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<S> <C>
DIRECTORS OFFICERS
Barton M. Biggs James W. Grisham
CHAIRMAN OF THE BOARD VICE PRESIDENT
Chairman and Director, Morgan Stanley Michael F. Klein
Asset Management Inc. and Morgan Stanley VICE PRESIDENT
Asset Management Limited; Managing Harold J. Schaaff,
Director, Morgan Stanley & Co. Jr.
Incorporated; Director, Morgan Stanley VICE PRESIDENT
Group Inc. Joseph P. Stadler
Warren J. Olsen VICE PRESIDENT
DIRECTOR AND PRESIDENT Valerie Y. Lewis
Principal, Morgan Stanley Asset SECRETARY
Management Inc. and Morgan Stanley & Co. Karl O. Hartmann
Incorporated ASSISTANT SECRETARY
John D. Barrett II James R. Rooney
Chairman and Director, TREASURER
Barrett Associates, Inc. Joanna M. Haigney
Gerard E. Jones ASSISTANT TREASURER
Partner, Richards & O'Neil LLP
Andrew McNally IV
Chairman and Chief Executive Officer, Rand
McNally
Samuel T. Reeves
Chairman of the Board and CEO, Pinacle
L.L.C.
Fergus Reid
Chairman and Chief Executive Officer,
LumeLite Corporation
Frederick O. Robertshaw
Of Counsel, Bryan, Cave LLP
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INVESTMENT ADVISER AND ADMINISTRATOR
Morgan Stanley Asset Management Inc.
1221 Avenue of the Americas
New York, New York 10020
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DISTRIBUTOR
Morgan Stanley & Co. Incorporated
1251 Avenue of the Americas
New York, New York 10020
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CUSTODIANS
The Chase Manhattan Bank
770 Broadway
New York, New York 10003
Morgan Stanley Trust Company
One Pierrepont Plaza
Brooklyn, New York 11210
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LEGAL COUNSEL
Morgan, Lewis & Bockius LLP
2000 One Logan Square
Philadelphia, Pennsylvania 19103
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INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York 10036
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For current performance, current net asset value, or for assistance with your
account, please contact the Fund at (800) 548-7786. This report is authorized
for distribution only when preceded or accompanied by prospectuses of the Morgan
Stanley Institutional Fund, Inc.
[LOGO] MORGAN STANLEY
INSTITUTIONAL FUND, INC.
P.O. Box 2798
Boston, MA 02208-2798
[LOGO] MORGAN STANLEY
INSTITUTIONAL FUND, INC.
VALUE EQUITY PORTFOLIO
FIRST QUARTER REPORT
MARCH 31, 1997
<PAGE>
LETTER TO SHAREHOLDERS
- -------
Our value investment philosophy for the Value Equity Portfolio is based on the
premise that a diversified portfolio of undervalued securities will outperform
the market over the long-term, and can be expected to preserve principal in a
difficult market environment.
Key aspects of our philosophy are as follows:
Reversion to mean valuation levels (return to the long term average) is the
most consistent and powerful force in investing.
We buy companies selling at less than our research measures to be their true
worth.
Our Portfolio is characterized by a distinctly below average
price-to-earnings ratio, price-to-book ratio, and an above average dividend
yield.
We limit our universe of investments to larger, liquid stocks. This is a
list similar to the S&P 500.
Investment decisions are based on research undertaken by the Morgan Stanley
Asset Management/ Chicago investment team.
PERFORMANCE COMPARED TO THE S&P 500 INDEX AND THE INDATA EQUITY-MEDIAN INDEX(1)
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<TABLE>
<CAPTION>
TOTAL RETURNS(2)
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AVERAGE
ONE ANNUAL AVERAGE ANNUAL
YTD YEAR FIVE YEARS SINCE INCEPTION
--------- --------- ----------- ---------------
<S> <C> <C> <C> <C>
PORTFOLIO--CLASS A........ 2.09% 15.83% 15.55% 12.81%
PORTFOLIO--CLASS B(3)..... 1.87 15.45 NA 16.40
S&P 500................... 2.69 19.84 16.41 15.56
INDATA EQUITY-MEDIAN...... 0.42 15.37 9.94 14.41
</TABLE>
1. The S&P 500 Stock Index and the Indata Equity-Median Index are unmanaged
indices of common stocks. The Indata Equity-Median Index includes an average
asset allocation of 8% cash and 92% equity based on $440.5 billion in assets
among 1,254 portfolios for the period ended March 31, 1997.
2. Total returns for the Portfolio reflect expenses waived and reimbursed, if
applicable, by the Adviser. Without such waiver and reimbursement, total
returns would be lower.
3. The Portfolio began offering Class B shares on January 2, 1996.
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
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THE PERFORMANCE RESULTS PROVIDED ARE FOR INFORMATIONAL PURPOSES ONLY AND SHOULD
NOT BE CONSTRUED AS A GUARANTEE OF THE PORTFOLIO'S FUTURE PERFORMANCE. PAST
PERFORMANCE SHOWN IS NOT PREDICTIVE OF FUTURE PERFORMANCE. INVESTMENT RETURN AND
PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY
BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST.
For the three months ended March 31, 1997, the Portfolio had a total return of
2.09% for the Class A shares and 1.87% for the Class B shares, as compared to a
total return of 2.69% for the S&P 500 Index and 0.42% for the Indata
Equity-Median Index. The average annual total return for the one year and
five-year periods ended March 31, 1997 and for the period from inception on
January 31, 1990 through March 31, 1997 was 15.83%, 15.55% and 12.81%,
respectively, for the Class A shares as compared to 19.84%, 16.41% and 15.56%,
respectively, for the S&P 500 Index and 15.37%, 9.94% and 14.41%, respectively,
for the Indata Equity-Median Index. According to Lipper Mutual Funds Quarterly,
the average equity-income mutual fund (value-style fund) had a return of 1.68%
in the quarter ended March 31, 1997, while the average general equity fund
declined -1.98%.
The Portfolio holds undervalued companies with a wide valuation gap as compared
to the characteristics of the S&P 500 Index:
<TABLE>
<CAPTION>
PRICE-EARNINGS PRICE-TO-BOOK
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<S> <C> <C>
VALUE EQUITY PORTFOLIO............... 15.1X 2.6X
S&P 500.............................. 19.7X 4.9X
</TABLE>
After having a very strong January, driven by favorable earnings reports, solid
mutual fund inflows, and benign interest rates, the market weakened considerably
in February and March. The broad-based S&P 500 and the Dow Jones Industrial
Average peaked in mid-February and mid-March, respectively, both finishing the
quarter down 7% from their first quarter highs. The Nasdaq Composite, dominated
by technology stocks, began to weaken earlier than the broader market, and ended
the quarter down 12% from its January high. As the economy continued its advance
from the fourth quarter of 1996, investors focused on the possibility of
interest rate increases. Public comments made by the Fed Chairman added to these
fears, which were confirmed by the .25% increase in the Federal funds rate made
in late March.
Within this environment, large-cap stocks continued to outperform small-cap
stocks and growth stocks outperformed value stocks. The larger-cap S&P 500
returned 2.6% while the S&P small cap index returned -5.57%. The S&P/Barron
Growth Index returned 3.5% while the S&P/Barron Value Index returned 1.7%.
2
<PAGE>
During the quarter, the best performing sectors in the Portfolio were health
care, up 12%, services and growth, up 10%, and technology, also up 10%.
Underperforming sectors for the quarter included transportation, down 6%, paper
and forest products, down 5%, and utilities and consumer durables, both down 4%.
The best performing stocks in the quarter were Texas Instruments, up 18%,
Sprint, up 14%, Bausch & Lomb, also up 14%, Harris Corp., up 13%, and Ogden,
also up 13%. Stocks providing the biggest disappointment included Texas
Utilities, down 15%, AT&T, also down 15%, Apple Computer, down 13%, and
Willamette Industries, down 10%.
Changes made to the Portfolio during the quarter included decreasing the
exposure to consumer staples by selling the final position in American Brands.
We added to the energy sector with Occidental Petroleum. Occidental, one of the
more efficient oil and gas exploration and production companies, is in the
process of transforming its business mix, has reduced debt and cut costs, and is
attractive on a valuation basis. We established a partial position in Olin, a
chemical company that is also restructuring its businesses, selling assets,
paying down debt and generating cash for additional value-added actions.
Finally, we increased exposure to the retail sector by purchasing Wal-Mart.
Wal-Mart began generating positive free cash flow in 1996 and recently announced
a 30% dividend increase and a stock buyback program. Compared to the S&P 500
Index, we continue to overweight financial services and utilities, and
underweight technology and health care.
Stephen C. Sexauer
PORTFOLIO MANAGER
Alford E. Zick, Jr.
PORTFOLIO MANAGER
April 1997
3
<PAGE>
INVESTMENTS (UNAUDITED)
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MARCH 31, 1997
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- --------------- ---------
<C> <S> <C>
COMMON STOCKS (98.7%)
AEROSPACE (1.1%)
14,700 United Technologies Corp. $ 1,106
---------
BANKING (14.5%)
16,950 BankAmerica Corp. 1,708
24,600 Bankers Trust (New York) Corp. 2,017
26,100 Bank of Boston Corp. 1,749
25,200 Chase Manhattan Corp. 2,359
43,400 First of America Bank Corp. 2,593
33,350 Mellon Bank Corp. 2,426
56,900 PNC Bank Corp. 2,276
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15,128
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CAPITAL GOODS (2.2%)
52,300 Deere & Co. 2,275
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CHEMICALS (2.4%)
39,175 Eastman Chemical Co. 2,106
10,400 Olin Corp. 413
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2,519
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COMMUNICATIONS (7.0%)
84,600 AT&T Corp. 2,940
48,700 Sprint Corp. 2,216
65,000 U.S. West, Inc. 2,210
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7,366
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CONSUMER-DURABLES (3.4%)
61,300 Chrysler Corp. 1,839
31,100 General Motors Corp. 1,722
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3,561
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CONSUMER-RETAIL (6.5%)
56,700 J.C. Penney Co., Inc. 2,700
41,800 Wal-Mart Stores, Inc. 1,165
127,300 Woolworth Corp. 2,976
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6,841
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CONSUMER-SERVICE & GROWTH (3.6%)
12,900 Eastman Kodak Co. 979
130,000 Ogden Corp. 2,746
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3,725
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CONSUMER-STAPLES (8.0%)
136,500 Fleming Cos., Inc. 2,389
26,600 Philip Morris Cos., Inc. 3,036
93,000 RJR Nabisco Holdings Corp. 2,999
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8,424
---------
<CAPTION>
VALUE
SHARES (000)
- --------------- ---------
<C> <S> <C>
ENERGY (9.7%)
53,700 Ashland, Inc. $ 2,161
23,000 Atlantic Richfield Co. 3,105
17,000 Exxon Corp. 1,832
15,400 Mobil Corp. 2,012
42,800 Occidental Petroleum Corp. 1,054
---------
10,164
---------
ELECTRIC (0.4%)
13,562 Energy Group plc ADR 436
---------
FINANCIAL-DIVERSIFIED (2.9%)
31,550 Student Loan Marketing Association 3,005
---------
HEALTH CARE (4.0%)
64,100 Bausch & Lomb, Inc. 2,532
38,700 Baxter International, Inc. 1,669
---------
4,201
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INDUSTRIAL (3.1%)
13,562 Hanson plc ADR 309
45,100 Rockwell International Corp. 2,926
---------
3,235
---------
INSURANCE (6.1%)
53,700 American General Corp. 2,188
41,100 Lincoln National Corp. 2,199
31,600 St. Paul Cos., Inc. 2,050
---------
6,437
---------
METALS (0.9%)
12,500 Phelps Dodge Corp. 914
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PAPER & PACKAGING (4.2%)
105,800 Louisiana-Pacific Corp. 2,195
35,400 Willamette Industries, Inc. 2,213
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4,408
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SERVICES (1.4%)
28,400 McGraw-Hill Cos., Inc. 1,452
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TECHNOLOGY (5.4%)
33,800 Apple Computer, Inc. 617
39,900 Harris Corp. 3,067
25,689 Texas Instruments, Inc. 1,923
---------
5,607
---------
TRANSPORTATION (3.2%)
17,200 AMR Corp. 1,419
</TABLE>
4
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<TABLE>
<CAPTION>
VALUE
SHARES (000)
- --------------- ---------
<C> <S> <C>
TRANSPORTATION (CONTINUED)
64,700 Ryder System, Inc. $ 1,892
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3,311
---------
UTILITIES (8.7%)
75,000 GPU, Inc. 2,409
61,700 NIPSCO Industries, Inc. 2,422
72,800 Pinnacle West Capital Corp. 2,193
60,400 Texas Utilities Co. 2,069
---------
9,093
---------
TOTAL COMMON STOCKS (Cost $87,990) 103,208
---------
TOTAL INVESTMENTS (98.7%) (Cost $87,990) 103,208
---------
OTHER ASSETS AND LIABILITIES (1.3%)
Other Assets 1,990
Liabilities (603)
---------
1,387
---------
NET ASSETS (100%) $ 104,595
---------
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CLASS A:
NET ASSETS $102,872
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 7,252,895 outstanding $0.001 par
value shares (authorized 500,000,000 shares) $14.18
---------
---------
CLASS B:
NET ASSETS $1,723
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 121,832 outstanding $0.001 par value
shares (authorized 500,000,000 shares) $14.15
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---------
</TABLE>
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ADR -- American Depositary Receipt
5
