<PAGE>
MORGAN STANLEY
RUSSIA & NEW EUROPE FUND, INC.
- ---------------------------------------------
OFFICERS AND DIRECTORS
Barton M. Biggs William G. Morton, Jr.
CHAIRMAN OF THE BOARD DIRECTOR
OF DIRECTORS Peter A. Nadosy
Frederick B. Whittemore DIRECTOR
VICE-CHAIRMAN OF THE BOARD OF DIRECTORS Michael F. Klein
Warren J. Olsen VICE PRESIDENT
PRESIDENT AND DIRECTOR Harold J. Schaaff, Jr.
Peter J. Chase VICE PRESIDENT
DIRECTOR Joseph P. Stadler
John W. Croghan VICE PRESIDENT
DIRECTOR Valerie Y. Lewis
David B. Gill SECRETARY
DIRECTOR James R. Rooney
Graham E. Jones TREASURER
DIRECTOR Belinda A. Brady
John A. Levin ASSISTANT TREASURER
DIRECTOR
- ---------------------------------------------
INVESTMENT ADVISER
Morgan Stanley Asset Management Inc.
1221 Avenue of the Americas
New York, New York 10020
- ---------------------------------------------------------
ADMINISTRATOR
The Chase Manhattan Bank
73 Tremont Street
Boston, Massachusetts 02108
- ---------------------------------------------------------
CUSTODIAN
The Chase Manhattan Bank
Chaseside
Bournemouth BH7 7DB
United Kingdom
- ---------------------------------------------------------
SHAREHOLDER SERVICING AGENT
American Stock Transfer & Trust Company
40 Wall Street
New York, New York 10005
(800) 278-4353
- ---------------------------------------------------------
LEGAL COUNSEL
Rogers & Wells
200 Park Avenue
New York, New York 10166
- ---------------------------------------------------------
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York 10036
- ---------------------------------------------------------
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.
----------
MORGAN STANLEY
RUSSIA & NEW EUROPE
FUND, INC.
----------
ANNUAL REPORT
DECEMBER 31, 1996
MORGAN STANLEY ASSET MANAGEMENT INC.
INVESTMENT ADVISER
<PAGE>
LETTER TO SHAREHOLDERS
- --------
For the period since commencement of operations on September 30, 1996 through
December 31, 1996, the Morgan Stanley Russia & New Europe Fund, Inc. (the
"Fund") had a total return, based on net asset value per share, of 4.18%. On
December 31, 1996, the closing price of the Fund's shares on the New York Stock
Exchange was $18.00 representing a 13.3% discount to the Fund's net asset value
per share.
The Fund's diverse target investment region, not to mention the early stages of
development of some of the markets within that region, has made the selection of
a benchmark index difficult. Until a more appropriate benchmark is created, the
Fund will be compared to a composite consisting of 50% of the Moscow Times 50
Index (dollar adjusted) and 50% of the MSCI Czech Republic, Hungary and Poland
Indices (weighted by market capitalization). This composite benchmark delivered
a return of 9.43% for the period from September 30, 1996 through December 31,
1996. The Fund is being invested at a rapid pace, but over the quarter its cash
weighting has held back the return. As of December 31, 1996, the Fund held 59%
of its assets in equities and 17% in debt securities from the region. A total of
76% of the Fund's assets are, therefore, invested in the target markets.
The Fund has maintained its original target country allocation of 70% Russia,
15% Poland, 7% Hungary, 5% Czech Republic and 3% other countries. Russia
continues to be the market with the most potential for both short and long term
growth. The Fund has focused on building investments in Russian companies which
have a sustainable international competitive advantage or provide important
local services. Natural resource companies such as Lukoil, Megionneftegas and
Gazprom, electricity providers such as Mosenergo and Unified Energy Systems plus
telephone operators such as St. Petersburg Telephone and Rostelecom have all
been placed in the portfolio. Domestic demand in each of these industries will
increase as the Russian economy starts to grow, as is expected in 1997. The Fund
has avoided heavy industry and the financial sectors as many of these companies
have yet to illustrate viability in the new Russian environment.
In the all important Russian political arena, the biggest event of the quarter
was President Yeltsin's successful quintuple by-pass operation. The removal of
the threat of an imminent election is important, in that it will allow the
government to maintain necessary, but unpopular, economic measures, such as
continued fiscal prudence and pursuit of tax-debtors. Also, there is no longer
the urgent need to find a reformist successor to Yeltsin, and this has put a
stop to much of the in-fighting that has been present in the government since
the July elections. The firing of General Alexander Lebed will further help the
government to adopt a uniform approach to policy.
On the economic front, Russia received recognition for its impressive
achievements on October 8th when S&P awarded a BB- sovereign debt rating to the
country. This rating is higher than both Brazil and Venezuela. Russia has now
returned to the international bond markets with a Eurobond issue of over $1
billion. Macroeconomic performance continues to be steady with inflation for
1996 estimated at only 22%, and, as mentioned earlier, the likelihood of real
economic growth in 1997 for the first time since the start of reforms.
The main area of economic difficulty for Russia is in the area of non-payments
at all levels, by companies to the government in the form of taxes, by the
government to firms and individuals for goods and employment and between firms
themselves. Trade by barter, not by cash, is fast becoming the standard
mechanism for doing business in Russia today. The government has started to take
steps to tackle these problems with the formation of a special committee to
enforce collection from those companies with the worst tax arrears, and by
beginning to push firms and banks that are not viable into bankruptcy. These
steps are naturally extremely unpopular, despite being vital for solving the
payment problem. The fact that the government is prepared to take these
difficult steps is very encouraging. This attitude, combined with the
government's new found security, should lead to all important wide-scale tax
reform in 1997.
Finally, the Russian equity market is also increasingly being seen as a
practical investment opportunity. The tremendous successes of the recent ADR
issues by Gazprom (5 times over-subscribed) and cellular phone operator,
Vimpel-Com (12 times over-subscribed) highlight this fact. With more and more
companies offering ADR's and the continued development of custody and
settlement, the amount of capital both wishing to and able to access the Russian
market will steadily expand.
The Fund continues to invest in Central and Eastern Europe, primarily in Poland
and Hungary. While Poland's cheap, well-educated workforce and strategic
location continue to drive the country's export-led
2
<PAGE>
growth, there are signs that domestic consumption will be the main force behind
growth in the second half of this decade. Strong real wage growth, combined with
increased consumer credit, has begun to fuel a consumption boom. The Fund has
positioned itself to benefit from the increased spending power of 40 million
Poles. Foreign strategic investors, mainly multinationals, also recognize the
country's potential. Poland became the largest recipient of foreign direct
investment (FDI) during 1996, attracting over $1 billion during the first half
of 1996 alone. Hungary's currency stability, through its crawling exchange rate
system, has meant that its main exporters have remained competitive and continue
to display strong earnings growth. Meanwhile, GDP is beginning to recover from
the austerity measures implemented during 1995. The Fund has invested in
companies that can both export and have significant domestic market share.
Poland and Hungary are poised to take a major step in the development of their
stock markets. During the next two years, both will grow steadily as a host of
new and secondary offerings come to market. The Polish government plans to
privatize scores of companies during 1997 using the stock exchange, and the
market capitalization should grow from a mere 25% of GDP to 50% before the year
2000. Since the opening of the Warsaw Stock Exchange, the performance of its
IPOs has been phenomenal, many have risen over 100% in less than 2 years, and
the Fund plans to participate in future offerings if attractively priced. The
Hungarian government plans to float its monopoly telephone company during
mid-1997 in what should prove to be the largest public offering in the region's
history. The broadening and deepening of Central European stock markets will
attract new investors to the region, greatly increase liquidity and further the
re-rating process as these countries strive for membership in the European
Union. The combination of these factors illustrate that the countries throughout
the region continue to make progress towards becoming modern, capitalist
economies, and that the Fund is one of the easiest and most effective way for
investors to benefit from this development.
Sincerely,
[SIGNATURE]
Warren J. Olsen
PRESIDENT AND DIRECTOR
[SIGNATURE]
Madhav Dhar
PORTFOLIO MANAGER
[SIGNATURE]
Marianne L. Hay
PORTFOLIO MANAGER
[SIGNATURE]
Michael Hewett
PORTFOLIO MANAGER
January 1997
- --------------------------------------------------------------------------------
MORGAN STANLEY GROUP INC., THE DIRECT PARENT COMPANY OF THE FUND'S INVESTMENT
ADVISER, MORGAN STANLEY ASSET MANAGEMENT INC., RECENTLY ANNOUNCED ITS INTENTION
TO MERGE WITH DEAN WITTER, DISCOVER & CO. TO FORM MORGAN STANLEY, DEAN WITTER,
DISCOVER & CO. IT CURRENTLY IS ANTICIPATED THAT THE TRANSACTION WILL CLOSE IN
MID-1997. THEREAFTER, MORGAN STANLEY ASSET MANAGEMENT INC. WILL BE A SUBSIDIARY
OF MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
3
<PAGE>
Morgan Stanley Russia & New Europe Fund, Inc.
Investment Summary as of December 31, 1996 (Unaudited)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
HISTORICAL
INFORMATION
<TABLE>
<CAPTION>
TOTAL RETURN (%)
---------------------------
NET ASSET
MARKET VALUE (2)
VALUE (1) ----------
---------- CUMULATIVE
CUMULATIVE ----------
----------
<S> <C> <C>
SINCE
INCEPTION* -9.72% 4.18%
</TABLE>
Past performance is not predictive of future performance.
- --------------------------------------------------------------------------------
RETURNS AND PER SHARE INFORMATION
A BAR CHART REFLECTING THE DATA BELOW IS REFLECTED HERE.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1996*
<S> <C>
Net Asset Value Per Share $ 20.77
Market Value Per Share $18.00
Premium/(Discount) -13.3%
Income Dividends $0.07
Capital Gains Distributions --
Fund Total Return (2) 4.18%
</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.
* The Fund commenced operations on September 30, 1996.
4
<PAGE>
Morgan Stanley Russia & New Europe Fund, Inc.
Portfolio Summary as of December 31, 1996 (Unaudited)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PORTFOLIO INVESTMENTS DIVERSIFICATION
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C>
Equity Securities 58.5%
Debt Instruments 16.6%
Short-Term Investments 24.9%
</TABLE>
- --------------------------------------------------------------------------------
SECTORS
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C>
Banking 5.6%
Chemicals 1.7%
Construction & Housing 2.0%
Data Processing & Reproduction 2.4%
Energy Sources 12.5%
Health & Personal Care 1.1%
Multi-Industry 1.5%
Retail - Major Dept. Store 1.5%
Telecommunications 6.2%
Utilities-Electrical & Gas 21.5%
Other 44.0%
</TABLE>
- --------------------------------------------------------------------------------
COUNTRY WEIGHTINGS
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C>
Russia 54.6%
Poland 12.3%
Hungary 4.0%
Bulgaria 3.2%
Croatia 1.8%
Czech Republic 1.0%
Other 23.1%
</TABLE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS*
PERCENT OF
NET ASSETS
----------
<C> <S> <C>
1. Russian Ministry of Finance 10.0%
2. Unified Energy System 8.2%
3. Lukoil Holdings 6.8%
4. Moscow Energy 6.7%
5. Gazprom ADR 5.0%
<CAPTION>
PERCENT OF
NET ASSETS
----------
<C> <S> <C>
6. Rostelecom 4.7%
7. Bank for Foreign Economic
Affairs 3.8%
8. Republic of Bulgaria Bonds 3.2%
9. Computerland Poland 2.4%
10. Tatneft ADR 1.9%
---
52.7%
---
---
</TABLE>
- --------------------------------------------------------------------------------
* Excludes Short-Term Investments.
5
<PAGE>
FINANCIAL STATEMENTS
- ---------
STATEMENT OF NET ASSETS
- ---------
DECEMBER 31, 1996
<TABLE>
<CAPTION>
VALUE
SHARES (000)
<S> <C> <C>
- -----------------------------------------------------------------
- -------------
COMMON STOCKS (59.9%)
(Unless otherwise noted)
- --------------------------------------------------
- ----------
CZECH REPUBLIC (1.0%)
FINANCE
Resolution Investment Fund 6,100 U.S.$ 190
--------------
BANKING
+PF IKS KB 132,497 823
--------------
1,013
--------------
- -----------------------------------------------------------------
- -------------
CROATIA (1.8%)
BANKING
+Zagrebacka Banka GDR 90,500 1,844
--------------
- -----------------------------------------------------------------
- -------------
HUNGARY (4.0%)
CHEMICALS
Pannonplast Rt. 47,325 1,741
--------------
ENERGY SOURCES
MOL Magyar Rt. GDR 100,000 1,265
--------------
HEALTH & PERSONAL CARE
Richter Gedeon Rt. GDR 20,100 1,171
--------------
4,177
--------------
- -----------------------------------------------------------------
- -------------
POLAND (12.3%)
BANKING
+Bank Ochrony Srodowiska 24,001 243
Bank Slaski 13,800 1,405
BIG 975,000 1,360
WBK 25,000 169
--------------
3,177
--------------
BEVERAGES & TOBACCO
Zywiec 15,000 696
--------------
CONSTRUCTION & HOUSING
Polifarb Cieszyn 222,000 1,231
Polifarb Wroclaw 150,000 847
--------------
2,078
--------------
DATA PROCESSING & REPRODUCTION
+Computerland Poland 100,900 2,498
--------------
ENERGY EQUIPMENT & SERVICES
Elektrobudowa 60,000 1,046
--------------
</TABLE>
- -----------------------------------------------------------------
- -------------
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- ---------------------------------------------------------
- ------------
<S> <C> <C>
FOOD & HOUSEHOLD PRODUCTS
Farm Food 20,000 U.S.$ 322
Zaklady Przemyslu Cukierniczego
Jutrzenka 21,000 407
--------------
729
--------------
MULTI-INDUSTRY
Elektrim Spolka Akcyjna 170,000 1,542
--------------
WHOLESALE & INTERNATIONAL TRADE
ROLIMPEX 123,451 960
--------------
12,726
--------------
- -----------------------------------------------------------------
- -------------
RUSSIA (40.8%)
ENERGY SOURCES
+Lukoil Holdings 630,000 7,119
+Megionneftegas 150,000 480
+Noyabrskneftegaz 150,000 941
+Purneftegaz 485,000 1,261
+Tatneft ADR 41,200 1,936
--------------
11,737
--------------
METALS -- STEEL
+Seversky Tube Works 200,000 250
+Seversky Tube Works ADR 10,000 125
--------------
375
--------------
RETAIL
+Trade House TSUM 4,000,000 1,562
--------------
TELECOMMUNICATIONS
+Nizhny Novgorod Telephone 200,000 440
+Rostelecom 2,005,000 4,852
+St. Petersburg Telephone Network 1,100,000 1,177
--------------
6,469
--------------
UTILITIES
+Gazprom ADR 300,000 5,175
+Irkutskenergo 4,000,000 530
+Lenenergo 3,000,000 1,133
+Moscow Energy 6,800,000 6,936
Unified Energy System 93,800,000 8,536
--------------
22,310
--------------
42,453
--------------
- -----------------------------------------------------------------
- -------------
TOTAL COMMON STOCKS
(Cost U.S. $59,000) 62,213
--------------
- -----------------------------------------------------------------
- -------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
6
<PAGE>
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- ---------------------------------------------------------
- ------------
<S> <C> <C>
DEBT INSTRUMENTS (17.0%)
- ---------------------------------------------------------
- ------------
BULGARIA (3.2%)
FOREIGN GOVERNMENT BONDS
+++Republic of Bulgaria Discount Bond
'A' 'Euro'6.6875%, 7/28/24 U.S.$ 4,500 U.S.$ 2,557
*Republic of Bulgaria Front Loaded
Interest Reduction Bond 'A' 'Euro'
2.25%, 7/28/12 2,000 769
--------------
3,326
--------------
- -----------------------------------------------------------------
- -------------
RUSSIA (13.8%)
BONDS
Ministry of Finance Tranche IV 3.00%,
5/14/03 6,000 3,671
#Ministry of Finance Tranche VI GDR
3.00%, 5/14/06 (144A) 14,000 6,720
--------------
10,391
--------------
LOAN AGREEMENT
##++Bank for Foreign Economic Affairs 5,000 3,991
--------------
14,382
--------------
- -----------------------------------------------------------------
- -------------
TOTAL DEBT INSTRUMENTS
(Cost U.S. $17,441) 17,708
--------------
- -----------------------------------------------------------------
- -------------
SHORT-TERM INVESTMENT (25.5%)
- ---------------------------------------------------------
- ------------
UNITED STATES (25.5%)
REPURCHASE AGREEMENT
Chase Securities, Inc. 5.95%, dated
12/31/96, due 1/2/97, to be
repurchased at U.S. $26,535,
collateralized by U.S. $25,925 United
States Treasury Notes 6.625%, due
7/31/01, valued at U.S. $26,526
(Cost U.S. $26,526) 26,526 26,526
--------------
- -----------------------------------------------------------------
- -------------
TOTAL INVESTMENTS (102.4%)
(Cost U.S. $102,967) 106,447
--------------
- -----------------------------------------------------------------
- -------------
OTHER ASSETS (0.6%)
Interest Receivable 529
Deferred Organization Costs 76
Other Assets 3 608
--------------- --------------
- -----------------------------------------------------------------
- -------------
LIABILITIES (-3.0%)
Payable for:
Investments Purchased (2,103)
Dividends Declared (325)
Bank Overdraft (274)
Custodian Fees (265)
Professional Fees (63)
Investment Advisory Fees (19)
Administrative Fees (13)
Directors' Fees and Expenses (6)
Other Liabilities (42) (3,110)
--------------- --------------
</TABLE>
- -----------------------------------------------------------------
- -------------
<TABLE>
<CAPTION>
AMOUNT
(000)
<S> <C> <C>
- ---------------------------------------------------------
- ------------
NET ASSETS (100%)
Applicable to 5,005,000 issued and outstanding U.S.
$0.01 par value shares (500,000,000 shares
authorized) U.S.$ 103,945
--------------
--------------
- -----------------------------------------------------------------
- -------------
NET ASSET VALUE PER SHARE U.S.$ 20.77
--------------
--------------
- -----------------------------------------------------------------
- -------------
AT DECEMBER 31, 1996, NET ASSETS CONSISTED OF:
- -----------------------------------------------------------------
Common Stock U.S.$ 50
Capital Surplus 100,050
Distributions in Excess of Net
Investment Income (10)
Accumulated Net Realized Gain 375
Unrealized Appreciation on Investments and Foreign
Currency Translations 3,480
- -----------------------------------------------------------------
- -------------
TOTAL NET ASSETS U.S.$ 103,945
--------------
--------------
- -----------------------------------------------------------------
- -------------
</TABLE>
+ -- Non-income producing.
++ -- Non-income producing -- In default.
+++ -- Variable/floating rate security - rate disclosed is as of December 31,
1996.
# -- 144A Security -- certain conditions for public sale may exist.
## -- Under restructuring at December 31, 1996 -- See Note A-6 to financial
statements.
* -- Step Bond -- coupon rate increases in increments to maturity. Rate
disclosed is as of December 31, 1996. Maturity date disclosed is the
ultimate maturity.
ADR -- American Depositary Receipt.
GDR -- Global Depositary Receipt.
December 31, 1996 exchange rate -- Czech Koruna (CZK)
27.204 = U.S.$1.00
<TABLE>
<S> <C> <C>
- -----------------------------------------------------------------
- -------------
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACT INFORMATION:
Under the terms of a forward foreign currency exchange contract open at
December 31, 1996, the Fund is obligated to deliver U.S. dollars in
exchange for foreign currency as indicated below:
</TABLE>
<TABLE>
<CAPTION>
CURRENCY IN NET
TO EXCHANGE UNREALIZED
DELIVER SETTLEMENT FOR VALUE GAIN/LOSS
(000) DATE (000) (000) (000)
- ------------ ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
U.S. $42 1/9/97 CZK 1,138 U.S.$42 U.S.$--
</TABLE>
The accompanying notes are an integral part of the financial statements.
7
<PAGE>
<TABLE>
<CAPTION>
PERIOD FROM
SEPTEMBER 30,
1996*
TO DECEMBER 31,
1996
STATEMENT OF OPERATIONS (000)
<S> <C>
- -----------------------------------------------------------------------------------------
INVESTMENT INCOME
Interest.......................................................... U.S.$ 1,135
- -----------------------------------------------------------------------------------------
Total Income.................................................... 1,135
- -----------------------------------------------------------------------------------------
EXPENSES
Investment Advisory Fees.......................................... 400
Custodian Fees.................................................... 266
Professional Fees................................................. 75
Administrative Fees............................................... 40
Shareholder Reporting Expenses.................................... 39
Directors' Fees and Expenses...................................... 9
Other Expenses.................................................... 13
- -----------------------------------------------------------------------------------------
Total Expenses.................................................. 842
- -----------------------------------------------------------------------------------------
Net Investment Income....................................... 293
- -----------------------------------------------------------------------------------------
NET REALIZED GAIN (LOSS)
Investment Securities Sold........................................ 420
Foreign Currency Transactions..................................... (23)
- -----------------------------------------------------------------------------------------
Net Realized Gain........................................... 397
- -----------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION/DEPRECIATION
Appreciation on Investments....................................... 3,480
- -----------------------------------------------------------------------------------------
Total Net Realized Gain and Change in Unrealized
Appreciation/Depreciation............................................ 3,877
- -----------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS.............. U.S.$ 4,170
- -----------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
PERIOD FROM
SEPTEMBER 30,
1996*
TO DECEMBER 31,
1996
STATEMENT OF CHANGES IN NET ASSETS (000)
<S> <C>
- -----------------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
Operations:
Net Investment Income............................................. U.S.$ 293
Net Realized Gain................................................. 397
Change in Unrealized Appreciation/Depreciation.................... 3,480
- -----------------------------------------------------------------------------------------
Net Increase in Net Assets Resulting from Operations.............. 4,170
- -----------------------------------------------------------------------------------------
Distributions:
Net Investment Income............................................. (325)
- -----------------------------------------------------------------------------------------
Capital Share Transactions:
Common Stock Issued through Initial Public Offering (5,005,000
Shares).......................................................... 100,100
- -----------------------------------------------------------------------------------------
Total Increase.................................................... 103,945
Net Assets:
Beginning of Period............................................... --
- -----------------------------------------------------------------------------------------
End of Period (including distribution in excess of net investment
income of $10)................................................... U.S.$103,945
- -----------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------
</TABLE>
*Commencement of Operations
The accompanying notes are an integral part of the financial statements.
8
<PAGE>
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
PERIOD FROM
SEPTEMBER 30,
1996*
TO DECEMBER 31,
SELECTED PER SHARE DATA AND RATIOS: 1996
<S> <C>
- -------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD............................................ U.S.$ 20.00
- -------------------------------------------------------------------------------------------------
Net Investment Income........................................................... 0.06
Net Realized and Unrealized Gain on Investments................................. 0.78
- -------------------------------------------------------------------------------------------------
Total from Investment Operations............................................ 0.84
- -------------------------------------------------------------------------------------------------
Distributions:
Net Investment Income....................................................... (0.07)
- -------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD.................................................. U.S.$ 20.77
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
PER SHARE MARKET VALUE, END OF PERIOD........................................... U.S.$ 18.00
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:
Market Value................................................................ (9.72)%
Net Asset Value (1)......................................................... 4.18%
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
RATIOS, SUPPLEMENTAL DATA:
- -------------------------------------------------------------------------------------------------
NET ASSETS, END OF PERIOD (THOUSANDS)........................................... U.S.$103,945
- -------------------------------------------------------------------------------------------------
Ratio of Expenses to Average Net Assets......................................... 3.30%**
Ratio of Net Investment Income to Average Net Assets............................ 1.15%**
Portfolio Turnover Rate......................................................... 2%
Average Commission Rate (2)..................................................... U.S.$0.0456
- -------------------------------------------------------------------------------------------------
*Commencement of operations
**Annualized
(1)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 of the Fund.
(2)For the year ended December 31, 1996, the average commission rate paid on trades on which
commissions were charged was 0.59% of the trade amount.
</TABLE>
The accompanying notes are an integral part of the financial statements.
9
<PAGE>
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
- ------------
The Morgan Stanley Russia & New Europe Fund, Inc. (the "Fund") was
incorporated on February 3, 1994 and is registered as a non-diversified,
closed-end management investment company under the Investment Company Act of
1940, as amended. The Fund's investment objective is long-term capital
appreciation through investments primarily in equity securities.
A. The following significant accounting policies, which are in conformity with
generally accepted accounting principles for investment companies, are
consistently followed by the Fund in the preparation of its financial
statements. Generally accepted accounting principles may require management to
make estimates and assumptions that affect the amounts and disclosures in the
financial statements. Actual results may differ from those estimates.
1. SECURITY VALUATION: In valuing the Fund's assets, all
listed securities for which market quotations are readily available are
valued at the last sales price on the valuation date, or if there was no
sale on such date, at the mean between the current bid and asked prices.
Securities which are traded over-the-counter are valued at the average of
the mean of current bid and asked prices obtained from reputable brokers.
All non-equity securities as to which market quotations are readily
available are valued at their market values. Short-term securities which
mature in 60 days or less are valued at amortized cost. All other securities
and assets for which market values are not readily available (including
investments which are subject to limitations as to their sale) are valued at
fair value as determined in good faith by the Board of Directors, although
the actual calculations may be done by others.
2. TAXES: It is the Fund's intention to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for U.S. Federal income taxes is required in the
financial statements.
The Fund may be subject to taxes imposed by countries in which it invests.
Such taxes are generally based on income and/or capital gains earned or
repatriated. Taxes are accrued and applied to net investment income, net
realized gains and net unrealized appreciation as such income and/or gains
are earned.
3. REPURCHASE AGREEMENTS: In connection with
transactions in repurchase agreements, a bank as custodian for the Fund takes
possession of the underlying securities, with a market value at least equal
to the amount of the repurchase transaction, including principal and accrued
interest. To the extent that any repurchase transaction exceeds one business
day, the value of the collateral is marked-to-market on a daily basis to
determine the adequacy of the collateral. In the event of default on the
obligation to repurchase, the Fund has the right to liquidate the collateral
and apply the proceeds in satisfaction of the obligation. In the event of
default or bankruptcy by the counterparty to the agreement, realization
and/or retention of the collateral or proceeds may be subject to legal
proceedings.
4. FOREIGN CURRENCY TRANSLATION: The books and
records of the Fund are maintained in U.S. dollars. Foreign currency amounts
are translated into U.S. dollars at the mean of the bid and asked prices of
such currencies against U.S. dollars last quoted by a major bank as follows:
- investments, other assets and liabilities at the prevailing rates of
exchange on the valuation date;
- investment transactions and investment income at the prevailing rates of
exchange on the dates of such transactions.
Although the net assets of the Fund are presented at the foreign exchange
rates and market values at the close of the period, the Fund does not
isolate that portion of the results of operations arising as a result of
changes in the foreign exchange rates from the fluctuations arising from
changes in the market prices of the securities held at period end.
Similarly, the Fund does not isolate the effect of changes in foreign
exchange rates from the fluctuations arising from changes in the market
prices of securities sold during the period. Accordingly, realized and
unrealized foreign currency gains (losses) are included in the reported net
realized and unrealized gains (losses) on investment transactions and
balances.
Net realized gains (losses) on foreign currency transactions represent net
foreign exchange gains (losses) from sales and maturities of forward foreign
currency exchange contracts, disposition of foreign currencies, currency
gains or losses realized between the trade and settlement dates on
securities transactions, and the difference between the amount of investment
income and foreign withholding taxes recorded on the Fund's books and the
U.S. dollar equivalent amounts actually received or paid. Net unrealized
currency gains (losses) from valuing foreign currency denominated assets and
liabilities at period end exchange rates are reflected as a component of
unrealized appreciation (depreciation) in the Statement of Net Assets. The
change in net unrealized currency gains (losses) for the period is reflected
in the Statement of Operations.
5. FORWARD FOREIGN CURRENCY EXCHANGE
CONTRACTS: The Fund may enter into forward foreign currency exchange contracts
to attempt to protect securities and related receivables and payables
against changes in future foreign exchange rates. A forward foreign currency
exchange contract is an agreement between two parties to buy or sell
currency at a set
10
<PAGE>
price on a future date. The market value of the contract will fluctuate with
changes in currency exchange rates. The contract is marked-to-market daily
and the change in market value is recorded by the Fund as unrealized gain or
loss. The Fund records realized gains or losses when the contract is closed
equal to the difference between the value of the contract at the time it was
opened and the value at the time it was closed. Risk may arise upon entering
into these contracts from the potential inability of counterparties to meet
the terms of their contracts and is generally limited to the amount of
unrealized gain on the contracts, if any, at the date of default. Risks may
also arise from unanticipated movements in the value of a foreign currency
relative to the U.S. dollar.
6. LOAN AGREEMENTS: The Fund may invest in fixed
and floating rate loans ("Loans") arranged through private negotiations
between an issuer of sovereign debt obligations and one or more financial
institutions ("Lenders") deemed to be creditworthy by the investment
adviser. The Fund's investments in Loans may be in the form of
participations in Loans ("Participations") or assignments of all or a
portion of Loans ("Assignments") from third parties. The Fund's investment
in Participations typically results in the Fund having a contractual
relationship with only the Lender and not with the borrower. The Fund has
the right to receive payments of principal, interest and any fees to which
it is entitled only from the Lender selling the Participation and only upon
receipt by the Lender of the payments from the borrower. The Fund generally
has no right to enforce compliance by the borrower with the terms of the
loan agreement. As a result, the Fund may be subject to the credit risk of
both the borrower and the Lender that is selling the Participation. When the
Fund purchases Assignments from Lenders it acquires direct rights against
the borrower of the Loan. Because Assignments are arranged through private
negotiations between potential assignees and potential assignors, the rights
and obligations acquired by the Fund as the purchaser of an Assignment may
differ from, and be more limited than, those held by the assigning Lender.
7. OTHER: Security transactions are accounted for on
the date the securities are purchased or sold. Realized gains and losses on
the sale of investment securities are determined on the specific identified
cost basis. Interest income is recognized on the accrual basis. Dividend
income is recorded on the ex-date (except certain dividends which may be
recorded as soon as the Fund is informed of such dividends) net of
applicable withholding taxes where recovery of such taxes is not reasonably
assured. Distributions to shareholders are recorded on the ex-date.
The amount and character of income and capital gain distributions to be paid
are determined in accordance with Federal income tax regulations which may
differ from generally accepted accounting principles. These differences are
primarily due to differing book and tax treatments for foreign currency
transactions and the timing of the recognition of gains or losses on
securities.
Permanent book and tax basis differences relating to shareholder
distributions may result in reclassifications to undistributed net
investment income (loss), accumulated net realized gain (loss) and capital
surplus.
Adjustments for permanent book-tax differences, if any, are not reflected in
ending undistributed net investment income (loss) for the purpose of
calculating net investment income (loss) per share in the financial
highlights.
B. Morgan Stanley Asset Management Inc. (the "Adviser") provides investment
advisory services to the Fund under the terms of an Investment Advisory
Agreement (the "Agreement"). Under the Agreement, the Adviser is paid a fee
computed weekly and payable monthly at an annual rate of 1.60% of the Fund's
average weekly net assets.
C. The Chase Manhattan Bank, through its affiliate Chase Global Funds Services
Company (the "Administrator"), provides administrative services to the Fund
under an Administration Agreement. Under the Administration Agreement, the
Administrator is paid a fee computed weekly and payable monthly at an annual
rate of 0.09% of the Fund's average weekly net assets, plus $65,000 per annum.
In addition, the Fund is charged certain out-of-pocket expenses by the
Administrator. The Chase Manhattan Bank acts as global custodian for the Fund's
assets.
D. For the period ended December 31, 1996, the Fund made purchases and sales
totaling approximately $77,265,000 and $1,454,000, respectively, of investment
securities other than long-term U.S. Government securities and short-term
investments. These were no purchases or sales of long-term U.S. Government
securities. At December 31, 1996, the U.S. Federal income tax cost basis of
securities was $102,967,000 and accordingly, net unrealized appreciation for
U.S. Federal income tax purposes was $3,480,000, of which $4,328,000 related to
appreciated securities and $848,000 related to depreciated securities. For the
period ended December 31, 1996, the Fund expects to defer to January 1, 1997,
for U.S. Federal income tax purposes, post-October currency losses of $11,000.
E. A significant portion of the Fund's assets consist of securities of issues
located in emerging markets, which are denominated in foreign currencies.
Changes in currency exchange rates will affect the value of and investment
income from such securities. Securities in emerging markets involve certain
considerations and risks not typically
11
<PAGE>
associated with investments in the United States. In addition to smaller size,
lesser liquidity and greater volatility, certain securities' markets in which
the Fund may invest are less developed than the U.S. securities market and there
is often substantially less publicly available information about these issuers.
Further, emerging market issues may be subject to substantial governmental
involvement in the economy and greater social, economic and political
uncertainty. Accordingly, the price which the Fund may realize upon sale of
securities in such markets may not be equal to its value as presented in the
financial statements.
Settlement and registration of securities transactions may be subject to
significant risks not normally associated with investments in the United States.
In certain markets, including Russia, ownership of shares is defined according
to entries in the issuer's share register. In Russia, there currently exists no
central registration system and the share registrars may not be subject to
effective state supervision. It is possible the Fund could lose its share
registration through fraud, negligence or even mere oversight.
F. In connection with its organization, the Fund incurred $80,000 of
organization costs. The organization costs are being amortized on a
straight-line basis over a five-year period beginning September 30, 1996, the
date the Fund commenced operations.
G. The Fund entered into an Agreement with a number of underwriters (the
"Underwriters") including Morgan Stanley & Co. Incorporated, an affiliate of the
Adviser, for the initial public offering of its shares and issued 5,005,000
shares on September 30, 1996. In connection with the initial offering of the
Fund's shares, the Adviser has agreed to pay the related offering costs totaling
approximately $420,000. In addition, the Adviser agreed to pay the underwriters
of the offering a commission equal to 4% of the initial public offering price
per share, other than for shares acquired for accounts managed by the Adviser.
H. Each Director of the Fund who is not an officer of the Fund or an affiliated
person as defined under the Investment Company Act of 1940, as amended, may
elect to participate in the Directors' Deferred Compensation Plan (the "Plan").
Under the Plan, such Directors may elect to defer payment of a percentage of
their total fees earned as a Director of the Fund. These deferred portions are
treated, based on an election by the Director, as if they were either invested
in the Fund's shares or invested in U.S. Treasury Bills, as defined under the
Plan.
I. During December 1996, the board declared a distribution of $0.065 per share,
derived from net investment income, payable on January 9, 1997, to shareholders
of record on December 31, 1996.
12
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
- ---------
To the Shareholders and Board of Directors of
Morgan Stanley Russia & New Europe Fund, Inc.
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Morgan Stanley Russia & New Europe Fund, Inc. (the "Fund") at December 31, 1996,
and the results of its operations, the changes in its net assets and the
financial highlights for the period September 30, 1996 (commencement of
operations) through December 31, 1996, in conformity with generally accepted
accounting principles. These financial statements and financial highlights
(hereafter referred to as "financial statements") are the responsibility of the
Fund's management; our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit of these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit, which included
confirmation of securities at December 31, 1996 by correspondence with the
custodian and brokers and the application of alternative auditing procedures
where confirmations from brokers were not received, provides a reasonable basis
for the opinion expressed above.
PRICE WATERHOUSE LLP
1177 Avenue of the Americas
New York, New York 10036
February 10, 1997
13
<PAGE>
DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN
Pursuant to the Dividend Reinvestment and Cash Purchase Plan (the "Plan"),
each shareholder will be deemed to have elected, unless American Stock Transfer
& Trust Company (the "Plan Agent") is otherwise instructed by the shareholder in
writing, to have all distributions automatically reinvested in Fund shares.
Participants in the Plan have the option of making additional voluntary cash
payments to the Plan Agent, annually, in any amount from $100 to $3,000, for
investment in Fund shares.
Dividend and capital gain distributions will be reinvested on the
reinvestment date in full and fractional shares. If the market price per share
equals or exceeds net asset value per share on the reinvestment date, the Fund
will issue shares to participants at net asset value. If net asset value is less
than 95% of the market price on the reinvestment date, shares will be issued at
95% of the market price. If net asset value exceeds the market price on the
reinvestment date, participants will receive shares valued at market price. The
Fund may purchase shares of its Common Stock in the open market in connection
with dividend reinvestment requirements at the discretion of the Board of
Directors. Should the Fund declare a dividend or capital gain distribution
payable only in cash, the Plan Agent will purchase Fund shares for participants
in the open market as agent for the participants.
The Plan Agent's fees for the reinvestment of dividends and distributions
will be paid by the Fund. However, each participant's account will be charged a
pro rata share of brokerage commissions incurred on any open market purchases
effected on such participant's behalf. A participant will also pay brokerage
commissions incurred on purchases made by voluntary cash payments. Although
shareholders in the Plan may receive no cash distributions, participation in the
Plan will not relieve participants of any income tax which may be payable on
such dividends or distributions.
In the case of shareholders, such as banks, brokers or nominees, which hold
shares for others who are the beneficial owners, the Plan Agent will administer
the Plan on the basis of the number of shares certified from time to time by the
shareholder as representing the total amount registered in the shareholder's
name and held for the account of beneficial owners who are participating in the
Plan.
Participants who wish to withdraw from the Plan should notify the Plan Agent
in writing. There is no penalty for non-participation or withdrawal from the
Plan, and shareholders who have previously withdrawn from the Plan may rejoin at
any time. Requests for additional information or any correspondence concerning
the Plan should be directed to the Plan Agent at:
Morgan Stanley Russia & New Europe Fund, Inc.
American Stock Transfer & Trust Company
Dividend Reinvestment and Cash Purchase Plan
40 Wall Street
New York, NY 10005
1-800-278-4353
14