<PAGE>
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THE
LATIN AMERICAN
DISCOVERY
FUND, INC.
- ------------------------------------------------------------------------------
THIRD QUARTER REPORT
SEPTEMBER 30, 1998
MORGAN STANLEY ASSET MANAGEMENT INC.
INVESTMENT ADVISER
THE LATIN AMERICAN DISCOVERY FUND, INC.
- ------------------------------------------------------------------------------
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DIRECTORS AND OFFICERS
Barton M. Biggs
CHAIRMAN OF THE BOARD
OF DIRECTORS
Michael F. Klein
PRESIDENT AND DIRECTOR
Peter J. Chase
DIRECTOR
John W. Croghan
DIRECTOR
David B. Gill
DIRECTOR
Graham E. Jones
DIRECTOR
John A. Levin
DIRECTOR
William G. Morton, Jr.
DIRECTOR
Stefanie V. Chang
VICE PRESIDENT
Harold J. Schaaff, Jr.
VICE PRESIDENT
Joseph P. Stadler
VICE PRESIDENT
Valerie Y. Lewis
SECRETARY
Joanna M. Haigney
TREASURER
Belinda A. Brady
ASSISTANT TREASURER
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INVESTMENT ADVISER
Morgan Stanley Asset Management Inc.
1221 Avenue of the Americas
New York, New York 10020
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U.S. ADMINISTRATOR
The Chase Manhattan Bank
73 Tremont Street
Boston, Massachusetts 02108
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CUSTODIANS
Morgan Stanley Trust Company
One Pierrepont Plaza
Brooklyn, New York 11201
The Chase Manhattan Bank
3 Chase MetroTech Center
Brooklyn, New York 11245
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SHAREHOLDER SERVICING AGENT
Boston Equiserve
Investor Relations Department
P.O. Box 644
Boston, Massachusetts 02102-0644
(800) 730-6001
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LEGAL COUNSEL
Rogers & Wells LLP
200 Park Avenue
New York, New York 10166
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INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP
1177 Avenue of the Americas
New York, New York 10036
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For additional Fund information, including the Fund's net asset value per share
and information regarding the investments comprising the Fund's portfolio,
please call 1-800-221-6726.
<PAGE>
LETTER TO SHAREHOLDERS
- ---------
For the nine months ended September 30, 1998, The Latin American Discovery Fund,
Inc. (the "Fund") had a total return, based on net asset value per share, of
- -40.02% compared with -39.65% for the Morgan Stanley Capital International
("MSCI") Emerging Markets Global Latin America Index (the "Index"). For the one
year ended September 30, 1998, and for the period since commencement of
operations on June 23, 1992 through September 30, 1998, the Fund's total return,
based on net asset value per share, was -45.12% and 63.08%, respectively,
compared with -46.09% and 20.12%, respectively, for the Index. On September 30,
1998, the closing price of the Fund's shares on the New York Stock Exchange was
$5 7/8, representing a 21.6% discount to the net asset value per share.
The poor returns in emerging markets equities over the last 5 years and
especially the last 12 months have been extremely disappointing to investors.
Is the emerging markets asset class fundamentally flawed and destined to further
underperformance? We firmly believe it is not and that the case for investing
in emerging markets over the next few years has never been stronger.
All asset classes go through investment cycles. After a long period of
out-performance emerging market equities have gone through a long period of
underperformance. This cycle has been more extreme than most given the nascent
nature of these markets and the furious pace of capital flows. Emerging markets
are riskier than developed markets, but this is a difference of degree and not
of kind. The fundamental investment cycles are the same.
At the moment we believe that we are close to a bottom in this cycle.
Therefore, this is not the time for long term money to be withdrawing from the
asset class. History shows that investing in times of fear is usually well
rewarded.
The third quarter was an extremely disappointing quarter for investors in the
emerging markets. News of the Russian ruble devaluation in August sparked a
worldwide equity sell-off on concerns that other emerging economies,
particularly Brazil, would follow suit. The Fund's net asset value per share
fell 30.10% during the third quarter versus a decline of 24.68% for the Index.
Underperformance relative to the Index was largely driven by disappointing stock
returns in Brazil. Because of their relatively high degree of liquidity
compared to other emerging market stocks, Brazilian blue chips slid
precipitously as worried investors reduced their exposure to the emerging
markets. Our country allocations contributed to performance. Specifically, our
underweight positions in Colombia (-37.9%) and Peru (-32.9%) and our overweight
stance in Mexico (-22.6%) helped performance.
Jitters over upcoming elections and currency vulnerabilities resulted in
negative returns throughout the Latin region. The "better" performing Latin
markets included Argentina (-15.6%), Chile (-19.9%), and Venezuela (-22.5%).
Colombia was the worst performing Latin market, plunging 37.9%. Most investors
focused on Brazil (-28.6%) during the third quarter, wondering if its currency
would devalue, particularly after the Russian ruble collapsed in August. Given
our concerns with respect to its currency and fiscal matters, we trimmed 3% from
our Brazilian exposure. With the Presidential election now over (early-October)
and President Cardoso re-elected, it is critical that fiscal inadequacies are
addressed, thereby reducing currency pressures.
Mexico fell 22.6% during the third quarter. Investors worried that government
spending cuts, diminished U.S. growth, price competition from Asian exports, and
curtailed demand in Asia, would stem Mexican corporate earnings growth. The
market did recover in September, gaining 19.1% as the possibility of a bailout
package for Brazil spurred Mexico's market. We added approximately 3% to our
Mexican weighting during the quarter.
Argentina's market fell given concerns over Russian and Asian economies,
disappointing company earnings and declining U.S. market returns. Argentina is
highly susceptible to Brazil's plight. Brazil is Argentina's main trading
partner and a devaluation in Brazil could trigger a wave of devaluations in
Latin America that would have destabilizing consequences for Argentina and other
regional equity markets. The Argentina market was boosted in September (+14.7%)
on news that the international financial community would help replenish
reserves, thus restoring confidence in Latin equity markets.
Chile's market was driven by depressed sentiment as declining prices for copper,
the country's principal export, have negatively affected the trade deficit. On
a positive note, the Chilean market turned around in September (+6.4%) building
on positive news of a U.S. and G-7 plan to restore confidence in Brazil by
providing foreign reserve cover. Chilean investors greeted the
2
<PAGE>
news favorably on hopes the aid package would supply the needed credit to
bolster the Brazilian currency as well as other regional currencies, including
the Chilean peso.
The emerging markets have significantly under-performed other asset classes over
the last few years and particularly recently. Uncertainty in Russia and near
term risks in China, Hong Kong and Brazil coupled with the currently volatile
equity environment in the U.S. and Europe make us cautious for the rest of 1998.
We believe, however, that flows into Latin American funds will pick up over the
course of 1999 for the following reasons: 1) better macroeconomic and
regulatory management, 2) increased focus on ROI and shareholder value leading
to higher earnings per share, 3) return of high gross domestic product growth,
4) extreme equity under-valuation, and 5) reversal of negative sentiment and
capital flows.
We cannot predict exactly when the Latin markets will bottom out. Currently we
are nervous that Brazil may not be able to deliver the strong fiscal adjustment
that the country needs and the market is demanding. In addition, developed
markets are experiencing very high volatility which no market can escape in the
short run. But the markets have priced in the bad events of the previous years
and most of the potential risks.
The recent crisis in Latin America, and all emerging markets, should be viewed
as growing pains and not a fundamental shift in the emerging markets concept.
Most governments are becoming more democratic and have accepted the challenge to
lay the foundations for better and sounder growth. Stocks are cheap, company
management are becoming more focused on ROI, and the capital markets will demand
greater transparency, efficiency and higher returns.
Emerging markets make up 84% of the world's population, about 18% of the world's
economy, and roughly 9% of the market capitalization. The opportunity set for
emerging markets has not become smaller. More than 125 companies and five more
countries are currently included in the MSCI Emerging Markets Index than were
included five years ago.
Looking forward, stock market returns will be the product of 1) earnings growth
2) price-earnings multiple changes and 3) currency movements. Increasing focus
on ROI coupled with the return of high gross domestic product growth should lead
to higher earnings. Sounder institutions and policies coupled with a reversal
of negative sentiment should lead to higher multiples. And, most of these
currencies are now undervalued. The result should be higher returns.
On September 15, 1998, the Fund commenced a share repurchase program for
purposes of enhancing shareholder value and reducing the discount at which the
Fund's shares traded from their net asset value. From that date through
September 30, 1998, the Fund repurchased 141,900 shares of its Common Stock at
an average price per share of $5.56 and an average discount of 25.32% from the
net asset value per share. The Fund will continue to repurchase its outstanding
shares at such time and in such amounts as it believes will further the
accomplishment of the foregoing objectives, subject to review by the Board of
Directors. We will update you on the progress of the repurchase program in
future shareholder reports.
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.
Sincerely,
/s/ Michael F. Klein
Michael F. Klein
PRESIDENT AND DIRECTOR
October 1998
3
<PAGE>
The Latin American Discovery Fund, Inc.
Investment Summary as of September 30, 1998 (Unaudited)
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<TABLE>
<CAPTION>
HISTORICAL
INFORMATION
TOTAL RETURN (%)
------------------------------------------------------------------------------------
MARKET VALUE (1) NET ASSET VALUE (2) INDEX (3)
------------------------ ----------------------- -----------------------
AVERAGE AVERAGE AVERAGE
CUMULATIVE ANNUAL CUMULATIVE ANNUAL CUMULATIVE ANNUAL
---------- ------- ---------- ------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
Fiscal Year to Date -46.72% -- -40.02% -- -39.65% --
One Year -51.15 -51.15% -45.12 -45.12% -46.09 -46.09%
Five Year -8.80+ -1.83+ 16.78+ 3.15+ .08 0.22
Since Inception* 27.75+ 3.98+ 63.08+ 8.11+ 20.12 2.97
</TABLE>
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
- --------------------------------------------------------------------------------
RETURNS AND PER SHARE INFORMATION
[GRAPH]
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, NINE MONTHS ENDED
SEPTEMBER 30,
1992* 1993 1994 1995 1996 1997 1998
------ ------- ------- ------- ------ ------ ----------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value Per Share. . . $15.23 $ 23.31 $ 17.16 $ 10.98 $14.77 $20.34 $ 7.50
Market Value Per Share . . . . $13.25 $ 27.13 $ 18.25 $ 9.88 $12.50 $17.94 $ 5.88
Premium/(Discount) . . . . . . -13.0% 16.4% 6.4% -10.0% -15.4% -11.8% -21.6%
Income Dividends . . . . . . . -- -- $ 0.00# -- $ 0.16 -- --
Capital Gains Distributions. . -- -- $ 5.74 $ 0.45 $ 1.14 $ 0.70 $ 6.67
Fund Total Return (2). . . . . 8.01% 65.36%+ -0.14%+ -27.61% 47.19% 43.06% -40.02%
Index Total Return (3) . . . . -2.26% 52.29% -3.69% -13.53% 21.96% 31.66% -39.65%
</TABLE>
(1) Assumes dividends and distributions, if any, were reinvested.
(2) Total investment return based on net asset value per share reflects the
effects of changes in net asset value on the performance of the Fund
during each period, and assumes dividends and distributions, if any, were
reinvested. These percentages are not an indication of the performance of
a shareholder's investment in the Fund based on market value due to
differences between the market price of the stock and the net asset value
per share of the Fund.
(3) The Morgan Stanley Capital International Emerging Markets Global Latin
America Index (MSCI EMG Latin America Index) is a broad based market cap
weighted composite index covering at least 60% of markets in Mexico,
Argentina, Brazil, Chile, Colombia, Peru and Venezuela, including
dividends.
* The Fund commenced operations on June 23, 1992.
# Amount is less than $0.01 per share.
+ This return excludes the effect of the rights issued in connection with
the Rights Offerings.
4
<PAGE>
The Latin American Discovery Fund, Inc.
Portfolio Summary as of September 30, 1998 (Unaudited)
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- ------------------------------------------------------------------------------
DIVERSIFICATION OF TOTAL INVESTMENTS
[CHART]
<TABLE>
<S> <C>
Equity Securities (99.1%)
Short-Term Investments (0.9%)
</TABLE>
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SECTORS
[CHART]
<TABLE>
<S> <C>
Other (14.8%)
Utilities -- Electrical & Gas (14.0%)
Telecommunications (30.2%)
Banking (3.7%)
Beverages & Tobacco (11.5%)
Broadcasting & Publishing (4.4%)
Building Material & Components (2.2%)
Energy Sources (6.8%)
Health & Personal Care (4.4%)
Merchandising (5.0%)
Metals -- Non-Ferrous (3.0%)
</TABLE>
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COUNTRY WEIGHTINGS
[CHART]
<TABLE>
<S> <C>
Other (7.5%)
Colombia (0.5%)
Chile (8.8%)
Argentina (10.5%)
Brazil (33.8%)
Mexico (38.9%)
</TABLE>
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TEN LARGEST HOLDINGS*
<TABLE>
<CAPTION>
PERCENT OF
NET ASSETS
----------
<S> <C>
1. Telmex (Mexico) 9.9%
2. FEMSA (Mexico) 7.5
3. Cemig (Brazil) 5.5
4. YPF (Argentina) 4.5
5. Kimberly (Mexico) 4.4
6. Televisa (Mexico) 4.1
7. Telesp (Brazil) 3.9
8. CRT (Brazil) 3.2
9. Telecom Argentina (Argentina) 3.1
10. CVRD (Brazil) 3.0
----
49.1%
----
----
</TABLE>
* Excludes short-term investments.
5
<PAGE>
FINANCIAL STATEMENTS
- -------
STATEMENT OF NET ASSETS (UNAUDITED)
- -------
SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- ------------------------------------------------------------------------------
<S> <C> <C>
COMMON STOCKS (91.7%)
(Unless otherwise noted)
- ------------------------------------------------------------------------------
ARGENTINA (10.5%)
BANKING
Banco del Suquia 1 U.S.$ -- @
-------------
BEVERAGES & TOBACCO
Quilmes Industrial ADR 122,655 1,004
-------------
ENERGY SOURCES
YPF ADR 161,795 4,207
-------------
TELECOMMUNICATIONS
Telecom Argentina ADR 97,488 2,894
Telefonica Argentina ADR 61,072 1,798
-------------
4,692
-------------
9,903
-------------
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BRAZIL (33.8%)
BANKING
Banco Nacional (Preferred) 95,420,000 4
Unibanco (Preferred) GDR 57,108 771
-------------
775
-------------
ENERGY SOURCES
Petrobras (Preferred) 8,435,877 868
Petrobras (Preferred) ADR 63,469 651
(a) Petrobras (Preferred) ADR 69,515 709
-------------
2,228
-------------
MERCHANDISING
Globex Utilidades (Preferred) 14,200 35
Lojas Arapua (Preferred) 41,337,400 11
(a) Lojas Arapua (Preferred) ADR 20,775 8
Lojas Renner (Preferred) 32,504,000 438
-------------
492
-------------
METALS -- NON-FERROUS
CVRD 5,000 55
CVRD (Preferred) 106,249 1,568
CVRD (Preferred) 'A' 25,242 362
CVRD (Preferred) ADR 59,130 863
CVRD Bonus 116,420 --
-------------
2,848
-------------
METALS -- STEEL
Gerdau (Preferred) 98,533,422 856
Usiminas (Preferred) 111,200 329
-------------
1,185
-------------
MULTI-INDUSTRY
Iven (Preferred) 1,268,500 257
-------------
REAL ESTATE
(a) Rossi Residencial GDR 176,972 476
Rossi Residencial GDS (Registered) 269,535 724
-------------
1,200
-------------
TELECOMMUNICATIONS
CRT (Preferred) 'A' 10,001,992 3,012
Embratel (Preferred) 71,204,790 751
Tele Celular Sul (Preferred) 136,730,790 193
Tele Centro Oeste Celular (Preferred) 116,126,790 84
Tele Centro-Sul (Preferred) 125,926,390 1,328
Tele Leste Celular (Preferred) 116,126,790 45
Tele Nordeste Celular (Preferred) 99,140,790 55
Tele Norte Celular (Preferred) 116,126,790 31
Tele Norte-Leste (Preferred) 16,986,000 198
Tele Sudeste Celular (Preferred) 116,126,790 362
Telebras (Preferred) 116,126,790 39
Telebras Holders 30,785 2,168
Telemig Celular (Preferred) 140,977,790 105
Telesp (Preferred) 72,078,790 1,733
Telesp (Preferred) 13,197,000 1,915
Telesp Celular (Preferred) 116,126,790 784
-------------
12,803
-------------
TEXTILES & APPAREL
Coteminas 5,426,400 636
(a) Coteminas ADR 144A 9,305 54
Encorpar 8,492,000 11
-------------
701
-------------
UTILITIES -- ELECTRICAL & GAS
Cemig (Preferred) 161,668,003 3,519
Cemig (Preferred) ADR 75,673 1,673
CERJ 3,637,800,000 1,289
Copel (Preferred) 'B' 337,725,400 2,222
Light Services de Electricidad 5,737,000 716
-------------
9,419
-------------
31,908
-------------
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CHILE (8.0%)
BANKING
Banco Edwards ADR 7,740 65
Banco Santander Chile ADR 14,900 164
Banco Santiago ADR 14,300 178
-------------
407
-------------
BEVERAGES & TOBACCO
CCU ADR 54,925 1,009
-------------
FOOD & HOUSEHOLD PRODUCTS
D&S ADR 37,675 377
-------------
MERCHANDISING
Santa Isabel ADR 44,705 254
-------------
MULTI-INDUSTRY
Citicorp-Chile Financiero Fund 3,667 72
-------------
TELECOMMUNICATIONS
CTC ADR 65,755 1,257
Quinenco ADR 51,020 354
-------------
1,611
-------------
- ------------------------------------------------------------------------------
6
<PAGE>
<CAPTION>
VALUE
SHARES (000)
- ------------------------------------------------------------------------------
<S> <C> <C>
CHILE (CONTINUED)
UTILITIES -- ELECTRICAL & GAS
Chilectra ADR 103,090 U.S.$ 1,687
Endesa ADR 100,480 854
Enersis ADR 51,540 1,050
Gener ADR 13,680 205
-------------
3,796
-------------
7,526
-------------
- ------------------------------------------------------------------------------
COLOMBIA (0.5%)
BANKING
Bancolombia (Preferred) 1,081 1
-------------
BEVERAGES & TOBACCO
Bavaria 87,449 327
Valores Bavaria 159,679 174
-------------
501
-------------
FINANCIAL SERVICES
Corfivalle 2 -- @
-------------
502
-------------
- ------------------------------------------------------------------------------
MEXICO (38.9%)
BANKING
Banacci 'B' 572,455 505
Banacci 'L' 645,651 627
Bancomer 'B' 4,531,997 809
Banorte 'B' 684,441 349
-------------
2,290
-------------
BEVERAGES & TOBACCO
FEMSA 2,020,390 3,943
FEMSA ADR 161,715 3,174
Grupo Modelo 'C' 106,975 843
Pepsi-Gemex GDR 49,557 350
-------------
8,310
-------------
BROADCASTING & PUBLISHING
Televisa CPO GDR 199,610 3,855
TV Azteca ADR 41,886 275
-------------
4,130
-------------
BUILDING MATERIALS & COMPONENTS
Cemex 'B' 290,995 722
Cemex 'B' ADR 217,197 1,078
Cemex CPO 143,257 315
-------------
2,115
-------------
FOOD & HOUSEHOLD PRODUCTS
Gruma 'B' 89,895 185
Grupo Industrial Bimbo 'A' 624,755 1,103
-------------
1,288
-------------
HEALTH & PERSONAL CARE
Kimberly 'A' 1,724,765 4,144
-------------
MERCHANDISING
Cifra 'C' 758,587 871
Cifra 'V' 1,148,422 1,295
Cifra 'V' ADR 3,970 48
Soriana 'B' 731,935 1,759
-------------
3,973
-------------
MULTI-INDUSTRY
Grupo Carso 'A1' 393,785 1,116
-------------
RECREATION -- OTHER CONSUMER GOODS
Blockbuster de Mexico ADR 40,000 --
-------------
TELECOMMUNICATIONS
Telmex 'L' ADR 212,253 9,392
-------------
36,758
-------------
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TOTAL COMMON STOCKS
(Cost U.S.$136,336) 86,597
-------------
- ------------------------------------------------------------------------------
<CAPTION>
Face
Amount
(000)
- ------------------------------------------------------------------------------
<S> <C> <C>
SHORT-TERM INVESTMENTS(0.8%)
- ------------------------------------------------------------------------------
CHILE(0.8%)
TIME DEPOSIT
Citibank 2.30%, 10/08/98
(Cost U.S.$753) CLP 356,500 776
-------------
- ------------------------------------------------------------------------------
FOREIGN CURRENCY ON DEPOSIT WITH
CUSTODIAN (0.0%)
Chilean Peso CLP 306 1
Colombian Peso COP 10,016 6
-------------
(Cost U.S.$7) 7
-------------
- ------------------------------------------------------------------------------
TOTAL INVESTMENTS(92.5%)
(Cost U.S.$137,096) 87,380
-------------
- ------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (7.5%)
Other Assets U.S.$ 15,104
Liabilities (8,003) 7,101
--------------- -------------
- ------------------------------------------------------------------------------
NET ASSETS (100%)
Applicable to 12,596,625 issued and
outstanding U.S.$0.01 par value shares
(100,000,000 shares authorized) U.S.$ 94,481
-------------
-------------
- ------------------------------------------------------------------------------
NET ASSET VALUE PER SHARE U.S.$ 7.50
-------------
-------------
- ------------------------------------------------------------------------------
</TABLE>
@ -- Value is less than U.S.$500.
(a) -- 144A Security - certain conditions for public sale may exist.
ADR -- American Depositary Receipt
GDR -- Global Depositary Receipt
GDS -- Global Depositary Shares
- ------------------------------------------------------------------------------
7
