<PAGE>
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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. Belinda A. Brady
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
PricewaterhouseCoopers 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.
ASIAN REAL ESTATE PORTFOLIO
THIRD QUARTER REPORT
SEPTEMBER 30, 1998
<PAGE>
LETTER TO SHAREHOLDERS
- -------
PERFORMANCE COMPARED TO THE GPR LIFE FAR EAST ASIA REAL ESTATE T.R. INDEX(1)
- ----------------------------------------------------
<TABLE>
<CAPTION>
TOTAL RETURNS(2)
--------------------------
YTD SINCE INCEPTION
--------- ---------------
<S> <C> <C>
PORTFOLIO--CLASS A(3)................. -41.57% -53.21%
PORTFOLIO--CLASS B(3)................. -41.97 -53.41
INDEX................................. -39.82 -60.23
</TABLE>
1. The GPR Life Far East Asia Real Estate T.R. Index is a Far East market
capitalization weighted index of listed property/real estate securities
measuring total return.
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 commenced operations on October 1, 1997.
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
- ------------------------------
THE INFORMATION CONTAINED IN THIS OVERVIEW REGARDING SPECIFIC SECURITIES IS FOR
INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE CONSTRUED AS A RECOMMENDATION TO
PURCHASE OR SELL THE SECURITIES MENTIONED. THE COUNTRY SPECIFIC 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. PLEASE SEE THE PROSPECTUS FOR A DESCRIPTION OF CERTAIN
RISK CONSIDERATIONS ASSOCIATED WITH INTERNATIONAL INVESTING.
The investment objective of the Asian Real Estate Portfolio is to provide
long-term capital appreciation by investing primarily in equity securities of
companies in the Asian real estate industry whose shares trade on a recognized
stock exchange in Asia and in equity securities of companies organized under the
laws of an Asian country whose business is conducted principally in Asia.
For the nine months ended September 30, 1998, the Portfolio had a total return
of -41.57% for Class A shares and -41.97% for Class B shares compared to -39.82%
for the GPR Life Far East Asia Real Estate T.R. Index (the "Index"). From
inception on October 1, 1997 through September 30, 1998, the Portfolio had a
total return of -53.21% for Class A shares and -53.41% for Class B shares
compared to -60.23% for the Index.
For the three months ended September 30, 1998, the Portfolio had a total return
of -17.59% for the Class A shares and -17.68% for the Class B shares compared to
- -17.61% for the Index. The Portfolio's slight underperformance during the third
quarter was due to our overweight position in Singapore, which had a relatively
weak showing.
MACRO-ECONOMIC BACKDROP
The Asian financial crisis intensified during the third quarter when
Japanese economic and financial sector reforms were hindered by the country's
weak political structure and inability of its leaders to institute effective
policy responses. Consequently, the sharp weakening of the yen against the U.S.
dollar resulted in higher risk premia for the rest of Asia and redirected
investors' attention to the grim implications of a possible devaluation of the
Chinese currency, the RMB, on Non-Japan Asia. The contagion was further
aggravated in the third quarter with Russia's implosion and currency turmoil in
Latin America, posing a significant threat to the stability of the global
economy and financial system.
The real economies of Japan, Hong Kong, Indonesia, Korea, Malaysia and Thailand
moved into negative growth territory by the second quarter of 1998. Economic
fundamentals in Hong Kong continued to deteriorate with unemployment figures
rising to a 15-year high of 5%. In addition to pressure from fears of a RMB
devaluation, the government's recent intervention in the stock and futures
market introduced doubts that the SAR was no longer able to withstand further
downward adjustment in asset prices and that the operations of the Hong Kong
dollar peg will be severely compromised. In Malaysia, capital controls on the
ringgit were introduced after its gross domestic product contracted 6.8% in the
second quarter of 1998. This is expected to negatively
2
<PAGE>
impact trade and ringgit-related financial activities in neighboring Singapore.
The political feud between Malaysia's prime minister and his sacked deputy
sharply escalated fears of political upheavals within the ruling UMNO party.
Even Taiwan's robust real economy is showing signs of slowing down despite the
cut in bank reserve requirements. Turmoil in global financial markets continues
to weigh heavily on Australia--while inflation is under control, further slowing
is expected ahead.
Asian governments have shifted their policy objectives toward an easier monetary
stance. The possibility of concerted efforts by the U.S. and G7 countries to
ease global interest rates will play a critical role in helping Asia repair its
debt-ridden economies and restore confidence.
REAL ESTATE MARKETS
The severity of economic contraction throughout Asia has curtailed demand for
real estate, particularly in the office and residential sectors. The office
sector, for instance, saw rents coming under severe pressure in service-oriented
city-states such as Hong Kong and Singapore. In Hong Kong, the going rate for
prime offices in the Central Business District (CBD) has fallen from Hong Kong
$77 per square foot per month to about Hong Kong $40 per square foot per month.
Vacancy rates are expected to rise further when at least 8 million square feet
of newly completed office space come on-stream starting from the second half of
1998 onwards. Capital values are expected to face severe downward adjustments
because of the negative carry of asset financing. In Singapore, prime CBD office
vacancy rose quickly as existing tenants sought newer and cheaper alternatives
at fringe locations.
The mass residential market continues to suffer from the predicament of
collapsing demand. Fears of rising unemployment, weak confidence in economic
recovery, and restrictive financing from banks in the near term will further
depress residential prices. With a huge overhang of 25,000 primary units for
sale in the next six months, some Hong Kong developers have started to clear
inventory by selling at below breakeven prices to generate cash flow. In
response to the sharp decline in residential property prices, the Hong Kong
government had recently removed a series of anti-speculation measures to help
boost residential transaction volumes. Also the Hong Kong Exchange Fund has
announced that it will be injecting some Hong Kong $2 billion into the Honk Kong
Monetary Authority, which could be used to buy billions worth of existing
mortgages from the banking system, thereby improving liquidity in the home
buyers' market. With rising unemployment and further economic contraction on the
horizon, these measures are unlikely to stimulate housing demand in the near
term.
In Singapore, prices have declined by more than 30%, in local currency terms,
from their peak in 1996. Deteriorating economic conditions next year and the
impending cut in employer's pension fund contributions (effectively a nationwide
salary reduction program) may deter demand from public-sector housing
up-graders. However we do not rule out the possibility of further government
policy adjustments in the housing sector to prevent falling residential capital
values from threatening the stability of the Singapore banking system.
China is now the only country in Asia where housing demand remains healthy with
liquidity available for home financing. Demand continues unabated from state
institutions trying to utilize reserve funds to purchase homes for employees
before the deferred January 1999 housing reform dateline. The impending cut in
interest rates and fiscal or housing subsidies made to individual home purchases
as part of the new housing reform package to be implemented next year is
expected to help boost domestic demand for housing in China.
Property transactions remain scarce in the Philippines, Malaysia and Thailand.
Declining remittances from overseas contract workers amidst rising economic
uncertainty region-wide and the shortage of government funding to the
home-subsidy program have negatively impacted the sale of socialized housing in
the Philippines. In Bangkok, prime office vacancy rate is approaching 30% with
capital values at a 10-year low of around Baht 3,700 per square foot (U.S. $90
per square
3
<PAGE>
foot). The imposition of capital controls in Malaysia will deter foreign buyers
from taking up the excess supply of residential and commercial properties.
REAL ESTATE SECURITIES
Equity investors have continued to avoid the Asian property sector, further
widening price/NAV discounts of property shares. The major macroeconomic risks
on the horizon continue to be the protracted slump of the Japanese economy and
the threat of a marked slowdown in the Chinese economy leading to a devaluation
of the RMB. Hong Kong's intervention in the stock and futures markets and
Malaysia's capital control measures were drastic attempts taken by Asian
governments to ward off further speculative attacks on their currencies and
stocks.
We continue to expect further weakness in rents and capital values across most
Asian markets as their economies continue to undergo adjustments. However, we
believe the risk reward ratio is fast improving as many good quality companies
are now trading well below their appraised net asset values based on the most
conservative assumptions of asset price declines. Despite the credit crunch,
many Hong Kong developers have successfully restructured their balance sheets
and turned land inventory into cash in a falling market, and in doing so,
moderated the pace of net asset value erosion and enhanced their ability to make
new acquisitions at the opportune time. The recent decline in interest rates
should lend support to property share price performance. We remain overweight in
the major Hong Kong and Singapore residential developers, and significantly
underweight in companies with exposure to the office sector where oversupply
continues to be serious. The Japanese real estate shares have also become
increasingly attractive after their recent sharp correction.
Kiat Seng Seah
PORTFOLIO MANAGER
October 1998
4
<PAGE>
INVESTMENTS (UNAUDITED)
- ----------
SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- ------------ -------
<C> <S> <C>
COMMON STOCKS (86.1%)
AUSTRALIA (17.5%)
40,000 Armstrong Jones Retail Fund $ 22
48,000 BT Office Trust 42
36,000 Capital Property Trust 49
43,600 Centro Properties Group 73
39,000 IPOH Ltd. 39
55,000 Mirvac Property Trust 48
50,000 Westfield Trust 99
-------
372
-------
HONG KONG (31.9%)
33,000 Cheung Kong Holdings Ltd. 153
477,000 China Resources Beijing Land 103
248,800 HKR International Ltd. 77
19,000 Henderson Land Development Co., Ltd. 65
522,000 Hopson Development Holdings Ltd. 42
200,000 Lai Sun Development Co., Ltd. 23
68,000 New World Development Co., Ltd. 91
35,000 Sun Hung Kai Properties Ltd. 124
-------
678
-------
JAPAN (12.9%)
10,000 Daibiru Corp. 65
18,000 Mitsubishi Estate Co., Ltd. 118
13,000 Mitsui Fudosan Co., Ltd. 66
13,000 Sumitomo Realty & Development Co., Ltd. 24
-------
273
-------
PHILIPPINES (6.6%)
319,400 Ayala Land, Inc., Class B 47
1,000,000 Filinvest Land, Inc. 25
540,000 SM Prime Holdings, Inc. 67
-------
139
-------
SINGAPORE (13.5%)
44,000 City Developments Ltd. 97
68,000 DBS Land Ltd. 47
69,000 Marco Polo Developments Ltd. 36
23,000 Singapore Land Ltd. 33
200,000 Wing Tai Holdings Ltd. 74
-------
287
-------
TAIWAN (3.7%)
73,500 Delpha Construction Co., Ltd. 79
-------
TOTAL COMMON STOCKS (Cost $2,558) 1,828
-------
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- ------------ -------
<C> <S> <C>
CONVERTIBLE DEBENTURE (2.3%)
HONG KONG (2.3%)
$ 80 China Resources Beijing Land 2.00%, 4/30/04 (Cost
$39) $ 48
-------
<CAPTION>
NO. OF
RIGHTS
- ------------
<C> <S> <C>
RIGHTS (0.0%)
TAIWAN (0.0%)
5,395 Delpha Construction Co., Ltd.
(Cost $0) --
-------
<CAPTION>
FACE
AMOUNT
(000)
- ------------
<C> <S> <C>
FOREIGN CURRENCY (4.3%)
HKD 53 Hong Kong Dollar 7
PHP 11 Philippines Peso --
SGD 75 Singapore Dollar 44
TWD 1,362 Taiwan Dollar 40
-------
TOTAL FOREIGN CURRENCY (Cost $90) 91
-------
TOTAL INVESTMENTS (92.7%) (Cost $2,687) 1,967
-------
</TABLE>
<TABLE>
<S> <C>
OTHER ASSETS AND LIABILITIES (7.3%)
Other Assets 4,035
Liabilities (3,879)
-----------
156
-----------
NET ASSETS (100%) $ 2,123
-----------
-----------
CLASS A:
- --------
NET ASSETS $ 1,684
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 366,018 outstanding $0.001 par value
shares (authorized 500,000,000 shares) $ 4.60
-----
-----
CLASS B:
- --------
NET ASSETS $ 439
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 94,937 outstanding $0.001 par value
shares (authorized 500,000,000 shares) $ 4.62
-----
-----
</TABLE>
5
