<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.
FIXED INCOME PORTFOLIO
THIRD QUARTER REPORT
SEPTEMBER 30, 1998
<PAGE>
LETTER TO SHAREHOLDERS
- -------
PERFORMANCE COMPARED TO THE LEHMAN AGGREGATE BOND INDEX(1)
- ----------------------------------------------------
<TABLE>
<CAPTION>
TOTAL RETURNS(2)
------------------------------------------------
AVERAGE
AVERAGE ANNUAL
ANNUAL SINCE
YTD ONE YEAR FIVE YEARS INCEPTION
----- --------- ----------- -----------
<S> <C> <C> <C> <C>
PORTFOLIO--CLASS A.......... 7.80% 10.75% 7.23% 8.73%
PORTFOLIO--CLASS B.......... 7.60 10.49 N/A 7.81
INDEX--CLASS A.............. 8.32 11.51 7.21 8.80
INDEX--CLASS B.............. 8.32 11.51 N/A 7.87
</TABLE>
1. The Lehman Aggregate Bond Index is an unmanaged index comprised of the
Government/Corporate Index, the Mortgage-Backed Securities Index and the
Asset-Backed Securities Index.
2. Total returns for the Portfolio reflect expenses waived and reimbursed, if
applicable, by the Adviser. Without such waiver and reimbursement, total
returns would be lower.
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
- ------------------------------
THE 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 PERFORMANCE RESULTS PROVIDED ARE
FOR INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE CONSTRUED AS A GUARANTEE OF
THE PORTFOLIO'S FUTURE PERFORMANCE. PAST PERFORMANCE SHOWN IS NOT PREDICTIVE OF
FUTURE PERFORMANCE. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT
AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR
ORIGINAL COST. YIELDS WILL FLUCTUATE AS MARKET CONDITIONS CHANGE.
The Fixed Income Portfolio invests primarily in a diversified portfolio of U.S.
Government securities, corporate bonds (including competitively priced
Eurodollar bonds), mortgage-backed securities and other fixed income securities.
Targeted rates of return for the Portfolio are based on current and projected
market and economic conditions and on a conservative investment management
approach.
For the nine months ended September 30, 1998, the Portfolio had a total return
of 7.80% for the Class A shares and 7.60% for the Class B shares compared to a
total return of 8.32% for the Lehman Aggregate Bond Index (the "Index"). For the
one year ended September 30, 1998, the Portfolio had a total return of 10.75%
for the Class A shares and 10.49% for the Class B shares compared to 11.51% for
the Index. For the five-year period ended September 30, 1998, the average annual
total return of Class A was 7.23% compared to 7.21% for the Index. From
inception on May 15, 1991 through September 30, 1998, the average annual total
return of Class A was 8.73% compared to 8.80% for the Index. From inception on
January 2, 1996 through September 30, 1998, the average annual total return of
Class B was 7.81% compared to 7.87% for the Index. As of September 30, 1998, the
Portfolio had an SEC 30-day yield of 5.41% for the Class A shares and 5.26% for
the Class B shares.
For bond investors, the third quarter of 1998 will surely rank as one of the
most turbulent periods in memory. An extraordinary confluence of global
financial and economic developments conspired to create a "flight-to-quality,"
producing a powerful, historic rally in U.S. Treasury securities that pushed
yields on longer term government issues to record lows. By the end of the
quarter, for example, the 30-year Treasury bond was yielding just 4.98%, which
represents the lowest yield on the bellwether security since 1967.
Financial markets were primarily driven by concerns that the contagion arising
from the Asian economic crisis was spreading to other countries, most notably
Russia, which devalued its currency and declared a debt moratorium in August. At
the same time, Japan, the world's second largest economy, remained mired in a
deep recession with little hope of a quick recovery. Compounding matters was the
near-collapse of Long Term Capital Management, a well-known hedge fund, which
increased fears of further instability throughout the financial system. With
investors either less able or less willing to bear risk at a time of global
economic uncertainty, the yield spreads on corporate bonds and other
non-Treasury securities widened significantly. In
2
<PAGE>
response to the increasing weakness in foreign economies, as well as the
potential threats posed to the U.S. economy, the Federal Reserve eased monetary
policy via a 1/4 percent reduction in the targeted Federal Funds Rate at the end
of the quarter.
The current global situation is a growing source of concern. We believe that the
probability of a domestic recession has increased somewhat over the last month.
While demand for U.S. exports should suffer as a result of current global
economic difficulties, we still anticipate real GDP growth at or near an annual
rate of 2% in the second half of this year, and between zero and 2% in 1999.
There do not appear to be enough domestic imbalances to touch off an outright
recession, and lower interest rates will sustain demand, especially housing and
consumer durables. It is important to recognize that while the Fed can and will
continue to reduce short-term interest rates as needed to sustain the domestic
economy, the central bank is unable to offer liquidity on a global scale without
the cooperation of other major central banks around the world.
THIRD QUARTER STRATEGY
We began the third quarter with the duration of the Portfolio about half a year
longer than the benchmark. In late July we further increased our durations,
taking us at quarter end to almost a year above the Index. We added duration by
buying long-dated U.S. Treasury securities. Throughout the quarter we had a
heavier than Index exposure to the long end of the market.
Corporate yield spreads continued to widen dramatically during the quarter. As
an example, the long corporate component of the Index returned only 3.04% during
last quarter, while the long Treasury component had a return of 7.89%. In many
cases yield spreads have exceeded levels seen during the 1990-1991 recession.
During that period, corporate default rates were very high (over 4% on an annual
basis), corporate interest payments were over 50% of corporate profits, and
there was great concern about the viability of many financial institutions. In
contrast, default rates are currently quite low, corporate interest payments are
less than 20% of corporate profits, and the U.S. banking system is in far better
condition than it was during the last economic downturn.
FOURTH QUARTER OUTLOOK
Even though we reduced our corporate and mortgage exposures in the Portfolio,
widening spreads hurt our performance more than the extra duration helped. Fears
of increased prepayments knocked the mortgage market into a tailspin, not
sparing even the most straightforward discount government guaranteed issues.
Dealers have stepped back from the market, reducing their positions and, by and
large, de-leveraging as much as they could. Some of them were no strangers to
the type of arbitrage practiced by Long Term Capital Management, though not with
as much leverage. With time, liquidity will come back and spreads should narrow,
especially for the types of high quality securities we hold in the Portfolio.
However, how soon the market rights itself is hard to say, and in our opinion
the best strategy is to stay with the highest rated issues that should come back
first.
Finally, as long as we think that the threat of some form of a deflationary
cycle is real, we will maintain a longer-than-market duration with a heavy
weighting of non-callable U.S. government securities to help protect your
assets.
Warren Ackerman, III
PORTFOLIO MANAGER
October 1998
3
<PAGE>
INVESTMENTS (UNAUDITED)
- ----------
SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- ------------- --------
<C> <S> <C>
FIXED INCOME SECURITIES (95.5%)
U.S. GOVERNMENT AND AGENCY OBLIGATIONS (55.8%)
FEDERAL HOME LOAN MORTGAGE CORPORATION (0.0%)
$ 7 13.00%, 9/01/10 $ 8
--------
FEDERAL NATIONAL MORTGAGE ASSOCIATION (15.7%)
3,253 6.00%, 9/01/10 3,289
4,564 6.00%, 2/01/11 4,611
2,913 8.00%, 2/01/12 2,999
7,234 6.00%, 4/01/13 7,308
17,523 6.00%, 4/01/28 17,501
--------
35,708
--------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (4.9%)
5,927 7.50%, 8/15/26 6,143
5,019 6.00%, 8/15/28 5,041
--------
11,184
--------
U.S. TREASURY BONDS (16.0%)
25,000 8.75%, 5/15/20 36,434
--------
U.S. TREASURY NOTES (19.2%)
5,000 6.375%, 9/30/01 5,275
8,000 6.00%, 7/31/02 8,458
5,000 7.25%, 8/15/04 5,729
8,000 6.50%, 8/15/05 8,992
15,429 3.375%, 1/15/07 (Inflation Indexed) 15,198
--------
43,652
--------
TOTAL U.S. GOVERNMENT AND AGENCY OBLIGATIONS 126,986
--------
CORPORATE BONDS AND NOTES (26.2%)
CONSUMER STAPLES (1.1%)
2,500 Philip Morris Cos., Inc., (Floating Rate), 6.15%,
3/15/00 2,519
--------
ELECTRONICS (1.4%)
3,000 Sony Corp., 6.125%, 3/04/03 3,086
--------
FINANCE (17.8%)
(e) 2,000 American General Institutional Capital, Series A,
7.57%, 12/01/45 2,151
2,000 BT Capital Trust, Series B1, 7.90%, 1/15/27 1,848
2,250 Cincinnati Financial Corp., 6.90%, 5/15/28 2,346
3,000 CNA Financial Corp., 6.50%, 4/15/05 3,080
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- ------------- --------
<C> <S> <C>
$ 2,000 Donaldson, Lufkin & Jenrette, Inc., 6.90%,
10/01/07 $ 2,060
(e) 2,500 Farmers Exchange Capital, 7.05%, 7/15/28 2,525
(e) 2,000 First Chicago Corp., 7.75%, 12/01/26 2,114
2,000 Ford Motor Credit Co., 6.125%, 4/28/03 2,072
2,500 General Motors Acceptance Corp., 7.375%, 6/22/00 2,596
(e) 3,000 Goldman Sachs Group, 6.25%, 2/01/03 3,123
(e) 1,250 Hutchison Whampoa Ltd., Class B, 7.45%, 8/01/17 911
1,300 Lehman Brothers Holdings, Inc., 7.375%, 5/15/04 1,312
(e) 3,000 Liberty Mutual Insurance Co., 8.20%, 5/04/2097 3,510
(e) 1,500 Lumbermens Mutual Casualty Co., 8.45%, 12/01/69 1,590
3,000 Merrill Lynch & Co., 6.00%, 2/12/03 3,055
(e) 2,500 Prudential Insurance Co., 6.375%, 7/23/06 2,591
2,000 Salomon, Inc., 7.30%, 5/15/02 2,114
1,500 Simon Debartolo Group, MTN, 7.125%, 9/20/07 1,545
--------
40,543
--------
HEALTH CARE SUPPLIES & SERVICES (0.7%)
1,500 Columbia/HCA Healthcare, MTN, 8.85%, 1/01/07 1,631
--------
INDUSTRIAL (0.9%)
2,000 Ford Motor Co., 6.625%, 2/15/28 2,025
--------
TELECOMMUNICATIONS (1.4%)
3,000 Worldcom, Inc., 6.40%, 8/15/05 3,166
--------
UTILITIES (2.9%)
2,500 Endesa-Chile, (Yankee Bond), 7.75% 7/15/08 2,607
(e) 1,976 Oil Enterprises Ltd., 6.239%, 6/30/08 2,011
2,000 Telefonica de Argentina, (Yankee Bond), 11.875%,
11/01/04 1,970
--------
6,588
--------
TOTAL CORPORATE BONDS AND NOTES 59,558
--------
ASSET BACKED SECURITIES (6.9%)
3,000 Aesop Funding II LLC, Series 97-1, Class A1,
6.22%, 10/20/01 3,054
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- ------------- --------
<C> <S> <C>
</TABLE>
ASSET BACKED SECURITIES (CONTINUED)
<TABLE>
<C> <S> <C>
$ 1,500 First Plus Home Loan Trust, Series 97-4, Class
A4, 6.57%, 4/10/13 $ 1,525
5,000 Ford Credit Auto Owner Trust, Series 98-B, Class
A3, 5.85%, 10/15/01 5,056
2,332 Mid-State Trust, Series IV A, 8.33%, 4/01/30 2,605
3,250 Team Fleet Financing Corp., Series 97-1A, 7.35%,
5/15/03 3,434
--------
TOTAL ASSET BACKED SECURITIES 15,674
--------
COMMERCIAL MORTGAGE BACKED (6.6%)
685 Chase Commercial Mortgage Securities Corp.,
Series 97-2, Class A1, 6.45%, 12/19/04 704
3,213 First Union-Lehman Brothers Commercial Mortgage,
Series 97-C2, Class A1, 6.479%, 3/18/04 3,307
4,065 Lehman Brothers Large Loan, Series 97-LLI A1,
6.79%, 10/12/34 4,263
2,915 Merrill Lynch Mortgage Investors, Inc., Series
98-C2, Class A1, 6.22%, 2/15/30 2,921
792 Resolution Trust Corp., Series 91-M5, Class A,
9.00%, 3/25/17 788
(e) 2,947 World Financial Properties, Series 96WFP-B,
6.91%, 9/01/13 3,103
--------
TOTAL COMMERCIAL MORTGAGE BACKED 15,086
--------
U.S. GOVERNMENT OBLIGATIONS (0.0%)
3 Federal National Mortgage Association, REMIC,
Series 92-59, Class F, (Floating Rate), 5.787%,
8/25/06 3
--------
TOTAL FIXED INCOME SECURITIES (Cost $210,355) 217,307
--------
<CAPTION>
VALUE
(000)
--------
<C> <S> <C>
</TABLE>
<TABLE>
<S> <C>
TOTAL INVESTMENTS (95.5%) (Cost $210,355) $217,307
--------
OTHER ASSETS AND LIABILITIES (4.5%)
Other Assets 27,846
Liabilities (17,572)
--------
10,274
--------
NET ASSETS (100%) $227,581
--------
--------
CLASS A:
- --------
NET ASSETS $223,242
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 19,759,546 outstanding $0.001 par value shares
(authorized 500,000,000 shares) $ 11.30
--------
--------
CLASS B:
- --------
NET ASSETS $ 4,339
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 383,837 outstanding $0.001 par value shares
(authorized 500,000,000 shares) $ 11.30
--------
--------
</TABLE>
- ------------------------------
(e) -- 144A Security -- certain conditions for public sale
may exist.
Inflation Indexed -- Security includes principal adjustment
feature in which par amount adjusts with the Consumer
Price Index to insulate bonds from the effects of inflation.
The face amount shown is that in effect on September 30,
1998.
Floating Rate -- Interest rate changes on these instruments
are based on changes in a designated base rate. The
rates shown are those in effect on September 30, 1998.
MTN -- Medium Term Note
REMIC -- Real Estate Mortgage Investment Conduit
5
