<PAGE>
- ------------------------------------------------------------------
DIRECTORS OFFICERS
Barton M. Biggs Stefanie V. Chang
CHAIRMAN OF THE BOARD VICE PRESIDENT
Chairman and Director, Morgan Stanley Asset Management Harold J. Schaaff, Jr.
Inc. and Morgan Stanley VICE PRESIDENT
Asset Management Limited; Managing Joseph P. Stadler
Director, Morgan Stanley & Co. Incorporated VICE PRESIDENT
Michael F. Klein Valerie Y. Lewis
DIRECTOR AND PRESIDENT SECRETARY
Principal, Morgan Stanley Asset Management Inc. and Karl O. Hartmann
Morgan Stanley & Co. Incorporated ASSISTANT SECRETARY
John D. Barrett II Joanna M. Haigney
Chairman and Director, TREASURER
Barrett Associates, Inc. Rene J. Feuerman
Gerard E. Jones ASSISTANT TREASURER
Partner, Richards & O'Neil LLP
Andrew McNally IV
River Road Partners
Samuel T. Reeves
Chairman of the Board and Chief Executive Officer,
Pinacle L.L.C.
Fergus Reid
Chairman and Chief Executive Officer, LumeLite
Plastics Corporation
Frederick O. Robertshaw
Of Counsel, Copple, Chamberlin &
Boehm, P.C.
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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
1221 Avenue of the Americas
New York, New York 10020
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CUSTODIANS
The Chase Manhattan Bank
3 Chase MetroTech Center
Brooklyn, New York 11245
Morgan Stanley Trust Company
One Pierrepont Plaza
Brooklyn, New York 11210
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LEGAL COUNSEL
Morgan, Lewis & Bockius LLP
2000 One Logan Square
Philadelphia, Pennsylvania 19103
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INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York 10036
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For current performance, current net asset value, or for assistance with your
account, please contact the Fund at (800) 548-7786. This report is authorized
for distribution only when preceded or accompanied by prospectuses of the Morgan
Stanley Institutional Fund, Inc.
[LOGO] MORGAN STANLEY
INSTITUTIONAL FUND, INC.
P.O. Box 2798
Boston, MA 02208-2798
[LOGO] MORGAN STANLEY
INSTITUTIONAL FUND, INC.
VALUE EQUITY PORTFOLIO
FIRST QUARTER REPORT
MARCH 31, 1998
<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 should outperform
the market over the long-term, and would be expected to preserve principal in a
difficult market environment.
PERFORMANCE COMPARED TO THE S&P 500 INDEX AND THE INDATA EQUITY-MEDIAN INDEX(1)
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<TABLE>
<CAPTION>
TOTAL RETURNS(2)
----------------------------------------------
AVERAGE
AVERAGE ANNUAL
ANNUAL FIVE SINCE
YTD ONE YEAR YEARS INCEPTION
--------- --------- ----------- -----------
<S> <C> <C> <C> <C>
PORTFOLIO--CLASS A.......... 13.44% 43.57% 20.17% 16.19%
PORTFOLIO--CLASS B.......... 13.39 43.25 N/A 27.68
S&P 500 INDEX--CLASS A...... 13.95 47.99 22.40 19.16
INDATA EQUITY-MEDIAN
INDEX--CLASS A............. 12.25 44.14 19.97 17.70
S&P 500 INDEX--CLASS B...... 13.95 47.99 N/A 31.68
INDATA EQUITY-MEDIAN
INDEX--CLASS B............. 12.25 44.14 N/A 28.53
</TABLE>
1. The S&P 500 Index and the Indata Equity-Median Index are unmanaged indices
of common stocks. The Indata Equity-Median Index includes an average asset
allocation of 7% cash and 93% equity based on $544 billion in assets among
1,251 portfolios as of March 31, 1998.
2. Total returns for the Portfolio reflect expenses waived and reimbursed, if
applicable, by the Adviser. Without such waiver and reimbursement, total
returns would be lower.
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
- ------------------------------
THE PERFORMANCE RESULTS PROVIDED ARE FOR INFORMATIONAL PURPOSES ONLY AND SHOULD
NOT BE CONSTRUED AS A GUARANTEE OF THE PORTFOLIO'S FUTURE PERFORMANCE. PAST
PERFORMANCE SHOWN IS NOT PREDICTIVE OF FUTURE PERFORMANCE. INVESTMENT RETURN AND
PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY
BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST.
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 a high dividend yield.
We limit our universe of investments to larger, liquid stocks. This is a
list similar to the S&P 500.
For the three months ended March 31, 1998, the Portfolio had a total return of
13.44% for the Class A shares and 13.39% for the Class B shares compared to a
total return of 13.95% for the S&P 500 Index and 12.25% for the Indata
Equity-Median Index. For the one year ended March 31, 1998, the Portfolio had a
total return of 43.57% for the Class A shares and 43.25% for the Class B shares
as compared to a total return of 47.99% for the S&P 500 Index and 44.14% for the
Indata Equity-Median Index. For the five year period ended March 31, 1998, the
average annual total return of Class A was 20.17% compared to 22.40% for the S&P
500 Index and 19.97% for the Indata Equity-Median Index. From inception on
January 31, 1990 through March 31, 1998, the average annual total return of
Class A was 16.19% compared to 19.16% for the S&P 500 Index and 17.70% for the
Indata Equity-Median Index. From inception on January 2, 1996 through March 31,
1998, the average annual total return of Class B was 27.68% compared to 31.68%
for the S&P 500 Index and 28.53% for the Indata Equity-Median Index.
The Portfolio holds undervalued companies with a wide valuation gap as compared
to the characteristics of the S&P 500:
<TABLE>
<CAPTION>
PRICE-EARNINGS PRICE-BOOK
----------------- -----------------
<S> <C> <C>
VALUE EQUITY PORTFOLIO......... 18.0X 3.7X
S&P 500........................ 27.0X 6.0X
</TABLE>
A rough beginning to the quarter in early January developed into a surprisingly
resilient market and double
2
<PAGE>
digit gains. Profit concerns subsided early in the quarter as fourth quarter
earnings releases failed to generate any significant surprises. Views on Asia
continued to shift during the quarter, subsiding as evidence appeared of a
strengthening U.S. economy and employment, and resurfacing as new evidence of
earnings pressure appeared. However, even reduced first quarter earnings
expectations did not prevent the market from setting new highs. A strong
economy, low inflation, low interest rates, favorable liquidity and a reasonable
profit outlook beyond the first quarter were the prevailing factors that drove
the market.
Large cap stocks continued to outperform small cap stocks and growth
outperformed value during the first quarter. The larger cap Russell 1000
returned 13.30% for the quarter compared to the smaller cap Russell 2000 return
of 10.11%. The Russell 1000 Value Index increased 11.66% for the quarter
compared to the Russell 1000 Growth Index return of 15.01%.
During the quarter, the best performing sectors in the Portfolio were consumer
durables, up 24%, retail, also up 24%, and technology, up 19%. Underperforming
sectors for the quarter included consumer non-durables, down 6%, capital goods,
up 5%, and energy, up 6%. The best performing stocks in the quarter were Banc
One, up 29%, Meritor Automotive, JC Penney, and United Technologies, all up 27%.
Stocks providing the biggest disappointment included Philip Morris, down 7%,
Texas Utilities, down 4%, Atlantic Richfield, down 1%, and Litton Industries, up
0.3%.
Changes made to the Portfolio included increasing the exposure to the consumer
durable sector, while decreasing the consumer non-durable exposure. We added to
the Borg Warner Automotive and General Motors positions as valuations remained
attractive and fundamentals remained intact. In consumer non-durables, we sold
the RJR Nabisco position as the tobacco legislative outlook deteriorated in
Congress. At the same time, we slightly increased the position in Philip Morris,
a less contrarian tobacco name which is financially stronger to weather the
coming tobacco battles.
We added to the energy stocks opportunistically after oil prices appeared to
bottom and the sector sold off. In the financial services sector, we sold the
remaining First of America position, as the merger with National City Corp.
neared, and added a position in Allstate which should benefit from improving
trends in the insurance claim area. In the chemical sector, we established a new
position in Millennium Chemicals. We expect Millennium's highly incentivized
management team to eventually exit the lower value commodity businesses and grow
the higher margin operations which should drive both earnings growth and
valuation. In retail, we sold Wal Mart as the stock performed extremely well,
and reached what we felt was fair value.
Within the aircraft and defense sectors, we sold the positions in Gulfstream
Aerospace and Lockheed Martin, and established new positions in Northrop Grumman
and Thiokol. We established the Northrop Grumman position after their proposed
merger with Lockheed Martin appeared to fall apart. Northrop Grumman remains a
strong fundamental franchise which, if it remains independent, will benefit as a
consolidator of the defense industry. Thiokol has quietly become an industrial
conglomerate and is currently benefiting from the upturn in the commercial
aircraft sector, stabilization in its defense business and strong capital
spending. In the transportation area, we sold American Airlines, while adding to
Continental Airlines and establishing a new position in Northwest Airlines. We
believe the proposed Continental/Northwest alliance should yield significant
long term benefits to both carriers.
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
Philip W. Friedman
PORTFOLIO MANAGER
April 1998
3
<PAGE>
INVESTMENTS (UNAUDITED)
- ----------
MARCH 31, 1998
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- --------------- --------
<C> <S> <C>
COMMON STOCKS (97.4%)
BASIC MATERIALS (7.6%)
37,700 E.I. du Pont de Nemours & Co. $ 2,564
16,900 Georgia-Pac 1,094
80,000 Louisiana-Pacific Corp. 1,860
36,800 Millennium Chemicals, Inc. 1,233
24,000 Phelps Dodge Corp. 1,549
--------
8,300
--------
CAPITAL GOODS (13.2%)
59,500 Case Corp. 4,053
25,200 Northrop Grumman Corp. 2,707
14,400 Philips Electronics N.V. (New York
Shares) 1,058
51,200 Thiokol Corp. 2,474
44,500 United Technologies Corp. 4,108
--------
14,400
--------
COMMUNICATION SERVICES (6.6%)
43,700 AT&T Corp. 2,868
26,800 Sprint Corp. 1,814
45,800 U.S. WEST Communications Group 2,507
--------
7,189
--------
CONSUMER CYCLICALS (12.9%)
27,100 Borg-Warner Automotive, Inc. 1,738
49,500 General Motors Corp. 3,338
29,500 J.C. Penney Co., Inc. 2,233
90,866 Meritor Automotive, Inc. 2,413
73,800 Ogden Corp. 2,122
90,000 Woolworth Corp. 2,250
--------
14,094
--------
CONSUMER STAPLES (2.6%)
69,200 Philip Morris Cos., Inc. 2,885
--------
ENERGY (9.8%)
48,600 Ashland, Inc. 2,752
31,700 Atlantic Richfield Co. 2,492
33,700 Mobil Corp. 2,582
76,400 USX-Marathon Group 2,875
--------
10,701
--------
FINANCIAL (24.5%)
11,600 Allstate Corp. 1,067
36,500 American General Corp. 2,361
20,930 Banc One Corp. 1,324
<CAPTION>
VALUE
SHARES (000)
- --------------- --------
<C> <S> <C>
25,300 BankAmerica Corp. $ 2,090
19,700 BankBoston Corp. 2,172
21,100 Bankers Trust (New York) Corp. 2,539
19,100 Chase Manhattan Corp. 2,576
19,400 Fleet Financial Group, Inc. 1,650
37,000 Lincoln National Corp. 3,140
31,500 Mellon Bank Corp. 2,000
34,400 PNC Bank Corp. 2,062
34,475 SLM Holding Corp. 1,504
24,500 St. Paul Cos., Inc. 2,184
--------
26,669
--------
HEALTH CARE (0.9%)
22,000 Bausch & Lomb, Inc. 1,005
--------
TECHNOLOGY (8.0%)
50,600 Harris Corp. 2,638
31,700 Litton Industries, Inc. 1,829
51,100 SABRE Group Holdings, Inc. 1,833
44,178 Texas Instruments, Inc. 2,391
--------
8,691
--------
TRANSPORTATION (5.7%)
70,600 Continental Airlines, Inc., Class
B 4,152
15,200 Northwest Airlines Corp., Class A 938
29,300 Ryder System, Inc. 1,113
--------
6,203
--------
UTILITIES (5.6%)
87,600 NIPSCO Industries, Inc. 2,453
46,900 Pinnacle West Capital Corp. 2,084
40,300 Texas Utilities Co. 1,584
--------
6,121
--------
TOTAL COMMON STOCKS (Cost $82,913) 106,258
--------
<CAPTION>
FACE
AMOUNT
(000)
- ---------------
<C> <S> <C>
SHORT-TERM INVESTMENT (2.5%)
REPURCHASE AGREEMENT (2.5%)
$ 2,734 Chase Securities, Inc. 5.60%,
dated 3/31/98, due 4/01/98, to be
repurchased at $2,734,
collateralized by U.S. Treasury
Notes, 6.250%, due 4/30/01,
valued at $2,796 (Cost $2,734) 2,734
--------
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
AMOUNT
(000)
--------
<C> <S> <C>
TOTAL INVESTMENTS (99.9%) (Cost $85,647) $108,992
--------
OTHER ASSETS AND LIABILITIES (0.1%)
Other Assets 5,290
Liabilities (5,235)
--------
55
--------
NET ASSETS (100%) $109,047
--------
--------
CLASS A:
NET ASSETS $106,083
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 6,866,145 outstanding $.001 par value
shares (authorized 500,000,000 shares) $15.45
--------
--------
CLASS B:
NET ASSETS $2,964
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 192,337 outstanding $.001 par value
shares (authorized 500,000,000 shares) $15.41
--------
--------
</TABLE>
5
