UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED
MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number: 811-10593
Morgan Stanley Institutional Fund of Hedge Funds LP
(Exact name of Registrant as specified in Charter)
One Tower Bridge
100 Front Street, Suite 1100
West Conshohocken, Pennsylvania 19428-2881
(Address of principal executive offices)
Barry Fink, Esq.
Morgan Stanley Investment Management Inc.
1221 Avenue of the Americas
New York, NY 10020
(Name and address of agent for service)
COPY TO:
Leonard B. Mackey, Jr., Esq.
Clifford Chance US LLP
31 West 52nd Street
New York, NY 10019
Registrant’s Telephone Number, including Area Code: (610) 260-7600
Date of fiscal year end: December 31
Date of reporting period: June 30, 2005
[LOGO] Morgan Stanley
| ITEM 1. | REPORTS TO STOCKHOLDERS. The Registrant’s semi-annual report transmitted to limited partners pursuant to Rule 30e-1 under the Investment Company Act of 1940 is as follows: |
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
MORGAN STANLEY
INSTITUTIONAL FUND OF HEDGE
FUNDS LP
Financial Statements (Unaudited)
For the Period from January 1, 2005 to June 30, 2005
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Financial Statements (Unaudited)
For the Period from January 1, 2005 to June 30, 2005
Contents
Financial Statements (Unaudited) | ||
| 1 | ||
| 2 | ||
| 3 | ||
| 4 | ||
| 5 | ||
| 11 | ||
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Statement of Assets, Liabilities and Partners’ Capital (Unaudited)
June 30, 2005
Assets | ||||
Investments in investment funds, at fair value (cost $1,510,915,049) | $ | 1,688,906,474 | ||
Cash and cash equivalents, (cost $17,457,771) | 17,457,771 | |||
Purchased options, at fair value (cost $986,800) | 816,939 | |||
Due from broker | 68,055,451 | |||
Receivable for investments sold | 1,033,735 | |||
Unrealized appreciation on swap contracts | 1,451,770 | |||
Other assets | 36,090 | |||
Total assets | 1,777,758,230 | |||
Liabilities | ||||
Management fee payable | 1,625,669 | |||
Unrealized depreciation on swap contracts | 709,065 | |||
Directors’ fee payable | 23,035 | |||
Accrued expenses and other liabilities | 791,203 | |||
Total liabilities | 3,148,972 | |||
Net assets | $ | 1,774,609,258 | ||
Partners’ capital | ||||
Represented by: | ||||
Net capital contributions | $ | 1,578,421,549 | ||
Accumulated net investment loss | (5,393,973 | ) | ||
Accumulated net realized gain from investments | 23,017,413 | |||
Accumulated net unrealized appreciation on investments | 178,564,269 | |||
Total partners’ capital | $ | 1,774,609,258 | ||
The accompanying notes are an integral part of these financial statements and should be read in conjunction therewith.
1
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Statement of Operations (Unaudited)
For the Period from January 1, 2005 to June 30, 2005
Investment income | ||||
Interest | $ | 713,778 | ||
Expenses | ||||
Management fees | 4,903,193 | |||
Accounting and administration fees | 546,243 | |||
Legal fees | 325,002 | |||
Insurance expense | 125,603 | |||
Directors’ fees | 15,074 | |||
Other | 192,636 | |||
Total expenses | 6,107,751 | |||
Net investment loss | (5,393,973 | ) | ||
Realized and unrealized gain (loss) from investments: | ||||
Net realized gain from investments in investment funds | 19,458,246 | |||
Net realized gain from purchased options | 1,215,060 | |||
Net realized gain from swap contracts | 2,344,107 | |||
Net realized gain from investments | 23,017,413 | |||
Net change in unrealized appreciation on investments in investment funds | 2,298,940 | |||
Net change in unrealized depreciation on purchased options | (169,861 | ) | ||
Net change in unrealized appreciation on swap contracts | (2,173,718 | ) | ||
Net change in unrealized appreciation on investments | (44,639 | ) | ||
Net realized and unrealized gain from investments | 22,972,774 | |||
Net increase in partners’ capital resulting from operations | $ | 17,578,801 | ||
The accompanying notes are an integral part of these financial statements and should be read in conjunction therewith.
2
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Statements of Changes in Partners’ Capital
| General Partner | Limited Partners | Total | ||||||||||
Partners’ capital at December 31, 2003 | $ | 33,262,413 | $ | 1,063,536,184 | $ | 1,096,798,597 | ||||||
For the year ended December 31, 2004 | ||||||||||||
Increase (decrease) in partners’ capital: | ||||||||||||
From operations | ||||||||||||
Net investment loss | (265,080 | ) | (10,681,208 | ) | (10,946,288 | ) | ||||||
Net realized gain from investments | 110,292 | 3,349,182 | 3,459,474 | |||||||||
Net change in unrealized appreciation on investments | 1,754,175 | 80,501,291 | 82,255,466 | |||||||||
Net increase in partners’ capital resulting from operations | 1,599,387 | 73,169,265 | 74,768,652 | |||||||||
From partners’ capital transactions | ||||||||||||
Proceeds from partner subscriptions | — | 565,540,272 | 565,540,272 | |||||||||
Payments for partner redemptions | (8,775,000 | ) | (10,917,591 | ) | (19,692,591 | ) | ||||||
Reallocation of performance incentive | 54,887 | (54,887 | ) | — | ||||||||
Net increase (decrease) in partners’ capital from capital transactions | (8,720,113 | ) | 554,567,794 | 545,847,681 | ||||||||
Total increase (decrease) in partners’ capital | (7,120,726 | ) | 627,737,059 | 620,616,333 | ||||||||
Partners’ capital at December 31, 2004 | $ | 26,141,687 | $ | 1,691,273,243 | $ | 1,717,414,930 | ||||||
For the period from January 1, 2005 to June 30, 2005 (Unaudited) | ||||||||||||
Increase (decrease) in partners’ capital: | ||||||||||||
From operations | ||||||||||||
Net investment loss | $ | (79,855 | ) | $ | (5,314,118 | ) | $ | (5,393,973 | ) | |||
Net realized gain from investments | 341,430 | 22,675,983 | 23,017,413 | |||||||||
Net change in unrealized appreciation on investments | (2,035 | ) | (42,604 | ) | (44,639 | ) | ||||||
Net increase in partners’ capital resulting from operations | 259,540 | 17,319,261 | 17,578,801 | |||||||||
From partners’ capital transactions | ||||||||||||
Proceeds from partner subscriptions | — | 60,358,858 | 60,358,858 | |||||||||
Payments for partner redemptions | — | (20,743,331 | ) | (20,743,331 | ) | |||||||
Reallocation of performance incentive | — | — | — | |||||||||
Net increase in partners’ capital from capital transactions | — | 39,615,527 | 39,615,527 | |||||||||
Total increase in partners’ capital | 259,540 | 56,934,788 | 57,194,328 | |||||||||
Partners’ capital at June 30, 2005 | $ | 26,401,227 | $ | 1,748,208,031 | $ | 1,774,609,258 | ||||||
The accompanying notes are an integral part of these financial statements and should be read in conjunction therewith.
3
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Statement of Cash Flows (Unaudited)
For the Period from January 1, 2005 to June 30, 2005
Cash flows from operating activities | ||||
Net increase in partners’ capital resulting from operations | $ | 17,578,801 | ||
Adjustments to reconcile net increase in partners’ capital resulting from operations to net cash used in operating activities: | ||||
Net realized gain from investments | (23,017,413 | ) | ||
Net change in unrealized appreciation on investments | 44,639 | |||
Purchase of investments in investment funds | (178,500,000 | ) | ||
Purchase of options | (1,594,450 | ) | ||
Proceeds from sales of investments in investment funds | 125,650,036 | |||
Proceeds from closing of options | 1,822,710 | |||
Net proceeds from settlement of swap contracts | 2,344,107 | |||
Increase in due from broker | (30,986,751 | ) | ||
Decrease in receivable for investments sold | 60,620,330 | |||
Decrease in other assets | 124,079 | |||
Increase in management fee payable | 48,721 | |||
Decrease in directors’ fee payable | (459 | ) | ||
Increase in accrued expenses and other liabilities | 307,363 | |||
Net cash used in operating activities | (25,558,287 | ) | ||
Cash flows from financing activities | ||||
Proceeds from partner subscriptions | 60,358,858 | |||
Payments for partner redemptions | (24,600,043 | ) | ||
Net cash provided by financing activities | 35,758,815 | |||
Net increase in cash and cash equivalents | 10,200,528 | |||
Cash and cash equivalents at beginning of period | 7,257,243 | |||
Cash and cash equivalents at end of period | $ | 17,457,771 | ||
The accompanying notes are an integral part of these financial statements and should be read in conjunction therewith.
4
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Schedule of Investments (Unaudited)
June 30, 2005
Description | First Acquisition Date | Cost | Fair Value | Percent of Partners’ Capital | First Available Redemption Date * | Liquidity ** | |||||||||
Investment Funds | |||||||||||||||
Convertible Arbitrage | |||||||||||||||
KBC Convertible Opportunities Fund L.P. | 7/1/2002 | $ | 12,400,973 | $ | 12,038,224 | 0.68 | % | N/A | Quarterly | ||||||
Lydian Partners II L.P. | 7/1/2002 | 23,750,000 | 26,907,544 | 1.52 | N/A | Quarterly | |||||||||
Total Convertible Arbitrage | 36,150,973 | 38,945,768 | 2.20 | ||||||||||||
Credit Trading and Capital Structure Arbitrage | |||||||||||||||
Artesian Credit Arbitrage Total Return Fund LP | 4/1/2004 | 20,000,000 | 21,142,906 | 1.19 | N/A | Quarterly | |||||||||
Blue Mountain Credit Alternatives Fund L.P. | 6/1/2004 | 37,500,000 | 35,223,850 | 1.98 | N/A | Monthly | |||||||||
D.E. Shaw Laminar Fund, L.L.C. | 7/1/2002 | 28,750,000 | 53,762,438 | 3.03 | N/A | Quarterly | |||||||||
Fir Tree Recovery Fund, L.P. | 7/1/2002 | 15,500,000 | 23,553,710 | 1.33 | N/A | 2 Years | |||||||||
KBC Credit Arbitrage Fund L.P. | 1/1/2003 | 10,000,000 | 11,753,896 | 0.66 | N/A | Monthly | |||||||||
KBC Return Enhancement Fund L.P. | 9/1/2003 | 20,000,000 | 19,210,537 | 1.08 | 8/31/2005 | Monthly | |||||||||
Mariner - Credit Risk Advisors Relative Value Fund, LP | 9/1/2003 | 13,000,000 | 14,398,371 | 0.81 | N/A | Quarterly | |||||||||
Par IV Fund, L.P. | 11/1/2004 | 12,000,000 | 12,576,880 | 0.71 | 12/31/2005 | Quarterly | |||||||||
Pequot Credit Opportunities Fund, L.P. | 7/1/2003 | 18,250,000 | 19,628,372 | 1.11 | N/A | Quarterly | |||||||||
Solent Relative Value Credit Fund L.P. (formerly Solent Global Credit Fund, L.P.) | 11/1/2004 | 34,000,000 | 34,967,825 | 1.97 | N/A | Quarterly | |||||||||
Trilogy Financial Partners, L.P. | 1/1/2003 | 8,000,000 | 10,259,780 | 0.58 | N/A | Quarterly | |||||||||
Total Credit Trading and Capital Structure Arbitrage | 217,000,000 | 256,478,565 | 14.45 | ||||||||||||
Fixed Income Arbitrage | |||||||||||||||
Endeavour Fund I LLC | 3/1/2004 | 24,450,000 | 25,555,383 | 1.44 | N/A | Quarterly | |||||||||
The Precept Domestic Fund II, L.P. | 11/1/2004 | 20,971,155 | 19,017,060 | 1.07 | 12/31/2005 | Quarterly | |||||||||
Vega Relative Value Fund Limited | 7/1/2002 | 24,750,000 | 28,185,936 | 1.59 | N/A | Monthly | |||||||||
Total Fixed Income Arbitrage | 70,171,155 | 72,758,379 | 4.10 | ||||||||||||
The accompanying notes are an integral part of these financial statements and should be read in conjunction therewith.
5
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Schedule of Investments (Unaudited) (continued)
June 30, 2005
Description | First Acquisition Date | Cost | Fair Value | Percent of Partners’ Capital | First Available Redemption Date * | Liquidity ** | |||||||||||
Investment Funds (continued) | |||||||||||||||||
Long Only Distressed | |||||||||||||||||
Avenue Asia Investments, L.P. | 7/1/2002 | $ | 18,100,000 | $ | 26,760,935 | 1.51 | % | N/A | Annually | ||||||||
Avenue Europe Investments, L.P. | 8/1/2004 | 18,000,000 | 19,256,807 | 1.08 | 9/30/2005 | Quarterly | |||||||||||
ORN European Distressed Debt Fund LLC | 11/1/2003 | 9,131,840 | 11,295,598 | 0.64 | N/A | Quarterly | |||||||||||
Total Long Only Distressed | 45,231,840 | 57,313,340 | 3.23 | ||||||||||||||
Long-Short | |||||||||||||||||
Amici Associates, L.P. | 5/1/2004 | 20,000,000 | 21,130,427 | 1.19 | N/A | Quarterly | |||||||||||
Atlas Capital (QP), L.P. | 8/1/2004 | 27,000,000 | 27,776,652 | 1.56 | 9/30/2005 | Quarterly | |||||||||||
Bryn Mawr Capital, L.P. | 10/1/2002 | 9,987,725 | 12,145,441 | 0.68 | N/A | Quarterly | |||||||||||
Delta Institutional, LP | 3/1/2004 | 32,400,000 | 36,530,740 | 2.06 | N/A | Quarterly | |||||||||||
Durban Capital, L.P. | 7/1/2004 | 7,750,000 | 8,119,103 | 0.46 | N/A | Quarterly | |||||||||||
Elm Ridge Capital Partners, L.P. | 7/1/2004 | 14,000,000 | 14,057,670 | 0.79 | N/A | Quarterly | |||||||||||
FrontPoint Healthcare Fund, L.P. | 5/1/2003 | 22,000,000 | 24,516,105 | 1.38 | N/A | Quarterly | |||||||||||
Gotham Asset Management (U.S.), L.P. | 8/1/2003 | 14,500,000 | 17,347,319 | 0.98 | N/A | Annually | |||||||||||
Highbridge Long/Short Equity Fund, L.P. | 1/1/2005 | 14,000,000 | 14,665,337 | 0.83 | N/A | Quarterly | |||||||||||
Intrepid Capital Fund (QP), L.P. | 7/1/2004 | 15,500,000 | 16,419,852 | 0.93 | N/A | Quarterly | |||||||||||
Karsch Capital II, LP | 5/1/2004 | 21,000,000 | 22,637,892 | 1.28 | N/A | Quarterly | |||||||||||
Lancer Partners, L.P. | 7/1/2002 | 15,625,000 | — | (a) | 0.00 | N/A | (b) | ||||||||||
Lansdowne Global Financials Fund, L.P. | 10/1/2004 | 21,000,000 | 24,203,759 | 1.36 | 9/30/2005 | Monthly | |||||||||||
Maverick Fund USA, Ltd. | 7/1/2002 | 21,875,000 | 27,221,378 | 1.53 | N/A | Annually | |||||||||||
Tiger Consumer Partners, L.P. | 9/1/2003 | 5,000,000 | 5,428,820 | 0.31 | N/A | Quarterly | |||||||||||
Tiger Technology, L.P. | 1/1/2003 | 6,500,000 | 10,752,708 | 0.61 | 6/30/2006 | Annually | |||||||||||
Trivium Institutional Onshore Fund, LP | 6/1/2004 | 27,058,189 | 27,940,749 | 1.57 | N/A | Monthly | |||||||||||
Value Partners China Hedge Fund LLC | 2/1/2005 | 8,000,000 | 7,861,460 | 0.44 | N/A | Monthly | |||||||||||
Total Long-Short | 303,195,914 | 318,755,412 | 17.96 | ||||||||||||||
The accompanying notes are an integral part of these financial statements and should be read in conjunction therewith.
6
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Schedule of Investments (Unaudited) (continued)
June 30, 2005
Description | First Acquisition Date | Cost | Fair Value | Percent of Partners’ Capital | First Available Redemption Date * | Liquidity ** | ||||||||||||
Investment Funds (continued) | ||||||||||||||||||
Mortgage Arbitrage | ||||||||||||||||||
Ellington Mortgage Partners, L.P. | 7/1/2002 | $ | 40,750,000 | $ | 52,139,179 | 2.94 | % | N/A | Annually | |||||||||
Highland Opportunity Fund, L.P. | 8/1/2002 | 29,500,000 | 32,781,003 | 1.85 | N/A | Quarterly | ||||||||||||
Metacapital Fixed Income Relative Value Fund, L.P. | 7/1/2003 | 33,000,000 | 34,332,362 | 1.94 | N/A | Quarterly | ||||||||||||
MKP Partners, L.P. | 10/1/2004 | 41,000,000 | 41,188,609 | 2.32 | 9/30/2005 | Quarterly | ||||||||||||
Parmenides Fund, L.P. | 9/1/2003 | 38,000,000 | 41,379,896 | 2.33 | N/A | Monthly | ||||||||||||
Safe Harbor Fund, L.P. (c) | 7/1/2002 | 18,750,000 | 8,929,428 | (a) | 0.50 | N/A | (b | ) | ||||||||||
Smith Breeden Mortgage Partners L.P. | 12/1/2004 | 6,500,000 | 6,590,242 | 0.37 | N/A | Quarterly | ||||||||||||
Structured Servicing Holdings, L.P. | 7/1/2002 | 17,825,940 | 25,550,707 | 1.44 | N/A | Monthly | ||||||||||||
Total Mortgage Arbitrage | 225,325,940 | 242,891,426 | 13.69 | |||||||||||||||
Multi-Strategy | ||||||||||||||||||
Amaranth Partners L.L.C. | 11/1/2004 | 60,000,000 | 61,517,343 | 3.47 | 10/31/2005 | Annually | ||||||||||||
AQR Absolute Return Instititutional Fund, L.P. | 7/1/2002 | 24,750,000 | 28,623,635 | 1.61 | N/A | Quarterly | ||||||||||||
Brevan Howard L.P. | 8/1/2004 | 23,000,000 | 24,827,937 | 1.40 | 7/31/2005 | Monthly | ||||||||||||
Citadel Wellington LLC | 7/1/2002 | 76,250,000 | 91,342,677 | 5.15 | N/A | 3 Years | ||||||||||||
Deephaven Market Neutral Fund LLC | 7/1/2002 | 33,000,000 | 41,087,721 | 2.32 | N/A | Monthly | ||||||||||||
D.E. Shaw Oculus Fund, L.L.C. | 11/1/2004 | 34,000,000 | 43,394,950 | 2.44 | N/A | Quarterly | ||||||||||||
HBK Fund L.P. | 7/1/2002 | 36,661,677 | 48,723,000 | 2.75 | N/A | Quarterly | ||||||||||||
Jet Capital Arbitrage and Event Fund I, L.P. | 1/1/2003 | 18,000,000 | 20,292,775 | 1.14 | N/A | Quarterly | ||||||||||||
K Capital II, L.P. | 1/1/2003 | 22,000,000 | 23,682,595 | 1.33 | N/A | Annually | ||||||||||||
Nisswa Fund L.P. | 7/1/2002 | 6,424,976 | 5,677,902 | 0.32 | N/A | Quarterly | ||||||||||||
Nylon Flagship Fund L.P. | 2/1/2005 | 43,000,000 | 42,102,488 | 2.37 | N/A | Quarterly | ||||||||||||
Oak Hill CCF Partners, L.P. | 2/1/2005 | 10,000,000 | 9,979,475 | 0.56 | N/A | Monthly | ||||||||||||
OZ Domestic Partners, L.P. | 7/1/2002 | 37,500,000 | 52,302,870 | 2.95 | N/A | Annually | ||||||||||||
Q Funding III, L.P. | 7/1/2002 | 9,912,040 | 17,530,734 | 0.99 | 6/30/2009 | (d) | 3 Years | |||||||||||
Sagamore Hill Partners L.P. | 7/1/2002 | 41,750,000 | 46,155,261 | 2.60 | N/A | Quarterly | ||||||||||||
Severn River Capital Partners, LP | 8/1/2004 | 5,000,000 | 4,769,903 | 0.27 | 9/30/2005 | Quarterly | ||||||||||||
The Animi Fund, LP | 10/1/2003 | 31,000,000 | 31,271,214 | 1.76 | N/A | Monthly | ||||||||||||
Tiburon Fund, L.P. | 8/1/2002 | 22,722,150 | 20,524,388 | 1.16 | N/A | Quarterly | ||||||||||||
Total Multi-Strategy | 534,970,843 | 613,806,868 | 34.59 | |||||||||||||||
The accompanying notes are an integral part of these financial statements and should be read in conjunction therewith.
7
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Schedule of Investments (Unaudited) (continued)
June 30, 2005
Description | First Acquisition Date | Cost | Fair Value | Percent of Partners’ Capital | First Available Redemption Date * | Liquidity ** | |||||||||
Investment Funds (continued) | |||||||||||||||
Other Arbitrage | |||||||||||||||
Laxey Investors L.P. | 9/1/2004 | $ | 21,000,000 | $ | 23,527,237 | 1.33 | % | N/A | Monthly | ||||||
Western Investment Hedged Partners L.P. | 11/1/2003 | 6,600,000 | 7,339,063 | 0.41 | N/A | Monthly | |||||||||
Western Investment Institutional Partners LLC | 4/1/2004 | 2,000,000 | 2,192,738 | 0.12 | N/A | Monthly | |||||||||
Total Other Arbitrage | 29,600,000 | 33,059,038 | 1.86 | ||||||||||||
Risk Arbitrage | |||||||||||||||
Empyrean Capital Fund, LP | 7/1/2004 | 19,500,000 | 20,236,141 | 1.14 | N/A | Quarterly | |||||||||
Total Risk Arbitrage | 19,500,000 | 20,236,141 | 1.14 | ||||||||||||
Statistical Arbitrage | |||||||||||||||
IKOS, LP Equity Class | 7/1/2002 | 25,206,130 | 29,151,861 | 1.64 | N/A | Quarterly | |||||||||
Thales Fund, L.P. | 7/1/2002 | 4,562,254 | 5,509,676 | 0.31 | N/A | Quarterly | |||||||||
Total Statistical Arbitrage | 29,768,384 | 34,661,537 | 1.95 | ||||||||||||
Total Investments in Investment Funds | 1,510,915,049 | 1,688,906,474 | 95.17 | ||||||||||||
Purchased Options | |||||||||||||||
Iboxx CDX Swaption expires 12/20/05 | 127,400 | 211,221 | 0.01 | ||||||||||||
Iboxx CDX Swaption expires 12/20/05 | 122,500 | 197,268 | 0.01 | ||||||||||||
Iboxx CDX Swaption expires 12/20/05 | 62,400 | 96,621 | 0.01 | ||||||||||||
Iboxx CDX Swaption expires 12/20/05 | 273,000 | 129,376 | 0.01 | ||||||||||||
Iboxx CDX Swaption expires 12/20/05 | 401,500 | 182,453 | 0.01 | ||||||||||||
Total Purchased Options | 986,800 | 816,939 | 0.05 | ||||||||||||
Short-Term Investments | |||||||||||||||
State Street Euro Dollar Time Deposit | |||||||||||||||
2.50% due 07/01/05 | 17,457,771 | 17,457,771 | 0.98 | ||||||||||||
Total Short-Term Investments | 17,457,771 | 17,457,771 | 0.98 | ||||||||||||
The accompanying notes are an integral part of these financial statements and should be read in conjunction therewith.
8
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Schedule of Investments (Unaudited) (continued)
June 30, 2005
Description | Cost | Fair Value | Percent of Partners’ Capital | |||||||||
Total Investments in Investment Funds, Options and Short-Term Investments | $ | 1,529,359,620 | $ | 1,707,181,184 | 96.20 | % | ||||||
Other Assets, less Liabilities | 67,428,074 | 3.80 | ||||||||||
Total Partners’ Capital | $ | 1,774,609,258 | 100.00 | % | ||||||||
Underlying Investment Fund | Swap Counterparty | Maturity Date | Notional Amount | Unrealized Appreciation (Depreciation) | ||||||||
Total Return Swaps | ||||||||||||
ANOVA Fund Ltd. | UBS AG | ^ | $ | 26,587,971 | $ | (709,065 | ) | |||||
The Carrousel Fund Ltd. | UBS AG | ^ | 13,366,399 | 351,969 | ||||||||
HBK Fund L.P. | Deutsche Bank AG | ^ | 35,000,000 | 1,099,801 | ||||||||
| $ | 742,705 | |||||||||||
Detailed information about the Investment Funds’ portfolios is not available.
| * | From original investment date |
| ** | Available frequency of redemptions after initial lock-up period |
| ^ | Perpetual maturity. Resets quarterly. |
| N/A | Initial lock-up period has either expired prior to June 30, 2005 or Investment Fund did not have an initial lock-up period. |
| (a) | Fair valued by the Adviser. See discussion in Note 2 to the financial statements. |
| (b) | Liquidity restricted. See discussion of Note 2 to the financial statements. |
| (c) | In liquidation. See discussion in Note 2 to the financial statements. |
| (d) | Based on an agreement with the underlying fund’s investment manager, if the investment becomes greater than 8% of the Partnership’s net assets, the Partnership may elect to redeem at the next available month-end date in an amount sufficient to bring the investment’s value to below 8% of the Partnership’s net assets. |
The accompanying notes are an integral part of these financial statements and should be read in conjunction therewith.
9
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Schedule of Investments (Unaudited) (continued)
June 30, 2005
Strategy Allocation | Percent of Partners’ Capital | ||
Multi-Strategy | 34.59 | % | |
Long-Short | 17.96 | ||
Credit Trading and Capital Structure Arbitrage | 14.45 | ||
Mortgage Arbitrage | 13.69 | ||
Fixed Income Arbitrage | 4.10 | ||
Long Only Distressed | 3.23 | ||
Convertible Arbitrage | 2.20 | ||
Statistical Arbitrage | 1.95 | ||
Other Arbitrage | 1.86 | ||
Risk Arbitrage | 1.14 | ||
Total Investments in Investment Funds | 95.17 | % | |
The accompanying notes are an integral part of these financial statements and should be read in conjunction therewith.
10
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Notes to Financial Statements (Unaudited)
June 30, 2005
1. Organization
Morgan Stanley Institutional Fund of Hedge Funds LP (the “Partnership”) was organized under the laws of the State of Delaware as a limited partnership on November 6, 2001 and commenced operations on July 1, 2002 pursuant to an Amended and Restated Agreement of Limited Partnership (as it may be amended, modified or otherwise supplemented from time to time, the “Agreement”). The Partnership is registered under the U.S. Investment Company Act of 1940, as amended (the “1940 Act”), as a closed-end, non-diversified management investment company. The Partnership’s investment objective is to seek capital appreciation principally through investing in investment funds (“Investment Funds”) managed by third-party investment managers who employ a variety of alternative investment strategies. Investments of the Partnership are selected opportunistically from a wide range of Investment Funds in order to create a broad-based portfolio of such Investment Funds while seeking to invest in compelling investment strategies and with promising investment managers at optimal times. The Partnership may seek to gain investment exposure to certain Investment Funds or to adjust market or risk exposure by entering into derivative transactions, such as total return swaps, options and futures.
The Partnership’s Board of Directors (the “Board”) provides broad oversight over the operations and affairs of the Partnership. A majority of the Board is comprised of persons who are independent with respect to the Partnership.
Morgan Stanley Alternative Investment Partners LP serves as the General Partner (the “General Partner”) of the Partnership subject to the ultimate supervision of, and subject to any policies established by, the Board. The General Partner has claimed an exclusion from the definition of commodity pool operator with the National Futures Association (“NFA”) in connection with the Partnership. Morgan Stanley AIP GP LP serves as the Partnership’s investment adviser (the “Adviser”) and is responsible for providing day-to-day investment management services to the Partnership, subject to the supervision of the Board. The Adviser is registered as an investment adviser under the U.S. Investment Advisers Act of 1940, as amended, and has claimed an exemption from registration as a commodity trading adviser with the NFA in connection with the Partnership. The General Partner and the Adviser are affiliates of Morgan Stanley. The Partnership has no fixed termination date and will continue unless the Partnership is otherwise terminated under the terms of the Agreement or unless and until required by law.
Limited partnership interests of the Partnership (the “Interests”) are generally issued at the beginning of each calendar quarter, unless otherwise determined at the discretion of the General Partner. Additional subscriptions for Interests by eligible investors are accepted into the Partnership at net asset value. The Partnership may from time to time offer to repurchase Interests (or portions of them) at net asset value pursuant to written tender made by a limited partner of the Partnership (a “Limited Partner”). Repurchases will be made at such times, in such amounts and on such terms as may be determined by the Board in its sole discretion.
11
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Notes to Financial Statements (Unaudited) (continued)
1. Organization (continued)
It is anticipated that each repurchase offer by the Partnership will be made with respect to Interests representing 5%-25% of the current net asset value of the Partnership. It is also anticipated that, subject to the approval of the Board, the Partnership will make such offers to repurchase Interests (or portions of them) from Limited Partners quarterly on each March 31, June 30, September 30 and December 31 (or, if any such date is not a business day, on the immediately preceding business day). In general, the Partnership will initially pay at least 90% of the estimated value of the repurchased Interests (or portions of them) to Limited Partners within 30 days after the value of the Interests to be repurchased is determined; the remaining amount will be paid out promptly after completion of the annual audit of the Partnership.
2. Significant Accounting Policies
The following significant accounting policies are in conformity with U.S. generally accepted accounting principles. Such policies are consistently followed by the Partnership in preparation of its financial statements. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires the General Partner to make estimates and assumptions that affect the reported amounts and disclosures in the financial statements, including the estimated fair value of investments. Actual results could differ from those estimates.
Portfolio Valuation
The net asset value of the Partnership will be determined as of the close of business at the end of any fiscal period in accordance with the valuation principles set forth below or as may be determined from time to time pursuant to policies established by the Board.
At June 30, 2005, 94.73% of the Partnership’s portfolio was comprised of investments in Investment Funds. Of the remainder of the portfolio, 4.24%, based on the notional value, was invested in total return equity swaps (see Note 5), 0.05% in purchased options and 0.98% in a Eurodollar time deposit. The Board has approved procedures pursuant to which the Partnership values its investments in Investment Funds at fair value, which ordinarily will be the amount equal to the Partnership’s pro rata interest in the net assets of such Investment Fund, as such value is supplied by the Investment Fund’s investment manager from time to time, usually monthly. Such valuations are net of management and performance incentive fees or allocations payable to the Investment Funds’ managers pursuant to the Investment Funds’ operating agreements. The Investment Funds value their underlying investments in accordance with policies established by each Investment Fund, as described in each of their financial statements and offering memoranda. The Partnership’s investments in Investment Funds are subject to the terms and conditions of the respective operating agreements and offering memoranda, as appropriate. Where no fair value is readily available from an Investment Fund or where a value supplied by an Investment Fund is deemed by the Adviser not to be indicative of its value, the Adviser will determine, in good faith, the fair
12
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Notes to Financial Statements (Unaudited) (continued)
2. Significant Accounting Policies (continued)
Portfolio Valuation (continued)
value of the Investment Fund under procedures adopted by the Board and subject to Board supervision. In accordance with the Agreement, the Adviser values the Partnership’s assets based on such reasonably available relevant information as it considers material. Because of the inherent uncertainty of valuation, the values of the Partnership investments may differ significantly from the values that would have been used had a ready market for the investments held by the Partnership been available.
The Partnership’s investment in Lancer Partners, L.P. (“Lancer”), an Investment Fund, was fair valued in good faith by the Adviser as of June 30, 2005 at a value of $0, representing 0.00% of partners’ capital. The manager of Lancer has failed to deliver audited financial statements for Lancer for 2001, 2002, 2003 and 2004. In February 2003, the General Partner initiated a legal action against Lancer and its manager in the Superior Court of the State of Connecticut for access to the full books and records of Lancer. Subsequently, Lancer filed a petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. The General Partner is a member of the creditors committee formed as part of that proceeding. On July 8, 2003, the United States Securities and Exchange Commission (“SEC”) instituted a civil action against Lancer, Lancer Management Group, LLC, Lancer Management Group II, LLC (Lancer’s general partner and fund manager, referred to with Lancer Management Group, LLC as “Lancer Management”), Michael Lauer (the principal of Lancer Management) as well as against other entities affiliated with Lauer. The SEC alleges that Lauer and Lancer Management made fraudulent misrepresentations to investors by, among other things, overstating the value of the funds and manipulating the price of shares of some of the companies in which Lancer invested. The SEC obtained a temporary restraining order which appointed a receiver for Lancer Management and granted other relief against Lancer Management and Lauer, while deferring to the bankruptcy court with respect to Lancer. Subsequently, the receiver advised the bankruptcy court that it was now in control of Lancer, that Lauer would not be contesting the preliminary injunction sought by the SEC, and that Lauer had agreed not to take any further action with respect to Lancer. It is anticipated that the receiver will evaluate the financial status of Lancer and, in consultation with the creditor and equity committees in the bankruptcy proceeding, propose a plan for winding up Lancer. The Partnership will continue to pursue its rights with regard to the bankruptcy action.
The Partnership’s investment in Safe Harbor Fund, L.P. (“Safe Harbor”), an Investment Fund, was fair valued in good faith by the Adviser as of June 30, 2005 at a value of $8,929,428, representing 0.50% of partners’ capital. Safe Harbor, formerly managed by Beacon Hill Asset Management LLC, was placed into receivership by order of the U.S. Federal District Court, Southern District of New York (the “District Court”), on September 16, 2003. Safe Harbor, along with two other funds, is a feeder fund of Beacon Hill Master, Ltd. (In Official Liquidation) (“Beacon Hill Master”). On January 30, 2004, the Grand Court of the Cayman Islands entered an order appointing two Joint Official Liquidators (the “JOLs”) of Beacon Hill Master. One of the JOLs also serves as receiver for Safe Harbor. On June 7, 2005, the JOLs mailed a notice announcing their intent to allocate Beacon Hill Master’s assets to its three feeder funds, including Safe Harbor, using a distribution methodology that uses the averaged shareholdings as a basis for allocation (referred to as the “Averaged Method”). On August 11, 2005, the shareholders of the Bristol Fund Ltd. (the “Bristol Fund”),
13
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Notes to Financial Statements (Unaudited) (continued)
2. Significant Accounting Policies (continued)
Portfolio Valuation (continued)
another feeder fund of Beacon Hill Master, approved the Scheme of Arrangement, which employs the Averaged Method, for distribution of Bristol Fund shares. A hearing in the Grand Court of the Cayman Islands to formally approve the Averaged Method was held on August 17, 2005, however the court adjourned the hearing due to an objecting shareholder’s request, and will readjourn when such shareholder has had a chance to join as a party to the proceedings. Bristol Fund’s Official Liquidator is drafting a response to the objecting shareholder that will hopefully relieve the concerns of the objecting shareholder and abate the need for the pursuit of the shareholder’s present objections. While the receiver for Safe Harbor intends to endorse the Averaged Method for distribution of Beacon Hill Master’s assets, counsel for the objecting shareholder has advised the receiver that it does not endorse the Averaged Method. Should such objecting shareholder’s position not waiver, Beacon Hill Master may be required to conduct a Scheme of Arrangement similar to the one presently being conducted by the Bristol Fund. The Partnership has been informed by the receiver that either way, pending the outcome of the Bristol Fund Scheme of Arrangement, the Cayman counsel to the JOLs will seek directions on this matter from the Grand Court of the Cayman Islands sometime shortly after the Bristol Fund Scheme of Arrangement is decided. The distribution methodology will have to be approved by the courts in litigation that is pending against Safe Harbor. The Adviser has determined that the Averaged Method is the appropriate method to use as the basis for the fair value of the Partnership’s investment in Safe Harbor and has done so as of June 30, 2005. The ultimate value of the Partnership’s investment in Safe Harbor will not be determined until a final distribution methodology in respect of Safe Harbor and Beacon Hill Master is approved by the courts and any potential liabilities associated with them are resolved. In particular, Safe Harbor’s fair value does not reflect any potential liabilities associated with either the liquidation of Beacon Hill Master or any pending action against Safe Harbor, Beacon Hill Master, their former investment manager or any party with a potential indemnification claim that succeeds against Safe Harbor or Beacon Hill Master.
Fair Value of Financial Instruments
The fair value of the Partnership’s assets and liabilities which qualify as financial instruments under Statement of Financial Accounting Standards No. 107, “Disclosures about Fair Values of Financial Instruments,” approximates the carrying amounts presented in the Statement of Assets, Liabilities and Partners’ Capital.
Income Recognition and Expenses
The Partnership recognizes interest income on an accrual basis. Income, expenses and realized and unrealized gains and losses are recorded monthly. The change in Investment Funds’ net asset value is included in net change in unrealized appreciation on investments in Investment Funds on the Statement of Operations. Redemptions received, whether in the form of cash or securities, are applied as a reduction of the Investment Fund’s cost and realized gain (loss) from investments in Investment Funds on a pro rata basis.
14
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Notes to Financial Statements (Unaudited) (continued)
2. Significant Accounting Policies (continued)
Income Recognition and Expenses (continued)
Net profits or net losses of the Partnership for each of its fiscal periods are allocated among and credited to or debited against the capital accounts of all Limited Partners and the General Partner (collectively, the “Partners”) as of the last day of each month in accordance with the Partners’ investment percentages as of the first day of each month. Net profits or net losses are measured as the net change in the value of the net assets of the Partnership, including any net change in unrealized appreciation or depreciation on investments, income, net of accrued expenses, and realized gains or losses, before giving effect to any repurchases by the Partnership of Interests or portions of Interests.
Cash and Cash Equivalents
The Partnership treats all highly liquid financial instruments that have original maturities within three months of acquisition as cash equivalents. Cash equivalents are valued at cost plus accrued interest, which approximates fair value. All cash is invested overnight in a short-term time deposit with the Partnership’s custodian, State Street Bank and Trust Company.
Income and Withholding Taxes
No provision for federal, state, or local income taxes is provided in the financial statements. In accordance with the Internal Revenue Code of 1986, as amended, the Partners are to include their respective share of the Partnership’s realized profits or losses in their individual tax returns.
The Partnership is required to withhold U.S. tax from U.S. source dividends allocable to its foreign partners and to remit those amounts to the Internal Revenue Service. The rate of withholding is generally the rate at which the particular foreign partner is subject to U.S. federal income tax. The foreign partners are obligated to indemnify the Partnership for any taxes that the Partnership is required to withhold as well as any interest or penalties. Withholding taxes are specifically allocated to the capital accounts of the foreign partners who incur the withholding. For the period from January 1, 2005 to June 30, 2005, the Partnership did not withhold or pay any taxes.
Limitation of Limited Partner Liability
Generally, except as provided under applicable law or under the Agreement, a Limited Partner shall not be liable for the Partnership’s debts, obligations and liabilities in any amount in excess of the capital account balance of such Limited Partner, plus such Limited Partner’s share of undistributed profits and assets. Subject to applicable law, a Limited Partner may be obligated to return to the Partnership certain amounts distributed to the Limited Partner.
15
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Notes to Financial Statements (Unaudited) (continued)
3. Management Fee, Performance Incentive, Related Party Transactions and Other
Under the terms of the Investment Advisory Agreement (the “Advisory Agreement”), as amended, between the Adviser and the Partnership, the Adviser receives a management fee for services provided to the Partnership, calculated and paid monthly at a rate of 0.046% (0.55% on an annualized basis) of the Partnership’s net assets as of the end of business on the last business day of each month, before adjustment for any redemptions effective on that day. For the period from January 1, 2005 to June 30, 2005, the Partnership incurred management fees of $4,903,193.
Under the terms of the Agreement, as amended, the General Partner’s “Performance Incentive” for each Incentive Period, as defined in the Agreement, is equal to 10% of the amount, if any, of: (1) the net profits allocated to each Limited Partner’s capital account for the Incentive Period in excess of any net losses so allocated for such Incentive Period; above (2) the greater of (a) the Limited Partner’s Hurdle Rate Amount (as defined below) for the Incentive Period or (b) the Loss Carryforward Amount(s), as defined in the Agreement, applicable to the Limited Partner’s capital account. With respect to each Limited Partner for each Incentive Period, the Performance Incentive allocated to the General Partner initially will not exceed 1.75% of the Limited Partner’s ending capital account balance for that Incentive Period, as determined prior to the deduction of the Performance Incentive.
The Partnership’s “Hurdle Rate” for a given Incentive Period is initially equal to 5% per annum plus the rate of return achieved by the Citi Three-Month U.S. Treasury Bill Index over the same Incentive Period. A Limited Partner’s “Hurdle Rate Amount” for a given Incentive Period is equal to the Hurdle Rate calculated for a given Incentive Period multiplied by the Limited Partner’s capital account balance as of the beginning of that Incentive Period. The Hurdle Rate is not cumulative and resets for each Incentive Period at the beginning of each such Incentive Period. The Performance Incentive is debited from each Limited Partner’s capital account and credited to the General Partner’s capital account at the end of each such Incentive Period. During the period from January 1, 2005 to June 30, 2005 and during the year ended December 31, 2004, the Performance Incentive was $0 and $54,887, respectively, and is included in the Statements of Changes in Partners’ Capital.
State Street Bank and Trust Company (the “Administrator”) provides accounting and administrative services to the Partnership. Under an administrative services agreement, the Administrator is paid a fee computed and payable monthly at an annual rate of 0.0650% of the Partnership’s average monthly net assets. In addition, the Partnership is charged for certain reasonable out-of-pocket expenses incurred by the Administrator on its behalf.
State Street Bank and Trust Company also serves as the custodian for the Partnership. Custody fees are payable monthly based on assets held in custody and investment purchases and sales activity, plus reimbursement for certain reasonable out-of-pocket expenses.
At June 30, 2005, there was one Limited Partner, unaffiliated with Morgan Stanley, with a capital balance that represented approximately 58% of the Partnership’s capital and another Limited Partner, unaffiliated with Morgan Stanley, that invested in the Partnership indirectly through a related limited partnership, which had a capital balance that represented approximately 17% of the Partnership’s capital.
16
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Notes to Financial Statements (Unaudited) (continued)
4. Investments in Investment Funds
As of June 30, 2005, the Partnership invested primarily in Investment Funds, none of which were related parties of Morgan Stanley. The agreements related to investments in Investment Funds provide for compensation to the Investment Funds’ managers/general partners in the form of management fees ranging from 0.0% to 2.5% annually of net assets and performance incentive fees/allocations ranging from 15% to 25% of net profits earned.
At June 30, 2005, approximately 0.99% of the Partnership’s capital was invested in Investment Funds with lock-ups extending beyond one year from June 30, 2005.
For the period from January 1, 2005 to June 30, 2005, aggregate purchases and proceeds from sales of investments in Investment Funds were $178,500,000, and $125,650,036, respectively.
The cost of investments for Federal income tax purposes is adjusted for items of taxable income or loss allocated to the Partnership from the Investment Funds. The allocated taxable income or loss is reported to the Partnership by the Investment Funds on Schedules K-1. The Partnership has not yet received all such Schedules K-1 for the year ended December 31, 2005.
5. Financial Instruments with Off-Balance Sheet Risk
In the normal course of business, the Investment Funds in which the Partnership invests trade various financial instruments and enter into various investment activities with off-balance sheet risk. These include, but are not limited to, short selling activities, written option contracts, and equity swaps. The Partnership’s risk of loss in these Investment Funds is limited to the value of these investments as reported by the Partnership.
Options
The Partnership may utilize options and “synthetic” options written by broker-dealers or other permissible financial intermediaries. Options transactions may be effected on securities exchanges or in over-the-counter markets. Options are valued based on market values provided by dealers. When options are purchased over-the-counter, the Partnership bears the risk that the counterparty that wrote the option will be unable or unwilling to perform its obligations under the option contract. Options may also be illiquid and, in such cases, the Adviser may have difficulty closing out the Partnership’s position. Over-the-counter options also may include options on “baskets” of specific securities.
17
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Notes to Financial Statements (Unaudited) (continued)
5. Financial Instruments with Off-Balance Sheet Risk (continued)
Options (continued)
The Partnership may purchase call and put options on specific securities for hedging purposes in pursuing its investment objectives. A put option gives the purchaser of the option the right to sell, and obligates the writer to buy, the underlying security at a stated exercise price, typically at any time prior to the expiration of the option. A call option gives the purchaser of the option the right to buy, and obligates the writer to sell, the underlying security at a stated exercise price, typically at any time prior to the expiration of the option.
The Partnership may purchase call and put options on stock indices listed on national securities exchanges or traded in over-the-counter markets for hedging purposes and non-hedging purposes in seeking to achieve its investment objective. A stock index fluctuates with changes in the market values of the stocks included in the index. Successful use of options on stock indexes will be subject to the Adviser’s ability to predict correctly movements in the direction of the stock market generally or of a particular industry or market segment, which requires different skills and techniques from those involved in predicting changes in the price of individual stocks.
Swap Agreements
The Partnership may enter into equity, interest rate, index and currency rate swap agreements. These transactions will be undertaken in an attempt to obtain a particular return when the Adviser determines appropriate, possibly at a lower cost than if the Partnership had invested directly in the investment or instrument. Swap agreements are two-party contracts entered into primarily by institutional investors for periods ranging from a few weeks to more than a year. In a standard swap transaction, two parties agree to exchange the returns (or differentials in rates of returns) earned or realized on particular predetermined investments or instruments, which may be adjusted for an interest factor. The gross returns to be exchanged or “swapped” between the parties are generally calculated with respect to a “notional amount,” that is, the return on or increase in value of a particular dollar amount invested at a particular interest rate, in a particular non-U.S. currency, in the value of an Investment Fund, or in a “basket” of securities representing a particular index. Effective January 1, 2004, the Partnership adopted the method of accounting for interim payments on swap contracts in accordance with clarification provided by the SEC to registered investment companies. The change in value of swaps, including the periodic amounts of interest to be paid or received on swaps, is reported as unrealized gains or losses in the Statement of Operations. Unrealized gains are reported as an asset and unrealized losses are reported as a liability on the Statement of Assets, Liabilities and Partners’ Capital. A realized gain or loss is recorded upon payment or receipt of a periodic payment or termination of swap agreements.
18
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Notes to Financial Statements (Unaudited) (continued)
5. Financial Instruments with Off-Balance Sheet Risk (continued)
Swap Agreements (continued)
Most swap agreements entered into by the Partnership require the calculation of the obligations of the parties to the agreements on a “net basis.” Consequently, current obligations or rights under a swap agreement generally will be equal only to the net amount to be paid or received under the agreement based on the relative values of the positions held by each party to the agreement.
Swaps are valued based on market values provided by dealers. The Partnership is subject to the market risk associated with changes in the value of the underlying investment or instrument, as well as exposure to credit risk associated with counterparty non-performance on swap contracts. The risk of loss with respect to swaps is limited to the net amount of payments that the Partnership is contractually obligated to make. If the other party to a swap defaults, the Partnership’s risk of loss consists of the net amount of payments that the Partnership contractually is entitled to receive, which may be different than the amounts recorded on the Statement of Assets, Liabilities and Partners’ Capital.
The unrealized appreciation/depreciation, rather than the contract amount, represents the approximate future cash to be received or paid, respectively.
As of June 30, 2005, the following swap contracts were outstanding:
| Notional Amount | Maturity Date | Description | Unrealized Appreciation (Depreciation) | ||||||
| $ | 26,587,971 | * | Agreement with UBS AG, London Branch, dated 1/01/05 to receive the total return of the Series B Investment Class shares of ANOVA Fund Ltd. in exchange for an amount to be paid quarterly. | $ | (709,065 | ) | |||
| $ | 13,366,399 | * | Agreement with UBS AG, London Branch, dated 1/01/05 to receive the total return of the Series D Investment Class shares of The Carrousel Fund Ltd. in exchange for an amount to be paid quarterly. | $ | 351,969 | ||||
| $ | 35,000,000 | * | Agreement with Deutsche Bank AG, London Branch, dated 1/01/05 to receive the total return of partnership interests in HBK Fund L.P. in exchange for an amount to be paid quarterly. | $ | 1,099,801 | ||||
| $ | 742,705 | ||||||||
| * | Perpetual maturity. Resets quarterly. |
Cash for $67,954,370 has been deposited with the counterparty and is included in due from broker in the Statement of Assets, Liabilities and Partners’ Capital.
19
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Notes to Financial Statements (Unaudited) (continued)
6. Contractual Obligations
The Partnership enters into contracts that contain a variety of indemnifications. The Partnership’s maximum exposure under these arrangements is unknown. However, the Partnership has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote.
7. Financial Highlights
The following represents ratios to average Limited Partners’ capital and other financial highlights information for Limited Partners. The calculations below are not annualized.
For the Period January 1, 2005 | For the Year Ended December 31, 2004 (e) | For the Year Ended December 31, 2003 | For the Period From July 1, 2002 (a) | |||||||||||||
Total return – prior to Performance Incentive | 1.01 | % | 5.58 | % | 10.61 | % | (0.67 | )% | ||||||||
Performance Incentive | — | 0.00 | (c) | (0.67 | ) | 0.00 | (c) | |||||||||
Total return – net of Performance Incentive (b) | 1.01 | % | 5.58 | % | 9.94 | % | (0.67 | )% | ||||||||
Ratio of total expenses to average Limited Partners’ capital (d) | 0.35 | % | 0.92 | % | 1.04 | % | 0.55 | % | ||||||||
Performance Incentive to average Limited Partners’ capital | — | 0.00 | (c) | 0.63 | 0.00 | (c) | ||||||||||
Ratio of total expenses and Performance Incentive to average Limited Partners’ capital (d) | 0.35 | % | 0.92 | % | 1.67 | % | 0.55 | % | ||||||||
Ratio of net investment loss to average Limited Partners’ capital (d)(f) | (0.31 | )% | (0.87 | )% | (0.99 | )% | (0.51 | )% | ||||||||
Portfolio turnover | 7 | % | 13 | % | 13 | % | 5 | % | ||||||||
Net assets at end of the period (000s) | $ | 1,774,609 | $ | 1,717,415 | $ | 1,096,799 | $ | 719,356 | ||||||||
| (a) | Commencement of operations. |
| (b) | Total return assumes a purchase of an interest in the Partnership at the beginning of the period indicated and a sale of the Partnership interest on the last day of the period indicated, after Performance Incentive, if any, to the General Partner, and does not reflect the impact of placement fees, if any, incurred when subscribing to the Partnership. |
| (c) | Impact of Performance Incentive represented less than 0.005%. |
| (d) | Ratios do not reflect the Partnership’s proportionate share of the income and expenses of the Investment Funds. |
| (e) | As of January 1, 2004, the Partnership adopted the method of accounting for interim payments on swap contracts in accordance with clarification provided by the SEC to registered investment companies. The Partnership has reclassified interim payments made under total return swap agreements. These interim payments are reflected within net realized loss and net change in unrealized appreciation on swap contracts on the Statement of Operations; however prior to January 1, 2004, these interim payments were reflected within interest expense on the Statement of Operations. The effect of this change for the year ended December 31, 2004 was to decrease the ratio of net investment loss to average Limited Partners’capital and to decrease the ratio of total expenses to average Limited Partners’ capital by 0.05% and 0.05%, respectively. |
| (f) | Excludes impact of Performance Incentive. |
The above ratios and total return have been calculated for the Limited Partners’ class taken as a whole. An individual Limited Partner’s return and ratios may vary from these returns and ratios due to the timing of capital transactions and withholding tax allocation.
20
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Notes to Financial Statements (Unaudited) (continued)
8. Subsequent Events
From July 1, 2005 through August 19, 2005, the Partnership accepted approximately $118.3 million in additional contributions and had withdrawals of approximately $7.9 million. The Partnership has also received tenders to repurchase Interests of $3.2 million as of September 30, 2005.
21
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Investment Advisory Agreement Approval (Unaudited)
Nature, Extent and Quality of Services
The Board reviewed and considered the nature and extent of the investment advisory services provided by the Adviser under the Advisory Agreement, including the selection of Investment Funds for investment of the Partnership’s assets, allocation of the Partnership’s assets among, and monitoring performance of, Investment Funds, evaluation of risk exposure of Investment Funds and reputation, experience and training of investment managers of Investment Funds, management of short-term cash and operations of the Partnership, day-to-day portfolio management and general due diligence examination of Investment Funds before and after committing assets of the Partnership for investment. The Board also reviewed and considered the nature and extent of the non-advisory, administrative services provided by the Adviser under the Advisory Agreement, including, among other things, providing to the Partnership office facilities, equipment, and personnel. The Board also reviewed and considered the qualifications of the portfolio managers, the senior administrative managers and other key personnel of the Adviser who provide the investment advisory and administrative services to the Partnership. The Board determined that the Adviser’s portfolio managers and key personnel are well qualified by education and/or training and experience to perform the services in an efficient and professional manner. The Board concluded that the overall quality of the advisory and administrative services was satisfactory.
Performance Relative to Comparable Funds Managed by Other Advisers
The Board reviewed performance of all funds managed by the Adviser based on information provided by Lipper Inc. (“Lipper”), an independent provider of investment company data. Lipper informed the Board that it could not find any performance information for any other registered fund of hedge funds that could provide the Board an objective basis for comparison with similar funds managed by other investment advisers. Lipper, therefore, provided a report to the Board (the “Lipper Report”) that showed the Partnership’s performance, without a comparison with other similar funds, for the one-year period ended November 30, 2004 and for the period from June 30, 2002 to November 30, 2004. The Board considered that the Partnership seeks capital appreciation that is neither highly correlated with fixed income or equity indices nor disproportionately influenced by the performance of any one Investment Fund. The Board considered the Partnership’s positive performance since inception, the relative lack of correlation of such performance to fixed income or equity indices generally or to any one Investment Fund, and the relatively low level of repurchases by Limited Partners of the Partnership. The Board concluded that performance was satisfactory.
22
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Investment Advisory Agreement Approval (Unaudited) (continued)
Fees and Expenses Relative to Comparable Funds Managed by Other Advisers
The Board reviewed the management fee rate, Performance Incentive and total expense ratio (as estimated by the Adviser) of the Partnership. The Board noted that Lipper did not provide fee and expense information for funds managed by other advisers with investment strategies comparable to those of the Partnership and, as a result, there was no expense peer group. However, the Board considered that (i) the Partnership reduced its management fee from 0.75% to 0.55% in November 2004; (ii) the Partnership’s Performance Incentive includes a relatively high hurdle rate and an incentive cap, which together limit the potential amount of the Performance Incentive in respect of any one year; and (iii) the Partnership’s estimated total expense ratio (excluding the Performance Incentive) was consistent with management’s expectations as expressed to the Board. The Board concluded that the Partnership’s management fee, Performance Incentive and estimated total expense ratio were reasonable and satisfactory in light of the services provided.
Breakpoints and Economies of Scale
The Board reviewed the structure of the Partnership’s management fee schedule under the Advisory Agreement and noted that it does not include any breakpoints. The Board considered that the Partnership reduced its management fee from 0.75% to 0.55% in November 2004 and concluded that the fee was sufficiently low that the Board did not need to consider adding breakpoints at this time.
Profitability of Adviser and Affiliates
The Board considered and reviewed information concerning the costs incurred and profits realized by the Adviser and its affiliates during the last two years from their relationship with the Partnership and the Morgan Stanley Fund Complex and reviewed with the Controller of the Adviser the cost allocation methodology used to determine the Adviser’s profitability. Based on their review of the information they received, the Board concluded that the profits earned by the Adviser and its affiliates were not excessive in light of the advisory, administrative and other services provided to the Partnership.
Fall-Out Benefits
The Board considered so-called “fall-out benefits” derived by the Adviser and its affiliates from their relationship with the Partnership and the Morgan Stanley Fund Complex. The Board considered the fall-out benefits to be minimal given the unique nature of the Partnership as a fund of hedge funds.
Soft Dollar Benefits
The Board considered whether the Adviser realizes any benefits from commissions paid to brokers who execute securities transactions for the Partnership (“soft dollars”). The Board noted that the Partnership invests substantially all its assets in Investment Funds, which do not generate soft dollars.
23
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Investment Advisory Agreement Approval (Unaudited) (continued)
Adviser Financially Sound and Financially Capable of Meeting the Fund’s Needs
The Board considered whether the Adviser is financially sound and has the resources necessary to perform its obligations under the Advisory Agreement. The Board noted that the Adviser’s operations remain profitable, although increased expenses in recent years have reduced the Adviser’s profitability. The Board concluded that the Adviser has the financial resources necessary to fulfill its obligations under the Advisory Agreement.
Historical Relationship Between the Partnership and the Adviser
The Board also reviewed and considered the historical relationship between the Partnership and the Adviser, including the organizational structure of the Adviser, the policies and procedures formulated and adopted by the Adviser for managing the Partnership’s operations and the Board’s confidence in the competence and integrity of the senior managers and key personnel of the Adviser. The Board concluded that it is beneficial for the Partnership to continue its relationship with the Adviser.
Other Factors and Current Trends
The Board considered the controls and procedures adopted and implemented by the Adviser and monitored by the Partnership’s Chief Compliance Officer and concluded that the conduct of business by the Adviser indicates a good faith effort on its part to adhere to high ethical standards in the conduct of the Partnership’s business.
General Conclusion
After considering and weighing all of the above factors, the Board concluded it would be in the best interest of the Partnership and its shareholders to approve renewal of the Advisory Agreement (and the Performance Incentive) for another year.
24
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
Proxy Voting Policies and Procedures and Proxy Voting Record (Unaudited)
A copy of (1) the Partnership’s policies and procedures with respect to the voting of proxies relating to the Partnership’s Investment Funds; and (2) how the Partnership voted proxies relating to Investment Funds during the most recent twelve-month period ended June 30 is available without charge, upon request, by calling the Partnership at 1-888-322-4675. This information is also available on the Securities and Exchange Commission’s website at http://www.sec.gov.
Quarterly Portfolio Schedule (Unaudited)
The Partnership also files a complete schedule of portfolio holdings with the Securities and Exchange Commission for the Partnership’s first and third fiscal quarters on Form N-Q. The Partnership’s Forms N-Q are available on the Securities and Exchange Commission’s website at http://www.sec.gov. The Partnership’s Form N-Q may be reviewed and copied at the Securities and Exchange Commission’s Public Reference Room in Washington, D.C. and information on the operation of the Public Reference Room may be obtained by calling 1-800-SEC-0330. Once filed, the most recent Form N-Q will be available without charge, upon request, by calling the Partnership at 1-888-322-4675.
25
MORGAN STANLEY ALTERNATIVE INVESTMENT PARTNERS LP
Morgan Stanley Institutional Fund of Hedge Funds LP
One Tower Bridge
100 Front Street, Suite 1100
West Conshohocken, Pennsylvania 19428
Directors
Charles A. Fiumefreddo, Chairman of the Board and Director
Michael Bozic
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Joseph J. Kearns
Michael Nugent
Fergus Reid
Officers
Mitchell M. Merin, President
Ronald E. Robison, Executive Vice President and Principal Executive Officer
Joseph J. McAlinden, Vice President
Barry Fink, Vice President
Stefanie Chang Yu, Vice President
Cory Pulfrey, Vice President
Amy R. Doberman, Vice President
Carsten Otto, Chief Compliance Officer
James W. Garrett, Treasurer and Chief Financial Officer
Noel Langlois, Assistant Treasurer
Mary E. Mullin, Secretary
Investment Adviser
Morgan Stanley AIP GP LP
One Tower Bridge
100 Front Street, Suite 1100
West Conshohocken, Pennsylvania 19428
Administrator, Custodian, Fund Accounting Agent and Escrow Agent
State Street Bank and Trust Company
225 Franklin Street
Boston, Massachusetts 02116
Independent Registered Public Accounting Firm
Ernst & Young LLP
5 Times Square
New York, New York 10036
Legal Counsel
Clifford Chance US LLP
31 West 52nd Street
New York, New York 10019
[LOGO] Morgan Stanley
| ITEM 2. | CODE OF ETHICS. Not applicable to a semi-annual report. | |
| ITEM 3. | AUDIT COMMITTEE FINANCIAL EXPERT. Not applicable to a semi-annual report. | |
| ITEM 4. | PRINCIPAL ACCOUNTANT FEES AND SERVICES. Not applicable to a semi-annual report. | |
| ITEM 5. | AUDIT COMMITTEE OF LISTED REGISTRANTS. Not applicable to the Registrant. | |
| ITEM 6. | SCHEDULE OF INVESTMENTS. Refer to Item 1. | |
| ITEM 7. | DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END MANAGEMENT INVESTMENT COMPANIES. Not applicable to a semi-annual report. | |
| ITEM 8 | Not applicable. | |
| ITEM 9. | PURCHASES OF EQUITY SECURITIES. Not applicable to the Registrant. | |
| ITEM 10. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. | |
| ITEM 11. | CONTROLS AND PROCEDURES. | |
| (a) | The Registrant’s principal executive officer and principal financial officer have concluded that the Registrant’s disclosure controls and procedures are sufficient to ensure that information required to be disclosed by the Registrant in this Form N-CSR was recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, based upon such officers’ evaluation of these controls and procedures as of a date within 90 days of the filing date of the report. |
| (b) | There were no changes in the Registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal half-year (the registrant’s second fiscal half-year in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting. |
| ITEM 12. | EXHIBITS. |
| (a) | Certifications of Principal Executive Officer and Principal Financial Officer attached to this report as part of EX-99.CERT. |
[LOGO] Morgan Stanley
SIGNATURES
Pursuant to the requirements of the Investment Company Act of 1940, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
MORGAN STANLEY INSTITUTIONAL FUND OF HEDGE FUNDS LP
| By: | /s/ Ronald E. Robison | |
| Name: | Ronald E. Robison | |
| Title: | Executive Vice President | |
| Date: | August 29, 2005 |
Pursuant to the requirements of the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
| By: | /s/ Ronald E. Robison | |
| Name: | Ronald E. Robison | |
| Title: | Principal Executive Officer | |
| Date: | August 29, 2005 | |
| By: | /s/ James W. Garrett | |
| Name: | James W. Garrett | |
| Title: | Principal Financial Officer | |
| Date: | August 29, 2005 | |