are limited
options markets in many countries, particularly emerging countries such
as Latin American countries, and the nature of the strategies adopted by
the Adviser and the extent to which those strategies are used will
depend on the development of such options markets. The primary risks
associated with the use of options are (i) imperfect correlation between
the change in market value of investments held, purchased or sold by the
Portfolio and the prices of options relating to such investments, and
(ii) possible lack of a liquid secondary market for an option.
STRUCTURED NOTES
Structured Notes are derivatives on which the amount of principal
repayment and/or interest payments is based upon the movement of one or
more factors. These factors include, but are not limited to, currency
exchange rates, interest rates (such as the prime lending rate and
LIBOR) and stock indices such as the S&P 500 Index. In some cases, the
impact of the movements of these factors may increase or decrease
through the use of multipliers or deflators. The Portfolio may use
structured notes to tailor its investments to the specific risks and
returns the Adviser wishes to accept while avoiding or reducing certain
other risks.
SWAPS -- SWAP CONTRACTS
Swaps and Swap Contracts are derivatives in the form of a contract
or other similar instrument in which two parties agree to exchange the
returns generated by a security, instrument, basket or index thereof for
the returns generated by another security, instrument, basket thereof or
index. The payment streams are calculated by reference to a specific
security, index or instrument and an agreed upon notional amount. The
relevant indices include but are not limited to, currencies, fixed
interest rates, prices and total return on interest rate indices, fixed
income indices, stock indices and commodity indices (as well as amounts
derived from arithmetic operations on these indices). For example, the
Portfolio may agree to swap the return generated by a fixed income index
for the return generated by a second fixed income index. The currency
swaps in which the Portfolio may enter will generally involve an
agreement to pay interest streams in one currency based on a specified
index in
<PAGE>
exchange for receiving interest streams denominated in another currency.
Such swaps may involve initial and final exchanges that correspond to
the agreed upon notional amount.
The Portfolio will usually enter into swaps on a net basis, i.e.,
the two return streams are netted out in a cash settlement on the
payment date or dates specified in the instrument, with the Portfolio
receiving or paying, as the case may be, only the net amount of the two
returns. The Portfolio's obligations under a swap agreement will be
accrued daily (offset against any amounts owing to the Portfolio) and
any accrued, but unpaid, net amounts owed to a swap counterparty will be
covered by the maintenance of a segregated account consisting of cash or
liquid securities. The Portfolio will not enter into any swap agreement
unless the counterparty meets the rating requirements set forth in
guidelines established by the Fund's Board of Directors
Interest rate and total rate of return swaps do not involve the
delivery of securities, other underlying assets, or principal.
Accordingly, the risk of loss with respect to interest rate and total
rate of return swaps is limited to the net amount of payments that the
Portfolio is contractually obligated to make. If the other party to an
interest rate or total rate of return swap defaults, the Portfolio's
risk of loss consists of the net amount of payments that the Portfolio
is contractually entitled to receive. In contrast, currency swaps may
involve the delivery of the entire principal value of one designated
currency in exchange for the other designated currency. Therefore, the
entire principal value of a currency swap may be subject to the risk
that the other party to the swap will default on its contractual
delivery obligations. If there is a default by the counterparty, the
Portfolio may have contractual remedies pursuant to the agreements
related to the transaction. The swaps market has grown substantially in
recent years with a large number of banks and investment banking firms
acting both as principals and as agents utilizing standardized swap
documentation. As a result, the swaps market has become relatively
liquid. Swaps that include caps, floors and collars are more recent
innovations for which standardized documentation has not yet been fully
developed and, accordingly, they are less liquid than "traditional"
swaps.
The use of swaps is a highly specialized activity which involves
investment techniques and risks different from those associated with
ordinary portfolio securities transactions. If the Adviser is incorrect
in its forecasts of market values, interest rates, and currency exchange
rates, the investment performance of the Portfolio would be less
favorable than it would have been if this investment technique were not
used.
--------------
The fourth bullet point under the heading "FIXED INCOME:" on page 8 of the
Prospectus is deleted and replaced with the following:
- 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.
--------------
PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE
<PAGE>
SUPPLEMENT DATED SEPTEMBER 26, 1997
TO PROSPECTUS DATED MAY 1, 1997
EQUITY GROWTH PORTFOLIO
EMERGING GROWTH PORTFOLIO
AGGRESSIVE EQUITY PORTFOLIO
PORTFOLIOS OF THE
MORGAN STANLEY INSTITUTIONAL FUND, INC. (THE "FUND")
P.O. BOX 2798
BOSTON, MASSACHUSETTS
02208-2798
-------------
The Prospectus is being amended and supplemented to: (i) reflect changes to
the parent of the investment adviser, administrator and the distributor; (ii)
reflect a change in the portfolio managers of the Emerging Growth Portfolio;
(iii) detail the Portfolios' revised investment policies with respect to certain
derivative instruments; and (iv) reflect a change in the definition of high
yield securities with respect to the High Yield Portfolio. The Prospectus is
amended and supplemented as follows:
--------------
On May 31, 1997, Morgan Stanley Group Inc. and Dean Witter, Discover & Co.
merged to form Morgan Stanley, Dean Witter, Discover & Co. Prior thereto, Morgan
Stanley Group Inc. was the direct parent of Morgan Stanley Asset Management Inc.
(the "Adviser") and Morgan Stanley & Co. Incorporated ("Morgan Stanley"). The
Adviser and Morgan Stanley are now subsidiaries of Morgan Stanley, Dean Witter,
Discover & Co.
--------------
Daniel R. Lascano no longer serves as a portfolio manager for the Emerging
Growth Portfolio. Accordingly, the fourth, fifth and sixth paragraphs on page 23
are deleted and replaced with the following:
EMERGING GROWTH PORTFOLIO -- KURT A. FEUERMAN AND CHRISTOPHER R.
BLAIR. Information about Mr. Feuerman is included under the Equity
Growth Portfolio above. Christopher Blair joined Morgan Stanley Asset
Management Inc. in 1993 as a Security Analyst in the Emerging Growth
Stock Group. He was elected Vice President in 1996. Prior to joining the
Adviser, he was a Financial Analyst for two years in Morgan Stanley's
Corporate Finance Department, where he focused on the telecommunications
and technology sectors. Mr. Blair graduated with Distinction from McGill
University with a B.A. in Economics and Political Science. Mr. Feuerman
and Mr. Blair have shared primary responsibility for managing the
Portfolio's assets since April 1997.
--------------
The section entitled "FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS" on
pages 17-18 is deleted.
The section entitled "OPTIONS TRANSACTIONS" on pages 19-20 is deleted.
After the section entitled "WHEN-ISSUED AND DELAYED DELIVERY SECURITIES" on
pages 21-22, the following sections are inserted:
DERIVATIVE INSTRUMENTS
The Portfolios are permitted to invest in various derivative
instruments for both hedging and non-hedging purposes. Derivatives
instruments include options, futures and options on futures, structured
<PAGE>
investments and structured notes, caps, floors, collars and swaps.
Additionally, the Portfolios may invest in other derivative instruments
that are developed over time if their use would be consistent with the
objectives of the Portfolios. Each Portfolio will limit its use of
derivative instruments to 33 1/3% of its total assets measured by the
aggregate notional amount of outstanding derivative instruments. The
Portfolios' investments in forward foreign currency contracts and
derivatives used for hedging purposes are not subject to the limit
described above.
The Portfolios may use derivative instruments under a number of
different circumstances to further their investment objectives. The
Portfolios may use derivatives when doing so provides more liquidity
than the direct purchase of the securities underlying such derivatives.
For example, a Portfolio may purchase derivatives to quickly gain
exposure to a market in response to changes in the Portfolio's
investment policy or upon the inflow of investable cash or when the
derivative provides greater liquidity than the underlying securities
market. A Portfolio may also use derivatives when it is restricted from
directly owning the underlying securities due to foreign investment
restrictions or other reasons or when doing so provides a price
advantage over purchasing the underlying securities directly, either
because of a pricing differential between the derivatives and securities
markets or because of lower transaction costs associated with the
derivatives transaction. Derivatives may also be used by a Portfolio for
hedging purposes and in other circumstances when a Portfolio's portfolio
managers believe it advantageous to do so consistent with the
Portfolio's investment objective. The Portfolios will not, however, use
derivatives in a manner that creates leverage, except to the extent that
the use of leverage is expressly permitted by a particular Portfolio's
investment policies, and then only in a manner consistent with such
policies.
Some of the derivative instruments in which the Portfolios may
invest and the risks related thereto are described in more detail below.
CAPS, FLOORS AND COLLARS
The Portfolios may invest in caps, floors and collars, which are
instruments analogous to options. In particular, a cap is the right to
receive the excess of a reference rate over a given rate and is
analogous to a put option. A floor is the right to receive the excess of
a given rate over a reference rate and is analogous to a call option.
Finally, a collar is an instrument that combines a cap and a floor. That
is, the buyer of a collar buys a cap and writes a floor, and the writer
of a collar writes a cap and buys a floor. The risks associated with
caps, floors and collars are similar to those associated with options.
In addition, caps, floors and collars are subject to risk of default by
the counterparty because they are privately negotiated instruments.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
The Portfolios may purchase and sell futures contracts and options
on futures contracts, including but not limited to securities index
futures, foreign currency exchange futures, interest rate futures
contracts and other financial futures. Futures contracts provide for the
sale by one party and purchase by another party of a specified amount of
a specific security, instrument or basket thereof, at a specific future
date and at a specified price. An option on a futures contract is a
legal contract that gives the holder the right to buy or sell a
specified amount of futures contracts at a fixed or determinable price
upon the exercise of the option.
<PAGE>
The Portfolios may sell securities index futures contracts and/or
options thereon in anticipation of or during a market decline to attempt
to offset the decrease in market value of investments in its portfolio,
or purchase securities index futures in order to gain market exposure.
Subject to applicable laws, the Portfolios may engage in transactions in
securities index futures contracts (and options thereon) which are
traded on a recognized securities or futures exchange, or may purchase
or sell such instruments in the over-the-counter market. There currently
are limited securities index futures and options on such futures in many
countries, particularly emerging countries. The nature of the strategies
adopted by the Adviser, and the extent to which those strategies are
used, may depend on the development of such markets.
The Portfolios may engage in transactions involving foreign currency
exchange futures contracts. Such contracts involve an obligation to
purchase or sell a specific currency at a specified future date and at a
specified price. The Portfolios may engage in such transactions to hedge
their respective holdings and commitments against changes in the level
of future currency rates or to adjust their exposure to a particular
currency.
The Portfolios may engage in transactions in interest rate futures
transactions. Interest rate futures contracts involve an obligation to
purchase or sell a specific debt security, instrument or basket thereof
at a specified future date at a specified price. The value of the
contract rises and falls inversely with changes in interest rates. The
Portfolios may engage in such transactions to hedge their holdings of
debt instruments against future changes in interest rates.
Financial futures are futures contracts relating to financial
instruments, such as U.S. Government securities, foreign currencies, and
certificates of deposit. Such contracts involve an obligation to
purchase or sell a specific security, instrument or basket thereof at a
specified future date at a specified price. Like interest rate futures
contracts, the value of financial futures contracts rises and falls
inversely with changes in interest rates. The Portfolios may engage in
financial futures contracts for hedging and non-hedging purposes.
Under rules adopted by the Commodity Futures Trading Commission,
each Portfolio may enter into futures contracts and options thereon for
both hedging and non-hedging purposes, provided that not more than 5% of
such 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.
Gains and losses on futures contracts and options thereon 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 and options are (i) imperfect
correlation between the change in market value of investments held by a
Portfolio and the prices of futures and options 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 a Portfolio will be unable to
close out a futures position or options contract will be minimized by
only entering into futures contracts or options transactions 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 both to the low margin deposits required and the
extremely high degree of leverage involved in futures pricing.
<PAGE>
OPTIONS TRANSACTIONS
The Portfolios may seek to increase their returns or may hedge their
portfolio investments through options transactions with respect to
securities, instruments, indices or baskets thereof in which such
Portfolios may invest, as well as with respect to foreign currency.
Purchasing a put option gives a Portfolio the right to sell a specified
security, currency or basket of securities or currencies at the exercise
price until the expiration of the option. Purchasing a call option gives
a Portfolio the right to purchase a specified security, currency or
basket of securities or currencies at the exercise price until the
expiration of the option.
Each Portfolio also may write (i.e., sell) put and call options on
investments held in its portfolio, as well as with respect to foreign
currency. A Portfolio that has written an option receives a premium,
which increases the Portfolio's return on the underlying security or
instrument in the event the option expires unexercised or is closed out
at a profit. However, by writing a call option, a Portfolio will limit
its opportunity to profit from an increase in the market value of the
underlying security or instrument above the exercise price of the option
for as long as the Portfolio's obligation as writer of the option
continues. The Portfolios may only write options that are "covered." A
covered call option means that so long as the Portfolio is obligated as
the writer of the option, it will earmark or segregate sufficient liquid
assets to cover its obligations under the option or own (i) the
underlying security or instrument subject to the option, (ii) securities
or instruments convertible or exchangeable without the payment of any
consideration into the security or instrument subject to the option, or
(iii) a call option on the same underlying security with a strike price
no higher than the price at which the underlying instrument was sold
pursuant to a short option position.
By writing (or selling) a put option, a Portfolio incurs an
obligation to buy the security or instrument 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. The Portfolios
may also write options that may be exercised by the purchaser only on a
specific date. A Portfolio that has written a put option will earmark or
segregate sufficient liquid assets to cover its obligations under the
option or will own a put option on the same underlying security with an
equal or higher strike price.
The Portfolios may engage in transactions in options which are
traded on recognized exchanges or over-the-counter. There currently are
limited options markets in many countries, particularly emerging
countries such as Latin American countries, and the nature of the
strategies adopted by the Adviser and the extent to which those
strategies are used will depend on the development of such options
markets. The primary risks associated with the use of options are (i)
imperfect correlation between the change in market value of investments
held, purchased or sold by a Portfolio and the prices of options
relating to such investments, and (ii) possible lack of a liquid
secondary market for an option.
STRUCTURED NOTES
Structured Notes are derivatives on which the amount of principal
repayment and/or interest payments is based upon the movement of one or
more factors. These factors include, but are not limited to, currency
exchange rates, interest rates (such as the prime lending rate and
LIBOR) and stock indices such as the S&P 500 Index. In some cases, the
impact of the movements of these factors may increase or decrease
through the use of multipliers or deflators. The Portfolios may use
structured
<PAGE>
notes to tailor their investments to the specific risks and returns the
Adviser wishes to accept while avoiding or reducing certain other risks.
SWAPS -- SWAP CONTRACTS
Swaps and Swap Contracts are derivatives in the form of a contract
or other similar instrument in which two parties agree to exchange the
returns generated by a security, instrument, basket or index thereof for
the returns generated by another security, instrument, basket thereof or
index. The payment streams are calculated by reference to a specific
security, index or instrument and an agreed upon notional amount. The
relevant indices include but are not limited to, currencies, fixed
interest rates, prices and total return on interest rate indices, fixed
income indices, stock indices and commodity indices (as well as amounts
derived from arithmetic operations on these indices). For example, a
Portfolio may agree to swap the return generated by a fixed income index
for the return generated by a second fixed income index. The currency
swaps in which the Portfolios may enter will generally involve an
agreement to pay interest streams in one currency based on a specified
index in exchange for receiving interest streams denominated in another
currency. Such swaps may involve initial and final exchanges that
correspond to the agreed upon notional amount.
A Portfolio will usually enter into swaps on a net basis, i.e., the
two return streams are netted out in a cash settlement on the payment
date or dates specified in the instrument, with a Portfolio receiving or
paying, as the case may be, only the net amount of the two returns. A
Portfolio's obligations under a swap agreement will be accrued daily
(offset against any amounts owing to the Portfolio) and any accrued, but
unpaid, net amounts owed to a swap counterparty will be covered by the
maintenance of a segregated account consisting of cash or liquid
securities. A Portfolio will not enter into any swap agreement unless
the counterparty meets the rating requirements set forth in guidelines
established by the Fund's Board of Directors.
Interest rate and total rate of return swaps do not involve the
delivery of securities, other underlying assets, or principal.
Accordingly, the risk of loss with respect to interest rate and total
rate of return swaps is limited to the net amount of payments that a
Portfolio is contractually obligated to make. If the other party to an
interest rate or total rate of return swap defaults, a Portfolio's risk
of loss consists of the net amount of payments that a Portfolio is
contractually entitled to receive. In contrast, currency swaps may
involve the delivery of the entire principal value of one designated
currency in exchange for the other designated currency. Therefore, the
entire principal value of a currency swap may be subject to the risk
that the other party to the swap will default on its contractual
delivery obligations. If there is a default by the counterparty, a
Portfolio may have contractual remedies pursuant to the agreements
related to the transaction. The swaps market has grown substantially in
recent years with a large number of banks and investment banking firms
acting both as principals and as agents utilizing standardized swap
documentation. As a result, the swaps market has become relatively
liquid. Swaps that include caps, floors and collars are more recent
innovations for which standardized documentation has not yet been fully
developed and, accordingly, they are less liquid than "traditional"
swaps.
The use of swaps is a highly specialized activity which involves
investment techniques and risks different from those associated with
ordinary portfolio securities transactions. If the Adviser is incorrect
in its forecasts of market values, interest rates, and currency exchange
rates, the investment performance of the Portfolio would be less
favorable than it would have been if this investment technique were not
used.
<PAGE>
--------------
The fourth bullet point under the heading "FIXED INCOME:" on page 9 of the
Prospectus is deleted and replaced with the following:
- 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.
--------------
PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE
<PAGE>
SUPPLEMENT DATED SEPTEMBER 26, 1997
TO PROSPECTUS DATED MAY 1, 1997
ACTIVE COUNTRY ALLOCATION PORTFOLIO
A PORTFOLIO OF THE
MORGAN STANLEY INSTITUTIONAL FUND, INC. (THE "FUND")
P.O. BOX 2798
BOSTON, MASSACHUSETTS
02208-2798
-------------
The Prospectus is being amended and supplemented to: (i) reflect changes to
the parent of the investment adviser, administrator and the distributor; (ii)
detail the Portfolio's revised investment policies with respect to certain
derivative instruments; and (iii) reflect a change in the definition of high
yield securities with respect to the High Yield Portfolio. The Prospectus is
amended and supplemented as follows:
--------------
On May 31, 1997, Morgan Stanley Group Inc. and Dean Witter, Discover & Co.
merged to form Morgan Stanley, Dean Witter, Discover & Co. Prior thereto, Morgan
Stanley Group Inc. was the direct parent of Morgan Stanley Asset Management Inc.
(the "Adviser") and Morgan Stanley & Co. Incorporated ("Morgan Stanley"). The
Adviser and Morgan Stanley are now subsidiaries of Morgan Stanley, Dean Witter,
Discover & Co.
--------------
The section entitled "FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS" on
pages 12-14 is deleted.
The section entitled "OPTIONS TRANSACTIONS" on pages 14-15 are deleted.
--------------
After the section entitled "WHEN-ISSUED AND DELAYED DELIVERY SECURITIES" on
page 15, the following sections are inserted:
DERIVATIVE INSTRUMENTS
The Portfolio is permitted to invest in various derivative
instruments for both hedging and non-hedging purposes. Derivatives
instruments include options, futures and options on futures, structured
investments and structured notes, caps, floors, collars and swaps.
Additionally, the Portfolio may invest in other derivative instruments
that are developed over time if their use would be consistent with the
objectives of the Portfolio. The Portfolio will limit its use of
derivative instruments to 33 1/3% of its total assets measured by the
aggregate notional amount of outstanding derivative instruments. The
Portfolio's investments in forward foreign currency contracts and
derivatives used for hedging purposes are not subject to the limit
described above.
The Portfolio may use derivative instruments under a number of
different circumstances to further its investment objectives. The
Portfolio may use derivatives when doing so provides more liquidity than
the direct purchase of the securities underlying such derivatives. For
example, the Portfolio may purchase derivatives to quickly gain exposure
to a market in response to changes in the Portfolio's investment policy
or upon the inflow of investable cash or when the derivative provides
greater liquidity than the underlying securities market. The Portfolio
may also use derivatives when it
<PAGE>
is restricted from directly owning the underlying securities due to
foreign investment restrictions or other reasons or when doing so
provides a price advantage over purchasing the underlying securities
directly, either because of a pricing differential between the
derivatives and securities markets or because of lower transaction costs
associated with the derivatives transaction. Derivatives may also be
used by the Portfolio for hedging purposes and in other circumstances
when the Portfolio's portfolio managers believe it advantageous to do so
consistent with the Portfolio's investment objective. The Portfolio will
not, however, use derivatives in a manner that creates leverage, except
to the extent that the use of leverage is expressly permitted by the
Portfolio's investment policies, and then only in a manner consistent
with such policies.
Some of the derivative instruments in which the Portfolio may invest
and the risks related thereto are described in more detail below.
CAPS, FLOORS AND COLLARS
The Portfolio may invest in caps, floors and collars, which are
instruments analogous to options. In particular, a cap is the right to
receive the excess of a reference rate over a given rate and is
analogous to a put option. A floor is the right to receive the excess of
a given rate over a reference rate and is analogous to a call option.
Finally, a collar is an instrument that combines a cap and a floor. That
is, the buyer of a collar buys a cap and writes a floor, and the writer
of a collar writes a cap and buys a floor. The risks associated with
caps, floors and collars are similar to those associated with options.
In addition, caps, floors and collars are subject to risk of default by
the counterparty because they are privately negotiated instruments.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
The Portfolio may purchase and sell futures contracts and options on
futures contracts, including but not limited to securities index
futures, foreign currency exchange futures, interest rate futures
contracts and other financial futures. Futures contracts provide for the
sale by one party and purchase by another party of a specified amount of
a specific security, instrument or basket thereof, at a specific future
date and at a specified price. An option on a futures contract is a
legal contract that gives the holder the right to buy or sell a
specified amount of futures contracts at a fixed or determinable price
upon the exercise of the option.
The Portfolio may sell securities index futures contracts and/or
options thereon in anticipation of or during a market decline to attempt
to offset the decrease in market value of investments in its portfolio,
or purchase securities index futures in order to gain market exposure.
Subject to applicable laws, the Portfolio may engage in transactions in
securities index futures contracts (and options thereon) which are
traded on a recognized securities or futures exchange, or may purchase
or sell such instruments in the over-the-counter market. There currently
are limited securities index futures and options on such futures in many
countries, particularly emerging countries. The nature of the strategies
adopted by the Adviser, and the extent to which those strategies are
used, may depend on the development of such markets.
The Portfolio may engage in transactions involving foreign currency
exchange futures contracts. Such contracts involve an obligation to
purchase or sell a specific currency at a specified future date and at a
specified price. The Portfolio may engage in such transactions to hedge
their respective
<PAGE>
holdings and commitments against changes in the level of future currency
rates or to adjust their exposure to a particular currency.
The Portfolio may engage in transactions in interest rate futures
transactions. Interest rate futures contracts involve an obligation to
purchase or sell a specific debt security, instrument or basket thereof
at a specified future date at a specified price. The value of the
contract rises and falls inversely with changes in interest rates. The
Portfolio may engage in such transactions to hedge its holdings of debt
instruments against future changes in interest rates.
Financial futures are futures contracts relating to financial
instruments, such as U.S. Government securities, foreign currencies, and
certificates of deposit. Such contracts involve an obligation to
purchase or sell a specific security, instrument or basket thereof at a
specified future date at a specified price. Like interest rate futures
contracts, the value of financial futures contracts rises and falls
inversely with changes in interest rates. The Portfolio may engage in
financial futures contracts for hedging and non-hedging purposes.
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.
Gains and losses on futures contracts and options thereon 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 and options are (i) imperfect
correlation between the change in market value of investments held by
the Portfolio and the prices of futures and options 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 or options contract will be
minimized by only entering into futures contracts or options
transactions 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 both to the low margin deposits
required and the extremely high degree of leverage involved in futures
pricing.
OPTIONS TRANSACTIONS
The Portfolio may seek to increase its return or may hedge its
portfolio investments through options transactions with respect to
securities, instruments, indices or baskets thereof in which the
Portfolio may invest, as well as with respect to foreign currency.
Purchasing a put option gives the Portfolio the right to sell a
specified security, currency or basket of securities or currencies at
the exercise price until the expiration of the option. Purchasing a call
option gives the Portfolio the right to purchase a specified security,
currency or basket of securities or currencies at the exercise price
until the expiration of the option.
The Portfolio also may write (i.e., sell) put and call options on
investments held in its portfolio, as well as with respect to foreign
currency. When the Portfolio has written an option, it receives a
premium, which increases the Portfolio's return on the underlying
security or instrument in the event the option expires unexercised or is
closed out at a profit. However, by writing a call option, the Portfolio
will limit its opportunity to profit from an increase in the market
value of the underlying
<PAGE>
security or instrument above the exercise price of the option for as
long as the Portfolio's obligation as writer of the option continues.
The Portfolio may only write options that are "covered." A covered call
option means that so long as the Portfolio is obligated as the writer of
the option, it will earmark or segregate sufficient liquid assets to
cover its obligations under the option or own (i) the underlying
security or instrument subject to the option, (ii) securities or
instruments convertible or exchangeable without the payment of any
consideration into the security or instrument subject to the option, or
(iii) a call option on the same underlying security with a strike price
no higher than the price at which the underlying instrument was sold
pursuant to a short option position.
By writing (or selling) a put option, the Portfolio incurs an
obligation to buy the security or instrument 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. The Portfolio may
also write options that may be exercised by the purchaser only on a
specific date. The Portfolio that has written a put option will earmark
or segregate sufficient liquid assets to cover its obligations under the
option or will own a put option on the same underlying security with an
equal or higher strike price.
The Portfolio may engage in transactions in options which are traded
on recognized exchanges or over-the-counter. There currently are limited
options markets in many countries, particularly emerging countries such
as Latin American countries, and the nature of the strategies adopted by
the Adviser and the extent to which those strategies are used will
depend on the development of such options markets. The primary risks
associated with the use of options are (i) imperfect correlation between
the change in market value of investments held, purchased or sold by the
Portfolio and the prices of options relating to such investments, and
(ii) possible lack of a liquid secondary market for an option.
STRUCTURED NOTES
Structured Notes are derivatives on which the amount of principal
repayment and/or interest payments is based upon the movement of one or
more factors. These factors include, but are not limited to, currency
exchange rates, interest rates (such as the prime lending rate and
LIBOR) and stock indices such as the S&P 500 Index. In some cases, the
impact of the movements of these factors may increase or decrease
through the use of multipliers or deflators. The Portfolio may use
structured notes to tailor its investments to the specific risks and
returns the Adviser wishes to accept while avoiding or reducing certain
other risks.
SWAPS -- SWAP CONTRACTS
Swaps and Swap Contracts are derivatives in the form of a contract
or other similar instrument in which two parties agree to exchange the
returns generated by a security, instrument, basket or index thereof for
the returns generated by another security, instrument, basket thereof or
index. The payment streams are calculated by reference to a specific
security, index or instrument and an agreed upon notional amount. The
relevant indices include but are not limited to, currencies, fixed
interest rates, prices and total return on interest rate indices, fixed
income indices, stock indices and commodity indices (as well as amounts
derived from arithmetic operations on these indices). For example, the
Portfolio may agree to swap the return generated by a fixed income index
for the return generated by a second fixed income index. The currency
swaps in which the Portfolio may enter will generally involve an
agreement to pay interest streams in one currency based on a specified
index in
<PAGE>
exchange for receiving interest streams denominated in another currency.
Such swaps may involve initial and final exchanges that correspond to
the agreed upon notional amount.
The Portfolio will usually enter into swaps on a net basis, i.e.,
the two return streams are netted out in a cash settlement on the
payment date or dates specified in the instrument, with the Portfolio
receiving or paying, as the case may be, only the net amount of the two
returns. The Portfolio's obligations under a swap agreement will be
accrued daily (offset against any amounts owing to the Portfolio) and
any accrued, but unpaid, net amounts owed to a swap counterparty will be
covered by the maintenance of a segregated account consisting of cash or
liquid securities. The Portfolio will not enter into any swap agreement
unless the counterparty meets the rating requirements set forth in
guidelines established by the Fund's Board of Directors.
Interest rate and total rate of return swaps do not involve the
delivery of securities, other underlying assets, or principal.
Accordingly, the risk of loss with respect to interest rate and total
rate of return swaps is limited to the net amount of payments that the
Portfolio is contractually obligated to make. If the other party to an
interest rate or total rate of return swap defaults, the Portfolio's
risk of loss consists of the net amount of payments that the Portfolio
is contractually entitled to receive. In contrast, currency swaps may
involve the delivery of the entire principal value of one designated
currency in exchange for the other designated currency. Therefore, the
entire principal value of a currency swap may be subject to the risk
that the other party to the swap will default on its contractual
delivery obligations. If there is a default by the counterparty, the
Portfolio may have contractual remedies pursuant to the agreements
related to the transaction. The swaps market has grown substantially in
recent years with a large number of banks and investment banking firms
acting both as principals and as agents utilizing standardized swap
documentation. As a result, the swaps market has become relatively
liquid. Swaps that include caps, floors and collars are more recent
innovations for which standardized documentation has not yet been fully
developed and, accordingly, they are less liquid than "traditional"
swaps.
The use of swaps is a highly specialized activity which involves
investment techniques and risks different from those associated with
ordinary portfolio securities transactions. If the Adviser is incorrect
in its forecasts of market values, interest rates, and currency exchange
rates, the investment performance of the Portfolio would be less
favorable than it would have been if this investment technique were not
used.
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The fourth bullet point under the heading "FIXED INCOME:" on page 7 of the
Prospectus is deleted and replaced with the following:
- 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.
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PLEASE RETAIN THIS SUPPLEMENT FOR FUTURE REFERENCE
