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: 811-07243
Morgan Stanley Balanced Income Fund
(Exact name of registrant as specified in charter)
1221 Avenue of the Americas, New York, New York 10020
(Address of principal executive offices) (Zip code)
Ronald E. Robison
1221 Avenue of the Americas, New York, New York 10020
(Name and address of agent for service)
Registrant's telephone number, including area code: 212-762-4000
Date of fiscal year end: January 31, 2006
Date of reporting period: July 31, 2005
Item 1 - Report to Shareholders
Welcome, Shareholder:
In this report, you'll learn about how your investment in Morgan Stanley
Balanced Income Fund performed during the semiannual period. We will provide an
overview of the market conditions, and discuss some of the factors that affected
performance during the reporting period. In addition, this report includes the
Fund's financial statements and a list of Fund investments.
THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE FUND BEING
OFFERED.
MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE
IS NO ASSURANCE THAT THE FUND WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE FUND IS
SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF
SECURITIES OWNED BY THE FUND WILL DECLINE AND, THEREFORE, THE VALUE OF THE
FUND'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE
MONEY INVESTING IN THIS FUND. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE
INFORMATION ON INVESTMENT RISKS.
FUND REPORT
For the six months ended July 31, 2005
TOTAL RETURN FOR THE 6 MONTHS ENDED JULY 31, 2005
<Table>
<Caption>
LEHMAN
BROTHERS RUSSELL LIPPER
U.S. GOV'T./ 1000(R) INCOME
CREDIT VALUE FUNDS
CLASS A CLASS B CLASS C CLASS D INDEX(1) INDEX(2) INDEX(3)
3.53% 3.05% 3.13% 3.57% 0.89% 6.60% 2.88%
</Table>
The performance of the Fund's four share classes varies because each has
different expenses. The Fund's total returns assume the reinvestment of all
distributions but do not reflect the deduction of any applicable sales charges.
Such costs would lower performance. See Performance Summary for standardized
performance and benchmark information.
MARKET CONDITIONS
During the six months ended July 31, 2005, renewed optimism about economic
growth helped fuel a rebound in the equity markets. As the period opened,
investors were anxious about oil prices, the geopolitical landscape, economic
growth, inflation and the prospect of interest rate increases. Sentiment
improved as the period progressed. Data continued to show that the economy was
growing at a moderate pace, consumer spending was still holding up, and job
growth was reasonable. Inflation concerns waned. As second-quarter corporate
earnings reporting generally exceeded expectations, stocks ended the period on a
particularly bright note -- despite sustained soaring oil prices and the
prospect of continued short-term interest rate increases. Overall, energy and
oil stocks were particularly well-rewarded by the market, while technology
lagged as a long-awaited burst in corporate spending did not materialize.
Continuing the cycle of measured increases that it began in June of 2004, the
Federal Open Market Committee (the "Fed") raised the federal funds target rate
four times during the period, to close at 3.25%, a three-year high. Although
yields of short- and intermediate-term bonds rose in response to these
increases, the yields of longer-term bonds did not follow suit. Apparently
undeterred by the prospect for inflation, buyers bid up the prices of long-term
U.S. Treasuries, driving long-term yields down (bond prices and yields in
opposition). As investors sought out income opportunities, bonds with lower
credit qualities and greater yields outperformed higher quality, lower yielding
credits.
PERFORMANCE ANALYSIS
Morgan Stanley Balanced Income Fund outperformed the Lehman Brothers U.S.
Government/Credit Index and the Lipper Income Funds Index and underperformed the
Russell 1000(R) Value Index for the six months ended July 31, 2005, assuming no
deduction of applicable sales charges.
Within the stock portion of the portfolio, energy holdings added the most to
overall returns. Refining companies led the group, driven by the wider profit
margins gained from the high price of crude oil. These companies' budgets were
structured based on oil prices estimated in the $25 to $30 per barrel range. As
crude prices soared, the refiners were able to capture significantly higher than
expected operating margins. Healthcare was also a source of strong performance,
led by notable contributions from pharmaceutical companies. Drug stocks had been
deeply discounted in the market due to legal and product pipeline concerns. In
2005, however, the group began to benefit from improving sentiment on
2
the legal front, stronger earnings and the anticipation of certain new drugs.
Our stock selection in the financials sector also served the Fund well. Our
investment process steered the Fund away from stocks with interest rate
exposure, such as banks. (As the difference between long-term and short-term
rates narrows, banks' profit margins shrink.) Instead, the Fund favored
insurance stocks, which continued to perform well, and brokerage stocks.
Consumer discretionary was a negative sector for the fund during the period.
Weakness came primarily from media-related holdings, which were unable to
demonstrate new growth amid flagging advertising revenues. Negative market
sentiment contributed to the industry's woes.
Within its fixed-income allocation, the Fund's emphasis on higher coupon, slow
prepaying mortgage issues benefited performance as rates rose during the bulk of
the period. The Fund's overall interest-rate exposure was well below that of its
fixed-income benchmark during the period. Against the backdrop of rising short-
and intermediate-term interest rates, this positioning proved advantageous
during the period. An underweighting versus the Lehman index in the energy and
banking and finance sectors benefited relative performance. However, a focus on
medium- and higher-quality corporate issues detracted modestly from relative
performance, as investors sought out higher yielding bonds.
During the six-month period, the Fund's stock and bond proportions remained
fairly constant. As of the end of the reporting period, the Fund held 33 percent
in stocks and 64 percent in bonds.
There is no guarantee that any sectors mentioned will continue to perform well
or that securities in such sectors will be held by the Fund in the future.
3
<Table>
<Caption>
TOP 10 HOLDINGS
U.S. Treasury Securities 32.2%
Federal National Mortgage Assoc. 3.3
JP Morgan Chase & Co. 1.0
Bayer AG (ADR) (Germany) 1.0
Bristol-Myers Squibb Co. 0.9
Merrill Lynch & Co., Inc. 0.8
Roche Holdings Ltd. (ADR) (Switzerland) 0.8
Schering-Plough Corp. 0.8
Time Warner Inc. 0.8
Unilever N.V. (NY Registered Shares)
(Netherlands) 0.8
</Table>
<Table>
<Caption>
PORTFOLIO COMPOSITION*
U.S. Government Agencies & Obligations 34.2%
Common Stocks 32.9
Corporate Bonds 18.0
Asset-Backed Securities 9.1
Short-Term Investments 3.4
Mortgage-Backed Securities 1.9
Foreign Government Obligations 0.3
Collateralized Mortgage Obligation 0.2
</Table>
* Does not include outstanding long futures contracts with an underlying face
amount of $2,885,594 with unrealized depreciation of $53,509 and short futures
contracts with an underlying face amount of $32,972,298 with unrealized
appreciation of $452,634.
Data as of July 31, 2005. Subject to change daily. All percentages for top 10
holdings are as a percentage of net assets and all percentages for portfolio
composition are as a percentage of total investments. These data are provided
for informational purposes only and should not be deemed a recommendation to buy
or sell the securities mentioned. Morgan Stanley is a full-service securities
firm engaged in securities trading and brokerage activities, investment banking,
research and analysis, financing and financial advisory services.
INVESTMENT STRATEGY
THE FUND WILL NORMALLY INVEST AT LEAST 80 PERCENT OF ITS ASSETS IN
INCOME-PRODUCING SECURITIES, CONSISTING OF (1) FIXED-INCOME SECURITIES AND (2)
DIVIDEND PAYING COMMON STOCKS AND SECURITIES CONVERTIBLE INTO COMMON STOCKS.
WITHIN THE LIMITATIONS DETAILED BELOW, THE FUND'S "INVESTMENT ADVISER," MORGAN
STANLEY INVESTMENT ADVISORS INC., MAY PURCHASE OR SELL SECURITIES IN ANY
PROPORTION IT BELIEVES DESIRABLE BASED ON ITS ASSESSMENT OF BUSINESS, ECONOMIC
AND INVESTMENT CONDITIONS.
FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS
EACH MORGAN STANLEY FUND PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN
ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE FUND'S SECOND
AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE
SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON
FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO
DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO FUND SHAREHOLDERS AND MAKES THESE
REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, WWW.MORGANSTANLEY.COM. EACH MORGAN
STANLEY FUND ALSO FILES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS WITH THE SEC
FOR THE FUND'S FIRST AND THIRD FISCAL QUARTERS ON FORM N-Q. MORGAN STANLEY DOES
NOT DELIVER THE REPORTS FOR THE FIRST AND THIRD FISCAL QUARTERS TO SHAREHOLDERS,
NOR ARE THE REPORTS POSTED TO THE MORGAN STANLEY PUBLIC WEB SITE. YOU MAY,
HOWEVER, OBTAIN THE FORM N-Q FILINGS (AS WELL AS THE FORM N-CSR AND N-CSRS
FILINGS) BY ACCESSING THE SEC'S WEB SITE, HTTP://WWW.SEC.GOV. YOU MAY ALSO
REVIEW AND COPY THEM AT THE SEC'S PUBLIC REFERENCE ROOM IN WASHINGTON, DC.
INFORMATION ON THE OPERATION OF THE SEC'S PUBLIC REFERENCE ROOM MAY BE OBTAINED
BY CALLING THE SEC AT (800) SEC-0330. YOU CAN ALSO REQUEST COPIES OF THESE
MATERIALS, UPON PAYMENT OF
4
A DUPLICATING FEE, BY ELECTRONIC REQUEST AT THE SEC'S E-MAIL ADDRESS
(PUBLICINFO@SEC.GOV) OR BY WRITING THE PUBLIC REFERENCE SECTION OF THE SEC,
WASHINGTON, DC 20549-0102.
PROXY VOTING POLICY AND PROCEDURES AND PROXY VOTING RECORD
YOU MAY OBTAIN A COPY OF THE FUND'S PROXY VOTING POLICY AND PROCEDURES WITHOUT
CHARGE, UPON REQUEST, BY CALLING TOLL FREE 800-869-NEWS OR BY VISITING THE
MUTUAL FUND CENTER ON OUR WEB SITE AT WWW.MORGANSTANLEY.COM. IT IS ALSO
AVAILABLE ON THE SECURITIES AND EXCHANGE COMMISSION'S WEB SITE AT
HTTP://WWW.SEC.GOV.
YOU MAY OBTAIN INFORMATION REGARDING HOW THE FUND VOTED PROXIES RELATING TO
PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30 BY
VISITING THE MUTUAL FUND CENTER ON OUR WEB SITE AT WWW.MORGANSTANLEY.COM. THIS
INFORMATION IS ALSO AVAILABLE ON THE SECURITIES AND EXCHANGE COMMISSION'S WEB
SITE AT HTTP://WWW.SEC.GOV.
HOUSEHOLDING NOTICE
TO REDUCE PRINTING AND MAILING COSTS, THE FUND ATTEMPTS TO ELIMINATE DUPLICATE
MAILINGS TO THE SAME ADDRESS. THE FUND DELIVERS A SINGLE COPY OF CERTAIN
SHAREHOLDER DOCUMENTS, INCLUDING SHAREHOLDER REPORTS, PROSPECTUSES AND PROXY
MATERIALS, TO INVESTORS WITH THE SAME LAST NAME WHO RESIDE AT THE SAME ADDRESS.
YOUR PARTICIPATION IN THIS PROGRAM WILL CONTINUE FOR AN UNLIMITED PERIOD OF TIME
UNLESS YOU INSTRUCT US OTHERWISE. YOU CAN REQUEST MULTIPLE COPIES OF THESE
DOCUMENTS BY CALLING (800) 350-6414, 8:00 A.M. TO 8:00 P.M., ET. ONCE OUR
CUSTOMER SERVICE CENTER HAS RECEIVED YOUR INSTRUCTIONS, WE WILL BEGIN SENDING
INDIVIDUAL COPIES FOR EACH ACCOUNT WITHIN 30 DAYS.
5
PERFORMANCE SUMMARY
AVERAGE ANNUAL TOTAL RETURNS -- PERIOD ENDED JULY 31, 2005
<Table>
<Caption>
CLASS A SHARES* CLASS B SHARES** CLASS C SHARES(+) CLASS D SHARES(++)
(since 07/28/97) (since 07/28/97) (since 03/28/95) (since 07/28/97)
SYMBOL BINAX BINBX BINCX BINDX
1 YEAR 9.54%(4) 8.64%(4) 8.82%(4) 9.74%(4)
3.79(5) 3.64(5) 7.82(5) --
5 YEARS 6.51(4) 5.67(4) 5.69(4) 6.72(4)
5.37(5) 5.34(5) 5.69(5) --
10 YEARS -- -- 6.73(4) --
-- -- 6.73(5) --
SINCE INCEPTION 5.85(4) 5.03(4) 7.21(4) 6.07(4)
5.14(5) 5.03(5) 7.21(5) --
</Table>
Performance data quoted represents past performance, which is no guarantee of
future results and current performance may be lower or higher than the figures
shown. For the most recent month-end performance figures, please visit
www.morganstanley.com or speak with your Financial Advisor. Investment returns
and principal value will fluctuate and fund shares, when redeemed, may be worth
more or less than their original cost. The table does not reflect the deduction
of taxes that a shareholder would pay on fund distributions or the redemption of
fund shares. Performance for Class A, Class B, Class C, and Class D shares will
vary due to differences in sales charges and expenses.
* The maximum front-end sales charge for Class A is 5.25%.
** The maximum contingent deferred sales charge (CDSC) for Class B is 5.0%. The
CDSC declines to 0% after six years.
+ The maximum contingent deferred sales charge for Class C is 1% for shares
redeemed within one year of purchase.
++ Class D has no sales charge.
(1) The Lehman Brothers U.S. Government/Credit Index tracks the performance of
government and corporate obligations, including U.S. government agency and
Treasury securities and corporate and Yankee bonds. Indexes are unmanaged
and their returns do not include any sales charges or fees. Such costs
would lower performance. It is not possible to invest directly in an index.
(2) The Russell 1000(R) Value Index measures the performance of those companies
in the Russell 1000(R) Index with lower price-to-book ratios and lower
forecasted growth values. Indexes are unmanaged and their returns do not
include any sales charges or fees. Such costs would lower performance. It
is not possible to invest directly in an index.
(3) The Lipper Income Funds Index is an equally weighted performance index of
the largest qualifying funds (based on net assets) in the Lipper Income
Funds classification. The Index, which is adjusted for capital gains
distributions and income dividends, is unmanaged and should not be
considered an investment. There are currently 30 funds represented in this
Index.
(4) Figure shown assumes reinvestment of all distributions and does not reflect
the deduction of any sales charges.
(5) Figure shown assumes reinvestment of all distributions and the deduction of
the maximum applicable sales charge. See the Fund's current prospectus for
complete details on fees and sales charges.
6
EXPENSE EXAMPLE
As a shareholder of the Fund, you incur two types of costs: (1) transaction
costs, including sales charges (loads) on purchase payments and redemption fees;
and (2) ongoing costs, including advisory fees; distribution and service (12b-1)
fees; and other Fund expenses. This example is intended to help you understand
your ongoing costs (in dollars) of investing in the Fund and to compare these
costs with the ongoing costs of investing in other mutual funds.
The example is based on an investment of $1,000 invested at the beginning of the
period and held for the entire period 02/01/05 - 07/31/05.
ACTUAL EXPENSES
The first line of the table below provides information about actual account
values and actual expenses. You may use the information in this line, together
with the amount you invested, to estimate the expenses that you paid over the
period. Simply divide your account value by $1,000 (for example, an $8,600
account value divided by $1,000 = 8.6), then multiply the result by the number
in the first line under the heading entitled "Expenses Paid During Period" to
estimate the expenses you paid on your account during this period.
HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES
The second line of the table below provides information about hypothetical
expenses based on the Fund's actual expense ratio and an assumed rate of return
of 5% per year before expenses, which is not the Fund's actual return. The
hypothetical account values and expenses may not be used to estimate the actual
ending account balance or expenses you paid for the period. You may use this
information to compare the ongoing cost of investing in the Fund and other
funds. To do so, compare this 5% hypothetical example with the 5% hypothetical
examples that appear in the shareholder reports of the other funds.
Please note that the expenses shown in the table are meant to highlight your
ongoing costs only and do not reflect any transactional costs, such as sales
charges (loads) and redemption fees. Therefore, the second line of the table is
useful in comparing ongoing costs, and will not help you determine the relative
total cost of owning different funds. In addition, if these transactional costs
were included, your costs would have been higher.
<Table>
<Caption>
BEGINNING ENDING EXPENSES PAID
ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD *
------------- ------------- ---------------
02/01/05 -
02/01/05 07/31/05 07/31/05
------------- ------------- ---------------
CLASS A
Actual (3.53% return)....................................... $1,000.00 $1,035.30 $5.75
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,019.14 $5.71
CLASS B
Actual (3.05% return)....................................... $1,000.00 $1,030.50 $9.52
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,015.42 $9.44
CLASS C
Actual (3.13% return)....................................... $1,000.00 $1,031.30 $9.52
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,015.42 $9.44
CLASS D
Actual (3.57% return)....................................... $1,000.00 $1,035.70 $4.49
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,020.38 $4.46
</Table>
- ------------------
* Expenses are equal to the Fund's annualized expense ratio of 1.14%, 1.89%,
1.89% and 0.89% respectively, multiplied by the average account value over
the period, multiplied by 181/365 (to reflect the one-half year period).
7
INVESTMENT ADVISORY AGREEMENT APPROVAL
NATURE, EXTENT AND QUALITY OF SERVICES
The Board reviewed and considered the nature and extent of the investment
advisory services provided by the Investment Adviser under the Advisory
Agreement, including portfolio management, investment research and equity and
fixed income securities trading. The Board also reviewed and considered the
nature and extent of the non-advisory, administrative services provided by the
Fund's Administrator under the Administration Agreement, including accounting,
clerical, bookkeeping, compliance, business management and planning, and the
provision of supplies, office space and utilities. (The Investment Adviser and
the Administrator together are referred to as the "Adviser" and the Advisory and
Administration Agreements together are referred to as the "Management
Agreement.") The Board also compared the nature of the services provided by the
Adviser with similar services provided by non-affiliated advisers as reported to
the Board by Lipper Inc. ("Lipper").
The Board reviewed and considered the qualifications of the portfolio managers,
the senior administrative managers and other key personnel of the Adviser who
provide the administrative and investment advisory services to the Fund. 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
nature and extent of the advisory and administrative services provided were
necessary and appropriate for the conduct of the business and investment
activities of the Fund. The Board also 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 the Fund's performance for the one-, three- and five-year
periods ended November 30, 2004, as shown in reports provided by Lipper (the
"Lipper Reports"), compared to the performance of comparable funds selected by
Lipper (the "performance peer group"), and noted that the Fund's performance was
lower than its performance peer group average for the one- and three-year
periods but better for the five-year period. The Board also noted that the
Fund's relative performance had improved from the three- to the one-year period.
The Board discussed with the Adviser the reasons for the improvement. The Board
concluded that it could reasonably be expected that the Fund's performance would
continue to improve.
FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT
STRATEGIES
The Board reviewed the advisory and administrative fees (together, the
"management fee") paid by the Fund under the Management Agreement. The Board
noted that the rate was comparable to the management fee rates charged by the
Adviser to any other funds it manages with investment strategies comparable to
those of the Fund.
8
FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS
The Board reviewed the management fee rate and the total expense ratio of the
Fund. The Board noted that: (i) the Fund's management fee rate was lower than
the average management fee rate for funds, selected by Lipper (the "expense peer
group"), managed by other advisers with investment strategies comparable to
those of the Fund, as shown in the Lipper Report for the Fund; and (ii) the
Fund's total expense ratio was also lower than the average total expense ratio
of the funds included in the Fund's expense peer group. The Board concluded that
the Fund's management fee and total expense ratio were competitive with those of
its expense peer group.
BREAKPOINTS AND ECONOMIES OF SCALE
The Board reviewed the structure of the Fund's management fee schedule under the
Management Agreement and noted that it includes a breakpoint. The Board also
reviewed the level of the Fund's management fee and noted that the fee, as a
percentage of the Fund's net assets, would decrease as net assets increase
because the management fee includes a breakpoint. The Board concluded that the
Fund's management fee would reflect economies of scale as assets increase.
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 Fund 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 Fund.
FALL-OUT BENEFITS
The Board considered so-called "fall-out benefits" derived by the Adviser and
its affiliates from their relationship with the Fund and the Morgan Stanley Fund
Complex, such as "float" benefits derived from handling of checks for purchases
and redemptions of Fund shares through a broker-dealer affiliate of the Adviser
and "soft dollar" benefits (discussed in the next section). The Board also
considered that a broker-dealer affiliate of the Adviser receives from the Fund
12b-1 fees for distribution and shareholder services. The Board also considered
that an affiliate of the Adviser, through a joint venture, receives revenue in
connection with trading done on behalf of the Fund through an electronic trading
system network ("ECN"). The Board concluded that the float benefits and the
above-referenced ECN-related revenue were relatively small and that the 12b-1
fees were competitive with those of other broker-dealer affiliates of investment
advisers of mutual funds.
9
SOFT DOLLAR BENEFITS
The Board considered whether the Adviser realizes any benefits as a result of
brokerage transactions executed through "soft dollar" arrangements. Under such
arrangements, brokerage commissions paid by the Fund and/or other funds managed
by the Adviser would be used to pay for research that a securities broker
obtains from third parties, or to pay for both research and execution services
from securities brokers who effect transactions for the Fund. The Adviser
informed the Board that it does not use Fund commissions to pay for third party
research. It does use commissions to pay for research which is bundled with
execution services. The Board recognized that the receipt of such research from
brokers may reduce the Adviser's costs but concluded that the receipt of such
research strengthens the investment management resources of the Adviser, which
may ultimately benefit the Fund and other funds in the Morgan Stanley Fund
Complex.
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 Management 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 Management Agreement.
HISTORICAL RELATIONSHIP BETWEEN THE FUND AND THE ADVISER
The Board also reviewed and considered the historical relationship between the
Fund and the Adviser, including the organizational structure of the Adviser, the
policies and procedures formulated and adopted by the Adviser for managing the
Fund'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 Fund 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 Fund'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 Fund'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 Fund and its shareholders to approve
renewal of the Management Agreement for another year.
10
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2005 (UNAUDITED)
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- --------------------------------------------------------------------------------------------------------
Common Stocks (33.2%)
Aerospace & Defense (0.7%)
12,340 Northrop Grumman Corp. ....................................................... $ 684,253
16,140 Raytheon Co. ................................................................. 634,786
-----------
1,319,039
-----------
Beverages: Non-Alcoholic (0.5%)
22,830 Coca-Cola Co. (The)........................................................... 999,041
-----------
Biotechnology (0.3%)
17,350 Chiron Corp.*................................................................. 628,591
-----------
Broadcasting (0.7%)
38,180 Clear Channel Communications, Inc. ........................................... 1,246,195
-----------
Chemicals: Major Diversified (1.3%)
49,630 Bayer AG (ADR) (Germany)...................................................... 1,770,798
13,300 Dow Chemical Co. (The)........................................................ 637,735
-----------
2,408,533
-----------
Computer Processing Hardware (0.5%)
39,670 Hewlett-Packard Co. .......................................................... 976,675
-----------
Department Stores (0.3%)
10,900 Kohl's Corp.*................................................................. 614,215
-----------
Discount Stores (0.8%)
5,520 Target Corp. ................................................................. 324,300
21,570 Wal-Mart Stores, Inc. ........................................................ 1,064,479
-----------
1,388,779
-----------
Electric Utilities (1.4%)
15,170 American Electric Power Co., Inc. ............................................ 587,079
9,170 Entergy Corp. ................................................................ 714,710
10,050 Exelon Corp. ................................................................. 537,876
14,900 FirstEnergy Corp. ............................................................ 741,722
-----------
2,581,387
-----------
</Table>
11
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2005 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- --------------------------------------------------------------------------------------------------------
Finance/Rental/Leasing (0.7%)
17,270 Freddie Mac................................................................... $ 1,092,846
7,910 MBNA Corp. ................................................................... 199,016
-----------
1,291,862
-----------
Financial Conglomerates (2.5%)
31,920 Citigroup, Inc. .............................................................. 1,388,520
51,246 JPMorgan Chase & Co. ......................................................... 1,800,784
11,190 Prudential Financial, Inc..................................................... 748,611
11,570 State Street Corp. ........................................................... 575,492
-----------
4,513,407
-----------
Financial Publishing/Services (0.1%)
5,320 Equifax, Inc. ................................................................ 193,648
-----------
Food: Major Diversified (1.0%)
13,880 Kraft Foods Inc. (Class A).................................................... 424,034
21,170 Unilever N.V. (NY Registered Shares) (Netherlands)............................ 1,416,485
-----------
1,840,519
-----------
Food: Specialty/Candy (0.3%)
15,480 Cadbury Schweppes PLC (ADR) (United Kingdom).................................. 598,147
-----------
Hotels/Resorts/Cruiselines (0.2%)
4,880 Marriott International, Inc. (Class A)........................................ 334,134
-----------
Household/Personal Care (0.3%)
9,140 Kimberly-Clark Corp. ......................................................... 582,766
-----------
Industrial Conglomerates (1.5%)
38,500 General Electric Co. ......................................................... 1,328,250
6,460 Ingersoll-Rand Co. Ltd. (Class A) (Bermuda)................................... 504,978
11,830 Siemens AG (ADR) (Germany).................................................... 910,555
-----------
2,743,783
-----------
Industrial Machinery (0.1%)
2,510 Parker Hannifin Corp. ........................................................ 164,957
-----------
Integrated Oil (2.4%)
18,170 BP PLC (ADR) (United Kingdom)................................................. 1,197,040
19,070 ConocoPhillips................................................................ 1,193,591
</Table>
12
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2005 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- --------------------------------------------------------------------------------------------------------
13,810 Exxon Mobil Corp. ............................................................ $ 811,338
18,300 Royal Dutch Shell PLC (ADR) (Class A) (United Kingdom)........................ 1,121,424
-----------
4,323,393
-----------
Investment Banks/Brokers (2.0%)
3,200 Goldman Sachs Group Inc. (The)................................................ 343,936
9,950 Lehman Brothers Holdings Inc. ................................................ 1,046,043
23,890 Merrill Lynch & Co., Inc. .................................................... 1,404,254
60,460 Schwab (Charles) Corp. (The).................................................. 828,302
-----------
3,622,535
-----------
Life/Health Insurance (0.1%)
16,050 Aegon N.V. (NY Registered Shares) (Netherlands)............................... 229,676
-----------
Major Banks (0.7%)
19,760 Bank of America Corp. ........................................................ 861,536
7,700 PNC Financial Services Group.................................................. 422,114
-----------
1,283,650
-----------
Major Telecommunications (1.2%)
20,370 France Telecom S.A. (ADR) (France)............................................ 629,433
22,050 Sprint Corp. ................................................................. 593,145
28,280 Verizon Communications Inc. .................................................. 968,024
-----------
2,190,602
-----------
Managed Health Care (0.6%)
10,210 CIGNA Corp. .................................................................. 1,089,918
-----------
Media Conglomerates (1.7%)
37,450 Disney (Walt) Co. (The)....................................................... 960,218
84,160 Time Warner, Inc. ............................................................ 1,432,403
21,040 Viacom Inc. (Class B) (Non-Voting)............................................ 704,630
-----------
3,097,251
-----------
Medical Specialties (0.5%)
9,600 Applera Corp. - Applied Biosystems Group...................................... 199,872
9,260 Bausch & Lomb, Inc. .......................................................... 783,859
-----------
983,731
-----------
Motor Vehicles (0.4%)
28,020 Honda Motor Co., Ltd. (ADR) (Japan)........................................... 722,075
-----------
</Table>
13
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2005 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- --------------------------------------------------------------------------------------------------------
Multi-Line Insurance (0.3%)
6,700 Hartford Financial Services Group, Inc. (The)................................. $ 539,819
-----------
Oil Refining/Marketing (0.5%)
10,250 Valero Energy Corp. .......................................................... 848,495
-----------
Oilfield Services/Equipment (0.7%)
15,770 Schlumberger Ltd. (Netherlands Antilles)...................................... 1,320,580
-----------
Packaged Software (0.5%)
42,250 Symantec Corp.*............................................................... 928,233
-----------
Pharmaceuticals: Major (4.3%)
69,570 Bristol-Myers Squibb Co. ..................................................... 1,737,859
11,230 GlaxoSmithKline PLC (ADR) (United Kingdom).................................... 532,751
15,720 Lilly (Eli) & Co. ............................................................ 885,350
21,140 Roche Holdings Ltd. (ADR) (Switzerland)....................................... 1,449,147
19,300 Sanofi-Aventis (ADR) (France)................................................. 835,690
67,990 Schering-Plough Corp. ........................................................ 1,415,552
21,170 Wyeth......................................................................... 968,528
-----------
7,824,877
-----------
Precious Metals (0.4%)
19,730 Newmont Mining Corp. ......................................................... 740,861
-----------
Property - Casualty Insurers (1.2%)
13,580 Chubb Corp. (The)............................................................. 1,206,176
24,344 St. Paul Travelers Companies, Inc. (The)...................................... 1,071,623
-----------
2,277,799
-----------
Railroads (0.2%)
7,200 Norfolk Southern Corp. ....................................................... 267,912
-----------
Restaurants (0.2%)
11,100 McDonald's Corp. ............................................................. 345,987
-----------
</Table>
14
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2005 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- --------------------------------------------------------------------------------------------------------
Semiconductors (0.8%)
31,290 Intel Corp. .................................................................. $ 849,211
52,490 Micron Technology, Inc.*...................................................... 623,581
-----------
1,472,792
-----------
Telecommunication Equipment (0.6%)
51,840 Motorola, Inc. ............................................................... 1,097,971
-----------
Tobacco (0.3%)
9,330 Altria Group, Inc. ........................................................... 624,737
-----------
Wireless Telecommunications (0.4%)
19,860 Nextel Communications, Inc. (Class A)*........................................ 691,127
-----------
Total Common Stocks (Cost $47,366,706)........................................ 60,949,699
-----------
</Table>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE
- --------- ------ --------
Corporate Bonds (18.0%)
Advertising/Marketing Services (0.1%)
$ 230 WPP Finance Corp. (United Kingdom)........................ 5.875% 06/15/14 237,846
------------
Aerospace & Defense (0.6%)
235 Northrop Grumman Corp. ................................... 4.079 11/16/06 233,347
235 Raytheon Co. ............................................. 8.30 03/01/10 267,824
509 Systems 2001 Asset Trust - 144A** (Cayman Islands)........ 6.664 09/15/13 544,912
------------
1,046,083
------------
Air Freight/Couriers (0.1%)
225 Fedex Corp. .............................................. 2.65 04/01/07 218,523
------------
Airlines (0.3%)
334 America West Airlines, Inc. (Series 01-1)................. 7.10 04/02/21 346,394
195 Southwest Airlines Co. (Series 01-1)...................... 5.496 11/01/06 197,438
------------
543,832
------------
Beverages: Alcoholic (0.3%)
305 FBG Finance Ltd. - 144A** (Australia)..................... 5.125 06/15/15 300,253
320 Miller Brewing Co. - 144A**............................... 4.25 08/15/08 316,115
------------
616,368
------------
</Table>
15
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2005 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Cable/Satellite TV (0.5%)
$ 35 Comcast Cable Communications Inc. ........................ 6.75 % 01/30/11 $ 38,104
350 Comcast Corp. ............................................ 6.50 01/15/15 384,195
40 Comcast Corp. ............................................ 7.625 02/15/08 42,641
270 Cox Communications, Inc. ................................. 4.625 01/15/10 265,628
105 TCI Communications, Inc. ................................. 7.875 02/15/26 128,561
------------
859,129
------------
Chemicals: Major Diversified (0.1%)
170 ICI Wilmington Inc. ...................................... 4.375 12/01/08 167,143
------------
Containers/Packaging (0.2%)
355 Sealed Air Corp. - 144A**................................. 5.625 07/15/13 359,401
------------
Department Stores (0.1%)
50 Federated Department Stores, Inc. ........................ 6.625 09/01/08 52,870
80 May Department Stores Co., Inc. .......................... 5.95 11/01/08 82,753
------------
135,623
------------
Drugstore Chains (0.2%)
290 CVS Corp. ................................................ 5.625 03/15/06 292,359
62 CVS Corp. - 144A**........................................ 6.204 10/10/25 67,015
------------
359,374
------------
Electric Utilities (2.0%)
305 Arizona Public Service Co. ............................... 5.80 06/30/14 321,031
75 Arizona Public Service Co. ............................... 6.75 11/15/06 77,084
265 Carolina Power & Light Co. ............................... 5.125 09/15/13 269,134
185 CC Funding Trust I........................................ 6.90 02/16/07 191,287
145 Cincinnati Gas & Electric Co. ............................ 5.70 09/15/12 151,988
155 Consolidated Natural Gas Co. ............................. 5.00 12/01/14 154,202
100 Consolidated Natural Gas Co. (Series A)................... 5.00 03/01/14 99,521
230 Consolidated Natural Gas Co. (Series C)................... 6.25 11/01/11 246,905
180 Consumers Energy Co. ..................................... 4.80 02/17/09 180,107
225 Detroit Edison Co. (The) - 144A**......................... 4.80 02/15/15 220,964
85 Detroit Edison Co. (The).................................. 6.125 10/01/10 90,403
130 Entergy Gulf States, Inc. ................................ 3.60 06/01/08 126,167
195 Entergy Gulf States, Inc. ................................ 3.73 ++ 12/01/09 195,661
165 Exelon Corp. ............................................. 6.75 05/01/11 180,288
385 FPL Group Capital Inc. ................................... 3.25 04/11/06 382,668
140 Pacific Gas & Electric Co. ............................... 6.05 03/01/34 150,620
70 Panhandle Eastern Pipe Line Co. (Series B)................ 2.75 03/15/07 68,008
220 Public Service Electric & Gas Co. (Series MTNB)........... 5.00 01/01/13 222,584
</Table>
16
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2005 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
$ 115 South Carolina Electric & Gas Co. ........................ 5.30 % 05/15/33 $ 115,507
155 Texas Eastern Transmission, LP............................ 7.00 07/15/32 184,386
120 Wisconsin Electric Power Co. ............................. 3.50 12/01/07 117,435
------------
3,745,950
------------
Electrical Products (0.1%)
240 Cooper Industries Inc. ................................... 5.25 07/01/07 242,767
------------
Electronics/Appliances (0.1%)
160 LG Electronics Inc. - 144A** (South Korea)................ 5.00 06/17/10 157,441
------------
Finance/Rental/Leasing (1.6%)
240 CIT Group, Inc. .......................................... 2.875 09/29/06 236,100
105 CIT Group, Inc. .......................................... 7.375 04/02/07 109,905
425 Countrywide Home Loans, Inc. (Series MTN)................. 3.25 05/21/08 409,652
170 Ford Motor Credit Co. .................................... 7.375 10/28/09 169,774
375 MBNA Corp. ............................................... 3.64 ++ 05/05/08 378,394
305 MBNA Corp. ............................................... 6.125 03/01/13 326,891
405 Nationwide Building Society - 144A** (United Kingdom)..... 4.25 02/01/10 397,772
280 Residential Capital Corp. - 144A**........................ 6.375 06/30/10 284,797
225 SLM Corp. ................................................ 4.00 01/15/10 218,846
350 SLM Corp. (Series MTNA)................................... 5.00 10/01/13 352,261
------------
2,884,392
------------
Financial Conglomerates (1.5%)
500 Associates Corp. of North America......................... 6.25 11/01/08 525,827
230 Bank One Corp. (Series MTNA).............................. 6.00 02/17/09 239,163
370 Chase Manhattan Corp. .................................... 6.00 02/15/09 386,610
80 Chase Manhattan Corp. .................................... 7.00 11/15/09 86,814
160 Citicorp.................................................. 6.75 08/15/05 160,166
185 Citigroup Inc. ........................................... 5.625 08/27/12 193,861
255 Citigroup Inc. ........................................... 5.75 05/10/06 258,080
125 Citigroup Inc. ........................................... 6.00 02/21/12 133,686
165 General Electric Capital Corp. ........................... 4.25 12/01/10 162,344
470 General Electric Capital Corp. (Series MTNA).............. 6.75 03/15/32 565,447
70 General Motors Acceptance Corp. .......................... 4.50 07/15/06 69,439
------------
2,781,437
------------
</Table>
17
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2005 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Food: Major Diversified (0.2%)
$ 80 General Mills Inc. ....................................... 3.875% 11/30/07 $ 78,820
115 Kraft Foods Inc. ......................................... 5.25 06/01/07 116,620
80 Kraft Foods Inc. ......................................... 5.625 11/01/11 83,649
------------
279,089
------------
Forest Products (0.1%)
160 Weyerhaeuser Co. ......................................... 6.00 08/01/06 162,366
48 Weyerhaeuser Co. ......................................... 6.125 03/15/07 49,040
------------
211,406
------------
Gas Distributors (0.4%)
195 NiSource Finance Corp. ................................... 3.854++ 11/23/09 195,981
295 Ras Laffan Liquid Natural Gas Co. Ltd. - 144A** (Qatar)... 8.294 03/15/14 346,630
180 Sempra Energy............................................. 4.621 05/17/07 180,017
------------
722,628
------------
Home Furnishings (0.1%)
135 Mohawk Industries, Inc. (Series D)........................ 7.20 04/15/12 151,317
------------
Hotels/Resorts/Cruiselines (0.5%)
305 Hyatt Equities LLC - 144A**............................... 6.875 06/15/07 312,547
505 Marriott International, Inc. (Series E)................... 7.00 01/15/08 531,730
------------
844,277
------------
Household/Personal Care (0.2%)
350 Clorox Co. (The).......................................... 3.525++ 12/14/07 350,701
------------
Industrial Conglomerates (0.3%)
155 Hutchison Whampoa International Ltd. - 144A** (Cayman
Islands)................................................ 5.45 11/24/10 158,451
230 Hutchison Whampoa International Ltd. - 144A** (Cayman
Islands)................................................ 6.50 02/13/13 245,857
200 Textron Financial Corp. .................................. 4.125 03/03/08 198,061
------------
602,369
------------
Insurance Brokers/Services (0.6%)
670 Farmers Exchange Capital - 144A**......................... 7.05 07/15/28 705,753
480 Marsh & McLennan Companies, Inc. ......................... 5.375 07/15/14 464,758
------------
1,170,511
------------
Investment Banks/Brokers (0.3%)
195 Goldman Sachs Group Inc. (The)............................ 5.25 10/15/13 198,129
345 Goldman Sachs Group Inc. (The)............................ 6.60 01/15/12 376,925
------------
575,054
------------
</Table>
18
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2005 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Life/Health Insurance (0.1%)
$ 135 John Hancock Financial Services, Inc. .................... 5.625% 12/01/08 $ 139,397
------------
Major Banks (0.6%)
120 Bank of New York Co., Inc. (The).......................... 5.20 07/01/07 121,503
250 Bank of New York Co., Inc. (The) (Series BKNT)............ 3.80 02/01/08 246,181
290 FleetBoston Financial Corp. .............................. 7.25 09/15/05 291,122
225 HSBC Finance Corp. ....................................... 6.75 05/15/11 246,013
250 Huntington National Bank (Series BKNT).................... 4.375 01/15/10 246,798
------------
1,151,617
------------
Major Telecommunications (0.9%)
320 Deutsche Telekom International Finance BV (Netherlands)... 8.75 06/15/30 429,370
315 France Telecom S.A. (France).............................. 8.75 03/01/31 435,154
95 Sprint Capital Corp. ..................................... 8.75 03/15/32 131,133
210 Telecom Italia Capital SpA (Luxembourg)................... 4.00 11/15/08 206,039
225 Telecom Italia Capital SpA - 144A** (Luxembourg).......... 4.00 01/15/10 217,326
300 Verizon New England Inc. ................................. 6.50 09/15/11 322,153
------------
1,741,175
------------
Managed Health Care (0.5%)
515 Aetna, Inc. .............................................. 7.875 03/01/11 590,477
30 Anthem, Inc. ............................................. 6.80 08/01/12 33,166
345 WellPoint Health Networks Inc. ........................... 6.375 06/15/06 351,161
------------
974,804
------------
Media Conglomerates (0.3%)
125 Historic TW Inc. ......................................... 6.625 05/15/29 137,531
115 News America Inc. ........................................ 7.28 06/30/28 132,139
90 News America Holdings, Inc. .............................. 7.75 02/01/24 106,337
40 Time Warner, Inc. ........................................ 7.625 04/15/31 49,442
90 Time Warner, Inc. ........................................ 7.70 05/01/32 112,806
------------
538,255
------------
Motor Vehicles (0.1%)
190 DaimlerChrysler North American Holdings Co. .............. 8.50 01/18/31 244,261
------------
Multi-Line Insurance (0.9%)
780 AIG Sun America Global Finance VI - 144A**................ 6.30 05/10/11 837,159
265 American General Finance Corp. (Series MTNF).............. 5.875 07/14/06 268,809
130 American General Finance Corp. (Series MTNH).............. 4.625 09/01/10 128,266
85 AXA Financial Inc. ....................................... 6.50 04/01/08 89,186
</Table>
19
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2005 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
$ 120 Hartford Financial Services Group, Inc. (The)............. 2.375% 06/01/06 $ 118,186
135 International Lease Finance Corp. ........................ 3.75 08/01/07 133,119
------------
1,574,725
------------
Oil & Gas Production (0.8%)
125 Pemex Project Funding Master Trust........................ 7.375 12/15/14 138,438
390 Pemex Project Funding Master Trust........................ 8.00 11/15/11 440,895
515 Pemex Project Funding Master Trust........................ 8.625 02/01/22 626,498
220 Pemex Project Funding Master Trust........................ 9.125 10/13/10 257,290
------------
1,463,121
------------
Other Metals/Minerals (0.1%)
235 Brascan Corp. (Canada).................................... 7.125 06/15/12 260,266
------------
Property - Casualty Insurers (0.4%)
460 Mantis Reef Ltd. - 144A** (Australia)..................... 4.692 11/14/08 454,349
315 St. Paul Travelers........................................ 5.01 08/16/07 316,960
------------
771,309
------------
Pulp & Paper (0.1%)
195 Sappi Papier Holding AG - 144A** (Austria)................ 6.75 06/15/12 202,459
------------
Railroads (0.4%)
162 Burlington North Santa Fe Railway Co. .................... 4.575 01/15/21 159,048
175 Norfolk Southern Corp. ................................... 7.35 05/15/07 183,400
105 Union Pacific Corp. ...................................... 3.625 06/01/10 99,258
35 Union Pacific Corp. ...................................... 6.625 02/01/08 36,707
100 Union Pacific Corp. - 144A**.............................. 5.214 09/30/14 100,710
110 Union Pacific Corp. (Series MTNE)......................... 6.79 11/09/07 115,388
------------
694,511
------------
Real Estate Development (0.5%)
414 World Financial Properties - 144A**....................... 6.91 09/01/13 442,151
408 World Financial Properties - 144A**....................... 6.95 09/01/13 435,328
------------
877,479
------------
Real Estate Investment Trusts (0.2%)
30 EOP Operating L.P. ....................................... 4.75 03/15/14 29,128
245 EOP Operating L.P. ....................................... 6.763 06/15/07 253,968
------------
283,096
------------
Regional Banks (0.3%)
510 Marshall & Ilsley Bank (Series BKNT)...................... 3.80 02/08/08 501,835
------------
</Table>
20
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2005 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Savings Banks (0.7%)
$ 195 Household Finance Corp. .................................. 4.125% 12/15/08 $ 191,870
220 Household Finance Corp. .................................. 5.875 02/01/09 228,146
105 Household Finance Corp. .................................. 6.375 10/15/11 112,680
230 Household Finance Corp. .................................. 6.40 06/17/08 241,300
100 Sovereign Bank (Series CD)................................ 4.00 02/01/08 98,885
195 Washington Mutual Bank.................................... 5.50 01/15/13 200,497
230 Washington Mutual Inc. ................................... 8.25 04/01/10 259,948
------------
1,333,326
------------
Tobacco (0.2%)
265 Altria Group, Inc. ....................................... 7.00 11/04/13 290,865
125 Altria Group, Inc. ....................................... 7.75 01/15/27 146,175
------------
437,040
------------
Trucks/Construction/Farm Machinery (0.3%)
425 Caterpillar Financial Services Corp. (Series MTNF)........ 3.35 ++ 08/20/07 425,795
70 Caterpillar Financial Services Corp. (Series MTNF)........ 3.625 11/15/07 68,641
------------
494,436
------------
Wireless Telecommunications (0.1%)
135 AT&T Wireless Services, Inc. ............................. 8.75 03/01/31 187,079
------------
Total Corporate Bonds (Cost $32,294,138)..................................... 33,132,852
------------
Foreign Government Obligations (0.3%)
160 United Mexican States (Mexico)............................ 8.375 01/14/11 183,920
350 United Mexican States (Mexico) (Series MTN)............... 8.30 08/15/31 433,475
------------
Total Foreign Government Obligations (Cost $587,300)......................... 617,395
------------
U.S. Government Agencies & Obligations (34.4%)
1,300 Federal Home Loan Mortgage Corp. ......................... 5.125 11/07/13 1,302,739
3,135 Federal National Mortgage Assoc. +........................ 4.25 08/15/10 3,110,911
U.S. Treasury Bonds
510 .......................................................... 6.125 08/15/29 628,576
7,700 .......................................................... 7.625 02/15/25 10,736,687
7,100 .......................................................... 8.125 08/15/19 - 9,976,790
08/15/21
U.S. Treasury Notes
1,750 .......................................................... 1.875 01/31/06 1,735,235
3,940 .......................................................... 3.875 02/15/13 3,855,814
25,500 .......................................................... 4.250 08/15/13 25,539,856
</Table>
21
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2005 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
U.S. Treasury Strips
$ 4,190 .......................................................... 0.00 % 08/15/20 $ 2,114,349
10,605 .......................................................... 0.00 02/15/25 - 4,263,509
02/15/27
Total U.S. Government Agencies & Obligations (Cost $60,636,552).............. 63,264,466
------------
Mortgage-Backed Securities (1.9%)
Federal Home Loan Mortgage Corp. Gold
192 .......................................................... 6.50 01/01/31 198,841
474 .......................................................... 7.50 10/01/29 - 506,119
08/01/32
Federal National Mortgage Assoc.
1,038 .......................................................... 6.50 03/01/32 - 1,074,630
06/01/33
267 .......................................................... 7.00 07/01/11 - 280,511
05/01/32
609 .......................................................... 7.50 08/01/23 - 649,338
07/01/32
637 .......................................................... 8.00 05/01/24 - 684,180
08/01/31
Government National Mortgage Assoc.
114 .......................................................... 7.50 08/15/25 - 122,296
10/15/26
69 .......................................................... 8.00 07/15/26 74,624
------------
Total Mortgage-Backed Securities (Cost $3,541,326)........................... 3,590,539
------------
Asset-Backed Securities (9.2%)
Finance/Rental/Leasing
700 American Express Credit Account Master Trust 2002-3 A..... 3.498++ 12/15/09 701,643
1,275 American Express Credit Account Master Trust 2003-3 A..... 3.498++ 11/15/10 1,278,682
59 Asset Backed Funding Certificates 2004-HE1 A1............. 3.59 ++ 06/25/22 58,974
725 Banc of America Securities Auto Trust 2005-WF1 A3......... 3.99 08/18/09 720,517
425 Capital Auto Receivables Asset Trust 2004-2 A............. 3.35 02/15/08 419,644
725 Capital Auto Receivables Asset Trust 2005-1 A4............ 4.05 07/15/09 721,548
650 Caterpillar Financial Asset Trust 2005-A A3............... 3.90 02/25/09 645,400
315 Chase Credit Card Master Trust 2001-4 A................... 5.50 11/17/08 319,148
300 CIT Equipment Collateral 2004-EF1 A3...................... 3.50 09/20/08 295,605
300 Citibank Credit Card Issuance Trust 2000-A1 A1............ 6.90 10/15/07 302,082
475 CNH Equipment Trust 2005-A A3............................. 4.02 04/15/09 472,382
575 Daimler Chrysler Auto Trust 2005-B A3..................... 4.04 09/08/09 572,326
475 Ford Credit Auto Owner Trust 2005-B A3.................... 4.17 01/15/09 473,866
550 GE Dealer Floorplan Master Note Trust 2004-1 A............ 3.48 ++ 07/20/08 550,287
</Table>
22
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2005 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
$ 900 Harley-Davidson Motorcycle Trust 2005-1 A2................ 3.76 % 12/17/12 $ 887,407
525 Harley-Davidson Motorcycle Trust 2005-2 A2................ 4.07 02/15/12 520,652
400 Honda Auto Receivables Owner Trust 2005-2 A3.............. 3.93 01/15/09 397,455
650 Honda Auto Receivables Owner Trust 2005-3 A3.............. 3.87 04/20/09 644,386
450 Hyundai Auto Receivables Trust 2005-A A3.................. 3.98 11/16/09 446,621
140 MBNA Master Credit Card Trust 1999-B A.................... 5.90 08/15/11 146,866
800 Merrill Auto Trust Securitization 2005-1 A3............... 4.10 08/25/09 796,010
575 National City Auto Receivables Trust 2004-A A4............ 2.88 05/15/11 558,000
825 Nissan Auto Receivables Owner Trust 2005-B A3............. 3.99 07/15/09 820,404
175 TXU Electric Delivery Transition Bond Co. LLC 2004-1A2.... 4.81 11/17/14 175,821
950 USAA Auto Owner Trust 2004-2 A-4.......................... 3.58 02/15/11 935,531
900 USAA Auto Owner Trust 2004-3 A3........................... 3.16 02/17/09 887,863
575 USAA Auto Owner Trust 2005-1 A3........................... 3.90 07/15/09 571,224
500 Volkswagen Auto Lease Trust 2005-A A3..................... 3.82 05/20/08 497,129
325 Wachovia Auto Owner Trust 2004-B A3....................... 2.91 04/20/09 320,071
400 Wachovia Auto Owner Trust 2005-A A3....................... 4.06 09/21/09 398,101
300 World Omni Auto Receivables Trust 2004-A A3............... 3.29 11/12/08 296,770
------------
Total Asset-Backed Securities (Cost $16,926,527)............................. 16,832,415
------------
Collateralized Mortgage Obligation (0.2%)
2000 Federal National Mortgage Assoc. 2005 - 68 XI (IO) (Cost
$300,000)............................................... 6.00 08/25/35 345,000
------------
Short-Term Investments (3.4%)
U.S. Government Obligation (a) (0.2%)
400 U.S. Treasury Bill*** (Cost $393,896)..................... 3.35 07/14/05 393,896
------------
Repurchase Agreement (3.2%)
5,822 Joint repurchase agreement account (dated 07/29/05;
proceeds $5,823,596) (b) (Cost $5,822,000).............. 3.29 08/01/05 5,822,000
------------
Total Short-Term Investments (Cost $6,215,896)....................... 6,215,896
------------
Total Investments (Cost $167,868,445) (c)(d)......................... 100.6% 184,948,262
Liabilities in Excess of Other Assets................................ (0.6) (1,130,075)
----- ------------
Net Assets........................................................... 100.0% $183,818,187
===== ============
</Table>
23
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2005 (UNAUDITED) continued
- ---------------------
<Table>
ADR American Depositary Receipt.
IO Interest-Only security.
* Non-income producing security.
** Resale is restricted to qualified institutional investors.
*** All or a portion of this security has been physically
segregated in connection with open futures contracts in an
amount equal to $199,750.
+ Security purchased on a forward commitment basis.
++ Floating rate security, rate shown is the rate in effect at
July 31, 2005.
(a) Purchased on a discount basis. The interest rates shown have
been adjusted to reflect a money market equivalent yield.
(b) Collateralized by federal agency and U.S. Treasury
obligations.
(c) Securities have been designated as collateral in an amount
equal to $39,290,516, in connection with securities
purchased on a forward commitment basis and open futures
contracts.
(d) The aggregate cost for federal income tax purposes
approximates the aggregate cost for book purposes. The
aggregate gross unrealized appreciation is $18,308,143 and
the aggregate gross unrealized depreciation is $1,228,326,
resulting in net unrealized appreciation of $17,079,817.
</Table>
FUTURES CONTRACTS OPEN AT JULY 31, 2005:
<Table>
<Caption>
UNREALIZED
NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE APPRECIATION
CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE (DEPRECIATION)
- --------- ---------- ---------------------- ------------------------ --------------
26 Long U.S. Treasury Notes $ 2,885,594 $(53,509)
10 Year September 2005
36 Short U.S. Treasury Notes (7,433,438) 64,932
2 Year September 2005
107 Short U.S. Treasury Notes (11,470,735) 179,640
5 Year September 2005
122 Short U.S. Treasury Bonds (14,068,125) 208,062
20 Year September 2005
--------
Net unrealized appreciation..................... $399,125
========
</Table>
24
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
July 31, 2005 (unaudited)
<Table>
Assets:
Investments in securities, at value (cost $167,868,445)..... $184,948,262
Receivable for:
Interest................................................ 1,700,129
Investments sold........................................ 652,310
Variation margin........................................ 158,619
Dividends............................................... 74,025
Shares of beneficial interest sold...................... 66,854
Prepaid expenses and other assets........................... 90,781
------------
Total Assets............................................ 187,690,980
------------
Liabilities:
Payable for:
Investments purchased................................... 3,302,244
Shares of beneficial interest redeemed.................. 282,222
Distribution fee........................................ 142,711
Investment advisory fee................................. 81,648
Administration fee...................................... 12,561
Accrued expenses and other payables......................... 51,407
------------
Total Liabilities....................................... 3,872,793
------------
Net Assets.............................................. $183,818,187
============
Composition of Net Assets:
Paid-in-capital............................................. $162,982,066
Net unrealized appreciation................................. 17,478,942
Accumulated undistributed net investment income............. 626,757
Accumulated undistributed net realized gain................. 2,730,422
------------
Net Assets.............................................. $183,818,187
============
Class A Shares:
Net Assets.................................................. $21,431,308
Shares Outstanding (unlimited authorized, $.01 par value)... 1,617,845
Net Asset Value Per Share............................... $13.25
============
Maximum Offering Price Per Share,
(net asset value plus 5.54% of net asset value)......... $13.98
============
Class B Shares:
Net Assets.................................................. $118,388,056
Shares Outstanding (unlimited authorized, $.01 par value)... 8,973,710
Net Asset Value Per Share............................... $13.19
============
Class C Shares:
Net Assets.................................................. $42,689,234
Shares Outstanding (unlimited authorized, $.01 par value)... 3,231,664
Net Asset Value Per Share............................... $13.21
============
Class D Shares:
Net Assets.................................................. $1,309,589
Shares Outstanding (unlimited authorized, $.01 par value)... 99,116
Net Asset Value Per Share............................... $13.21
============
</Table>
25
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
FINANCIAL STATEMENTS continued
Statement of Operations
For the six months ended July 31, 2005 (unaudited)
<Table>
Net Investment Income:
Income
Interest.................................................... $ 2,757,579
Dividends (net of $28,889 foreign withholding tax).......... 699,917
-----------
Total Income............................................ 3,457,496
-----------
Expenses
Distribution fee (Class A shares)........................... 18,415
Distribution fee (Class B shares)........................... 647,531
Distribution fee (Class C shares)........................... 212,874
Investment advisory fee..................................... 489,933
Transfer agent fees and expenses............................ 127,861
Administration fee.......................................... 75,374
Registration fees........................................... 38,100
Professional fees........................................... 35,244
Shareholder reports and notices............................. 34,382
Custodian fees.............................................. 23,125
Trustees' fees and expenses................................. 1,132
Other....................................................... 14,795
-----------
Total Expenses.......................................... 1,718,766
-----------
Net Investment Income................................... 1,738,730
-----------
Net Realized and Unrealized Gain (Loss):
Net Realized Gain (Loss) on:
Investments................................................. 6,379,628
Futures contracts........................................... (1,443,217)
-----------
Net Realized Gain....................................... 4,936,411
-----------
Net Change in Unrealized Appreciation/Depreciation on:
Investments................................................. (1,907,124)
Futures contracts........................................... 1,057,440
-----------
Net Depreciation........................................ (849,684)
-----------
Net Gain................................................ 4,086,727
-----------
Net Increase................................................ $ 5,825,457
===========
</Table>
26
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
FINANCIAL STATEMENTS continued
Statement of Changes in Net Assets
<Table>
<Caption>
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
JULY 31, 2005 JANUARY 31, 2005
------------- ----------------
(unaudited)
Increase (Decrease) in Net Assets:
Operations:
Net investment income....................................... $ 1,738,730 $ 3,543,356
Net realized gain........................................... 4,936,411 8,383,257
Net change in unrealized appreciation/depreciation.......... (849,684) (2,483,279)
------------ ------------
Net Increase............................................ 5,825,457 9,443,334
------------ ------------
Dividends and Distributions to Shareholders from:
Net investment income
Class A shares.......................................... (84,010) (238,355)
Class B shares.......................................... (544,067) (3,326,493)
Class C shares.......................................... (203,250) (935,448)
Class D shares.......................................... (14,947) (66,324)
Net realized gain
Class A shares.......................................... (126,897) --
Class B shares.......................................... (749,156) --
Class C shares.......................................... (264,158) --
Class D shares.......................................... (7,680) --
------------ ------------
Total Dividends and Distributions....................... (1,994,165) (4,566,620)
------------ ------------
Net decrease from transactions in shares of beneficial
interest.................................................. (18,722,360) (28,746,960)
------------ ------------
Net Decrease............................................ (14,891,068) (23,870,246)
Net Assets:
Beginning of period......................................... 198,709,255 222,579,501
------------ ------------
End of Period
(Including accumulated undistributed net investment income
of $626,757 and dividends in excess of net investment income
of $265,699, respectively).................................. $183,818,187 $198,709,255
============ ============
</Table>
27
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2005 (UNAUDITED)
1. Organization and Accounting Policies
Morgan Stanley Balanced Income Fund (the "Fund") is registered under the
Investment Company Act of 1940, as amended (the "Act"), as a diversified,
open-end management investment company. The Fund's investment objective is to
provide current income and moderate capital growth. The Fund was organized as a
Massachusetts business trust on November 23, 1994 and commenced operations on
March 28, 1995. On July 28, 1997, the Fund converted to a multiple class share
structure.
The Fund offers Class A shares, Class B shares, Class C shares and Class D
shares. The four classes are substantially the same except that most Class A
shares are subject to a sales charge imposed at the time of purchase and some
Class A shares, and most Class B shares and Class C shares are subject to a
contingent deferred sales charge imposed on shares redeemed within eighteen
months, six years and one year, respectively. Class D shares are not subject to
a sales charge. Additionally, Class A shares, Class B shares and Class C shares
incur distribution expenses.
Effective August 29, 2005, the Board of Trustees of the Fund approved the
implementation of a 2% redemption fee on Class A shares, Class B shares, Class C
shares, and Class D shares, which is paid directly to the Fund, for shares
redeemed within seven days of purchase. The redemption fee is designed to
protect the Fund and its remaining shareholders from the effects of short-term
trading.
The following is a summary of significant accounting policies:
A. Valuation of Investments -- (1) an equity portfolio security listed or traded
on the New York Stock Exchange ("NYSE") or American Stock Exchange or other
exchange is valued at its latest sale price prior to the time when assets are
valued; if there were no sales that day, the security is valued at the mean
between the last reported bid and asked price; (2) an equity portfolio security
listed or traded on the Nasdaq is valued at the Nasdaq Official Closing Price;
if there were no sales that day, the security is valued at the mean between the
last reported bid and asked price; (3) all other portfolio securities for which
over-the-counter market quotations are readily available are valued at the mean
between the last reported bid and asked price. In cases where a security is
traded on more than one exchange, the security is valued on the exchange
designated as the primary market; (4) for equity securities traded on foreign
exchanges, the last reported sale price or the latest bid price may be used if
there were no sales on a particular day; (5) futures are valued at the latest
price published by the commodities exchange on which they trade; (6) when market
quotations are not readily available or Morgan Stanley Investment Advisors Inc.
(the "Investment Adviser") determines that the latest sale price, the bid price
or the mean between the last reported bid and asked price do not reflect a
security's market value, portfolio securities are valued at their fair value as
determined in good faith under procedures established by and under the general
supervision of
28
Morgan Stanley Balanced Income Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2005 (UNAUDITED) continued
the Fund's Trustees. Occasionally, developments affecting the closing prices of
securities and other assets may occur between the times at which valuations of
such securities are determined (that is, close of the foreign market on which
the securities trade) and the close of business on the NYSE. If developments
occur during such periods that are expected to materially affect the value of
such securities, such valuations may be adjusted to reflect the estimated fair
value of such securities as of the close of the NYSE, as determined in good
faith by the Fund's Trustees or by the Investment Adviser using a pricing
service and/or procedures approved by the Trustees of the Fund; (7) certain
portfolio securities may be valued by an outside pricing service approved by the
Fund's Trustees; and (8) short-term debt securities having a maturity date of
more than sixty days at time of purchase are valued on a mark-to-market basis
until sixty days prior to maturity and thereafter at amortized cost based on
their value on the 61st day. Short-term debt securities having a maturity date
of sixty days or less at the time of purchase are valued at amortized cost.
B. Accounting for Investments -- Security transactions are accounted for on the
trade date (date the order to buy or sell is executed). Realized gains and
losses on security transactions are determined by the identified cost method.
Dividend income and other distributions are recorded on the ex-dividend date.
Discounts are accreted and premiums are amortized over the life of the
respective securities. Interest income is accrued daily.
C. Repurchase Agreements -- Pursuant to an Exemptive Order issued by the
Securities and Exchange Commission, the Fund, along with other affiliated
entities managed by the Investment Adviser, may transfer uninvested cash
balances into one or more joint repurchase agreement accounts. These balances
are invested in one or more repurchase agreements and are collateralized by
cash, U.S. Treasury or federal agency obligations. The Fund may also invest
directly with institutions in repurchase agreements. The Fund's custodian
receives the collateral, which is marked-to-market daily to determine that the
value of the collateral does not decrease below the repurchase price plus
accrued interest.
D. Multiple Class Allocations -- Investment income, expenses (other than
distribution fees), and realized and unrealized gains and losses are allocated
to each class of shares based upon the relative net asset value on the date such
items are recognized. Distribution fees are charged directly to the respective
class.
E. Futures Contracts -- A futures contract is an agreement between two parties
to buy and sell financial instruments or contracts based on financial indices at
a set price on a future date. Upon entering into such a contract, the Fund is
required to pledge to the broker cash, U.S. Government securities or other
liquid portfolio securities equal to the minimum initial margin requirements of
the applicable futures exchange. Pursuant to the contract, the Fund agrees to
receive from or pay to the
29
Morgan Stanley Balanced Income Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2005 (UNAUDITED) continued
broker an amount of cash equal to the daily fluctuation in the value of the
contract. Such receipts or payments known as variation margin are recorded by
the Fund as unrealized gains and losses. Upon closing of the contract, the Fund
realizes a gain or loss 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.
F. Federal Income Tax Policy -- It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Accordingly, no federal income tax provision is required.
G. Dividends and Distributions to Shareholders -- Dividends and distributions to
shareholders are recorded on the ex-dividend date.
H. Use of Estimates -- The preparation of financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts and disclosures.
Actual results could differ from those estimates.
2. Investment Advisory/Administration Agreements
Pursuant to an Investment Advisory Agreement with the Investment Adviser, the
Fund pays the Investment Adviser an advisory fee, accrued daily and payable
monthly, by applying the annual rate of 0.52% to the portion of the daily net
assets not exceeding $500 million and 0.495% to the portion of the daily net
assets in excess of $500 million.
Pursuant to an Administration Agreement with Morgan Stanley Services Company
Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Fund
pays an administration fee, accrued daily and payable monthly, by applying the
annual rate of 0.08% to the Fund's daily net assets.
3. Plan of Distribution
Shares of the Fund are distributed by Morgan Stanley Distributors Inc. (the
"Distributor"), an affiliate of the Investment Adviser and Administrator. The
Fund has adopted a Plan of Distribution (the "Plan") pursuant to Rule 12b-1
under the Act. The Plan provides that the Fund will pay the Distributor a fee
which is accrued daily and paid monthly at the following annual rates: (i) Class
A -- up to 0.25% of the average daily net assets of Class A; (ii) Class B -- up
to 1.0% of the average daily net assets of Class B; and (iii) Class C -- up to
1.0% of the average daily net assets of Class C.
In the case of Class B shares, provided that the Plan continues in effect, any
cumulative expenses incurred by the Distributor but not yet recovered may be
recovered through the payment of future distribution fees from the Fund pursuant
to the Plan and contingent deferred sales charges paid by investors upon
redemption of Class B shares. Although there is no legal obligation for the Fund
to
30
Morgan Stanley Balanced Income Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2005 (UNAUDITED) continued
pay expenses incurred in excess of payments made to the Distributor under the
Plan and the proceeds of contingent deferred sales charges paid by investors
upon redemption of shares, if for any reason the Plan is terminated, the
Trustees will consider at that time the manner in which to treat such expenses.
The Distributor has advised the Fund that such excess amounts totaled $6,642,327
at July 31, 2005.
In the case of Class A shares and Class C shares, expenses incurred pursuant to
the Plan in any calendar year in excess of 0.25% or 1.0% of the average daily
net assets of Class A or Class C, respectively, will not be reimbursed by the
Fund through payments in any subsequent year, except that expenses representing
a gross sales credit to Morgan Stanley Financial Advisors or other selected
broker-dealer representatives may be reimbursed in the subsequent calendar year.
For the six months ended July 31, 2005, the distribution fee was accrued for
Class A shares and Class C shares at the annual rate of 0.25% and 1.0%,
respectively.
The Distributor has informed the Fund that for the six months ended July 31,
2005, it received contingent deferred sales charges from certain redemptions of
the Fund's Class B shares and Class C shares of $100,311 and $2,561,
respectively and received $34,539 in front-end sales charges from sales of the
Fund's Class A shares. The respective shareholders pay such charges which are
not an expense of the Fund.
4. Security Transactions and Transactions with Affiliates
The cost of purchases and proceeds from sales/prepayments of portfolio
securities, excluding short-term investments, for the six months ended July 31,
2005, aggregated $81,076,073 and $97,079,006, respectively. Included in the
aforementioned are purchases and sales/prepayments of U.S. Government securities
of $54,117,784 and $65,293,871 respectively.
Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and
Distributor, is the Fund's transfer agent. At July 31, 2005, the Fund had
transfer agent fees and expenses payable of approximately $3,200.
The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan")
which allows each independent Trustee to defer payment of all, or a portion, of
the fees he receives for serving on the Board of Trustees. Each eligible Trustee
generally may elect to have the deferred amounts credited with a return equal to
the total return on one or more of the Morgan Stanley funds that are offered as
investment options under the Compensation Plan. Appreciation/depreciation and
distributions received from these investments are recorded with an offsetting
increase/decrease in the deferred compensation obligation and do not affect the
net asset value of the Fund.
31
Morgan Stanley Balanced Income Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2005 (UNAUDITED) continued
5. Shares of Beneficial Interest
Transactions in shares of beneficial interest were as follows:
<Table>
<Caption>
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
JULY 31, 2005 JANUARY 31, 2005
------------------------- -------------------------
(unaudited)
SHARES AMOUNT SHARES AMOUNT
---------- ------------ ---------- ------------
CLASS A SHARES
Sold.............................................. 109,795 $ 1,438,529 317,691 $ 3,989,301
Conversion from Class B........................... 1,134,150 14,717,231 -- --
Reinvestment of dividends and distributions....... 11,858 155,484 13,948 177,229
Redeemed.......................................... (287,681) (3,775,079) (259,961) (3,278,960)
---------- ------------ ---------- ------------
Net increase - Class A............................ 968,122 12,536,165 71,678 887,570
---------- ------------ ---------- ------------
CLASS B SHARES
Sold.............................................. 549,509 7,151,944 2,120,892 26,772,710
Conversion to Class A............................. (1,138,594) (14,717,231) -- --
Reinvestment of dividends and distributions....... 71,039 922,613 185,091 2,343,526
Redeemed.......................................... (1,730,989 (22,543,214) (4,500,852) (56,690,252)
---------- ------------ ---------- ------------
Net decrease - Class B............................ (2,249,035) (29,185,888) (2,194,869) (27,574,016)
---------- ------------ ---------- ------------
CLASS C SHARES
Sold.............................................. 188,797 2,462,832 491,664 6,201,714
Reinvestment of dividends and distributions....... 27,498 357,577 55,409 702,690
Redeemed.......................................... (327,788) (4,273,047) (617,049) (7,782,752)
---------- ------------ ---------- ------------
Net decrease - Class C............................ (111,493) (1,452,638) (69,976) (878,348)
---------- ------------ ---------- ------------
CLASS D SHARES
Sold.............................................. 15,403 201,773 24,387 310,527
Reinvestment of dividends and distributions....... 1,192 15,441 3,852 48,712
Redeemed.......................................... (63,853) (837,213) (122,109) (1,541,405)
---------- ------------ ---------- ------------
Net decrease - Class D............................ (47,258) (619,999) (93,870) (1,182,166)
---------- ------------ ---------- ------------
Net decrease in Fund.............................. (1,439,664) $(18,722,360) (2,287,037) $(28,746,960)
========== ============ ========== ============
</Table>
6. Federal Income Tax Status
The amount of dividends and distributions from net investment income and net
realized capital gains are determined in accordance with federal income tax
regulations which may differ from generally accepted accounting principles.
These "book/tax" differences are either considered temporary or permanent in
nature. To the extent these differences are permanent in nature, such amounts
are reclassified within the capital accounts based on their federal tax-basis
treatment; temporary differences do not require reclassification. Dividends and
distributions which exceed net investment income and net realized capital gains
for tax purposes are reported as distributions of paid-in-capital.
32
Morgan Stanley Balanced Income Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2005 (UNAUDITED) continued
The Investment Adviser has determined that a portion of the ordinary income
dividends paid in June will be recharacterized as additional long-term capital
gain distributions. This change is reflected throughout these financial
statements.
As of January 31, 2005, the Fund had temporary book/tax differences primarily
attributable to capital loss deferrals on wash sales, mark-to-market of open
futures contracts, capital loss deferrals on straddles and book amortization of
premiums on debt securities.
7. Purposes of and Risks Relating to Certain Financial Instruments
The Fund may invest in futures with respect to financial instruments and
interest rate indexes ("futures contracts").
These future contracts involve elements of market risk in excess of the amount
reflected in the Statement of Assets and Liabilities. The Fund bears the risk of
an unfavorable change in the value of the underlying securities. Risk may also
rise from the potential inability of counterparties to meet the terms of their
contracts.
8. Legal Matters
The Investment Adviser, certain affiliates of the Investment Adviser, certain
officers of such affiliates and certain investment companies advised by the
Investment Adviser or its affiliates, including the Fund, are named as
defendants in a consolidated class action. This consolidated action also names
as defendants certain individual Trustees and Directors of the Morgan Stanley
funds. The consolidated amended complaint, filed in the United States District
Court Southern District of New York on April 16, 2004, generally alleges that
defendants, including the Fund, violated their statutory disclosure obligations
and fiduciary duties by failing properly to disclose (i) that the Investment
Adviser and certain affiliates of the Investment Adviser allegedly offered
economic incentives to brokers and others to recommend the funds advised by the
Investment Adviser or its affiliates to investors rather than funds managed by
other companies, and (ii) that the funds advised by the Investment Adviser or
its affiliates, including the Fund, allegedly paid excessive commissions to
brokers in return for their efforts to recommend these funds to investors. The
complaint seeks, among other things, unspecified compensatory damages,
rescissionary damages, fees and costs. The defendants have moved to dismiss the
action and intend to otherwise vigorously defend it. On March 10, 2005,
Plaintiffs sought leave to supplement their complaint to assert claims on behalf
of other investors. While the Fund and Adviser believe that each has meritorious
defenses, the ultimate outcome of this matter is not presently determinable at
this early stage of the litigation, and no provision has been made in the Fund's
financial statements for the effect, if any, of this matter.
33
Morgan Stanley Balanced Income Fund
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED JANUARY 31,
MONTHS ENDED ------------------------------------------------------------------
JULY 31, 2005 2005 2004 2003 2002 2001
------------- ------ ------ ------ ------ ------
(unaudited)
Class A Shares:
Selected Per Share Data:
Net asset value, beginning of
period............................... $12.98 $12.66 $11.45 $12.35 $12.42 $11.80
------ ------ ------ ------ ------ ------
Income (loss) from investment
operations:
Net investment income++........... 0.17 0.30 0.26 0.33 0.43 0.47
Net realized and unrealized gain
(loss)............................ 0.28 0.39 1.28 (0.84) (0.06) 0.94
------ ------ ------ ------ ------ ------
Total income (loss) from investment
operations........................... 0.45 0.69 1.54 (0.51) 0.37 1.41
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income............. (0.10) (0.37) (0.33) (0.39) (0.44) (0.47)
Net realized gain................. (0.08) -- -- -- -- (0.32)
------ ------ ------ ------ ------ ------
Total dividends and distributions..... (0.18) (0.37) (0.33) (0.39) (0.44) (0.79)
------ ------ ------ ------ ------ ------
Net asset value, end of period........ $13.25 $12.98 $12.66 $11.45 $12.35 $12.42
====== ====== ====== ====== ====== ======
Total Return+......................... 3.53%(1) 5.55% 13.65% (4.19)% 3.13% 12.66%
Ratios to Average Net Assets(3):
Expenses.............................. 1.14%(2) 1.08% 1.09% 1.08% 1.16% 1.20%
Net investment income................. 2.53%(2) 2.39% 2.15% 2.79% 3.44% 3.97%
Supplemental Data:
Net assets, end of period, in
thousands............................ $21,431 $8,434 $7,318 $3,125 $2,216 $2,043
Portfolio turnover rate............... 43%(1) 89% 174% 173% 99% 21%
</Table>
- ---------------------
<Table>
++ The per share amounts were computed using an average number
of shares outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated
based on the net asset value as of the last business day of
the period.
(1) Not annualized.
(2) Annualized.
(3) Reflects overall Fund ratios for investment income and
non-class specific expenses.
</Table>
34
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
FINANCIAL HIGHLIGHTS continued
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED JANUARY 31,
MONTHS ENDED ---------------------------------------------------
JULY 31, 2005 2005 2004 2003 2002 2001
------------- -------- -------- -------- -------- -------
(unaudited)
Class B Shares:
Selected Per Share Data:
Net asset value, beginning of period........ $12.93 $12.61 $11.40 $12.31 $12.39 $11.77
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income++................. 0.12 0.20 0.17 0.24 0.34 0.37
Net realized and unrealized gain
(loss).................................. 0.27 0.39 1.28 (0.85) (0.07) 0.95
------ ------ ------ ------ ------ ------
Total income (loss) from investment
operations................................. 0.39 0.59 1.45 (0.61) 0.27 1.32
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income................... (0.05) (0.27) (0.24) (0.30) (0.35) (0.38)
Net realized gain....................... (0.08) -- -- -- -- (0.32)
------ ------ ------ ------ ------ ------
Total dividends and distributions........... (0.13) (0.27) (0.24) (0.30) (0.35) (0.70)
------ ------ ------ ------ ------ ------
Net asset value, end of period.............. $13.19 $12.93 $12.61 $11.40 $12.31 $12.39
====== ====== ====== ====== ====== ======
Total Return+............................... 3.05%(1) 4.83% 12.77% (4.98)% 2.32% 11.82%
Ratios to Average Net Assets(3):
Expenses.................................... 1.89%(2) 1.84% 1.86% 1.84% 1.91% 2.00%
Net investment income....................... 1.78%(2) 1.63% 1.38% 2.03% 2.68% 3.17%
Supplemental Data:
Net assets, end of period, in thousands..... $118,388 $145,072 $169,135 $135,146 $101,957 $45,803
Portfolio turnover rate..................... 43%(1) 89% 174% 173% 99% 21%
</Table>
- ---------------------
<Table>
++ The per share amounts were computed using an average number
of shares outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated
based on the net asset value as of the last business day of
the period.
(1) Not annualized.
(2) Annualized.
(3) Reflects overall Fund ratios for investment income and
non-class specific expenses.
</Table>
35
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
FINANCIAL HIGHLIGHTS continued
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED JANUARY 31,
MONTHS ENDED -----------------------------------------------
JULY 31, 2005 2005 2004 2003 2002 2001
------------- ------- ------- ------- ------- -------
(unaudited)
Class C Shares:
Selected Per Share Data:
Net asset value, beginning of period............ $12.95 $12.63 $11.42 $12.33 $12.41 $11.78
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income++..................... 0.12 0.21 0.17 0.24 0.33 0.38
Net realized and unrealized gain (loss)..... 0.28 0.38 1.28 (0.85) (0.05) 0.95
------ ------ ------ ------ ------ ------
Total income (loss) from investment
operations..................................... 0.40 0.59 1.45 (0.61) 0.28 1.33
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income....................... (0.06) (0.27) (0.24) (0.30) (0.36) (0.38)
Net realized gain........................... (0.08) -- -- -- -- (0.32)
------ ------ ------ ------ ------ ------
Total dividends and distributions............... (0.14) (0.27) (0.24) (0.30) (0.36) (0.70)
------ ------ ------ ------ ------ ------
Net asset value, end of period.................. $13.21 $12.95 $12.63 $11.42 $12.33 $12.41
====== ====== ====== ====== ====== ======
Total Return+................................... 3.13%(1) 4.84% 12.74% (5.00)% 2.32% 11.89%
Ratios to Average Net Assets(3):
Expenses........................................ 1.89%(2) 1.77% 1.85% 1.84% 1.91% 1.94%
Net investment income........................... 1.78%(2) 1.70% 1.39% 2.03% 2.68% 3.23%
Supplemental Data:
Net assets, end of period, in thousands......... $42,689 $43,308 $43,092 $32,439 $33,321 $24,205
Portfolio turnover rate......................... 43%(1) 89% 174% 173% 99% 21%
</Table>
- ---------------------
<Table>
++ The per share amounts were computed using an average number
of shares outstanding during the period.
+ Does not reflect the deduction of sales charge. Calculated
based on the net asset value as of the last business day of
the period.
(1) Not annualized.
(2) Annualized.
(3) Reflects overall Fund ratios for investment income and
non-class specific expenses.
</Table>
36
See Notes to Financial Statements
Morgan Stanley Balanced Income Fund
FINANCIAL HIGHLIGHTS continued
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED JANUARY 31
MONTHS ENDED ------------------------------------------------------------------
JULY 31, 2005 2005 2004 2003 2002 2001
------------- ------ ------ ------ ------ ------
(unaudited)
Class D Shares:
Selected Per Share Data:
Net asset value, beginning of
period............................... $12.95 $12.63 $11.42 $12.33 $12.40 $11.79
------ ------ ------ ------ ------ ------
Income (loss) from investment
operations:
Net investment income++........... 0.18 0.33 0.29 0.34 0.45 0.50
Net realized and unrealized gain
(loss)............................ 0.28 0.39 1.28 (0.83) (0.05) 0.93
------ ------ ------ ------ ------ ------
Total income (loss) from investment
operations........................... 0.46 0.72 1.57 (0.49) 0.40 1.43
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income............. (0.12) (0.40) (0.36) (0.42) (0.47) (0.50)
Net realized gain................. (0.08) -- -- -- -- (0.32)
------ ------ ------ ------ ------ ------
Total dividends and distributions..... (0.20) (0.40) (0.36) (0.42) (0.47) (0.82)
------ ------ ------ ------ ------ ------
Net asset value, end of period........ $13.21 $12.95 $12.63 $11.42 $12.33 $12.40
====== ====== ====== ====== ====== ======
Total Return+......................... 3.57%(1) 5.80% 13.94% (4.04)% 3.37% 12.88%
Ratios to Average Net Assets(3):
Expenses.............................. 0.89%(2) 0.84% 0.86% 0.84% 0.91% 1.00%
Net investment income................. 2.78%(2) 2.63% 2.38% 3.03% 3.68% 4.17%
Supplemental Data:
Net assets, end of period, in
thousands............................ $1,310 $1,895 $3,034 $1,476 $ 496 $ 107
Portfolio turnover rate............... 43%(1) 89% 174% 173% 99% 21%
</Table>
- ---------------------
<Table>
++ The per share amounts were computed using an average number
of shares outstanding during the period.
+ Calculated based on the net asset value as of the last
business day of the period.
(1) Not annualized.
(2) Annualized.
(3) Reflects overall Fund ratios for investment income and
non-class specific expenses.
</Table>
37
See Notes to Financial Statements
(This Page Intentionally Left Blank)
(This Page Intentionally Left Blank)
TRUSTEES
Michael Bozic
Charles A. Fiumefreddo
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Joseph J. Kearns
Michael E. Nugent
Fergus Reid
OFFICERS
Charles A. Fiumefreddo
Chairman of the Board
Mitchell M. Merin
President
Ronald E. Robison
Executive Vice President and Principal Executive Officer
Joseph J. McAlinden
Vice President
Barry Fink
Vice President
Amy R. Doberman
Vice President
Carsten Otto
Chief Compliance Officer
Stefanie V. Chang
Vice President
Francis J. Smith
Treasurer and Chief Financial Officer
Thomas F. Caloia
Vice President
Mary E. Mullin
Secretary
TRANSFER AGENT
Morgan Stanley Trust
Harborside Financial Center, Plaza Two
Jersey City, New Jersey 07311
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
Two World Financial Center
New York, New York 10281
INVESTMENT ADVISER
Morgan Stanley Investment Advisors Inc.
1221 Avenue of the Americas
New York, New York 10020
The financial statements included herein have been taken from the records of the
Fund without examination by the independent auditors and accordingly they do not
express an opinion thereon.
This report is submitted for the general information of the shareholders of the
Fund. For more detailed information about the Fund, its fees and expenses and
other pertinent information, please read its Prospectus. The Fund's Statement of
Additional Information contains additional information about the Fund, including
its trustees. It is available, without charge, by calling (800) 869-NEWS.
This report is not authorized for distribution to prospective investors in the
Fund unless preceded or accompanied by an effective Prospectus. Read the
Prospectus carefully before investing.
Investments and services offered through Morgan Stanley DW Inc., member SIPC.
Morgan Stanley Distributors Inc., member NASD.
(c) 2005 Morgan Stanley
[MORGAN STANLEY LOGO]
MORGAN STANLEY FUNDS
Morgan Stanley
Balanced Income Fund
Semiannual Report
July 31, 2005
[MORGAN STANLEY LOGO]
38400RPT-RA05-00746P-Y07/05
Item 2. Code of Ethics.
Not applicable for semiannual reports.
Item 3. Audit Committee Financial Expert.
Not applicable for semiannual reports.
Item 4. Principal Accountant Fees and Services
Not applicable for semiannual reports.
Item 5. Audit Committee of Listed Registrants.
Not applicable for semiannual reports.
Item 6.
Refer to Item 1.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies.
Not applicable for semiannual reports.
Item 8. Portfolio Managers of Closed-End Management Investment Companies
Applicable only to reports filed by closed-end funds.
Item 9. Closed-End Fund Repurchases
Applicable to reports filed by closed-end funds.
Item 10. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 11. Controls and Procedures
(a) The Fund's principal executive officer and principal financial officer have
concluded that the Fund's disclosure controls and procedures are sufficient to
ensure that information required to be disclosed by the Fund 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) Code of Ethics - Not applicable for semiannual reports.
(b) A separate certification for each principal executive officer and principal
financial officer of the registrant are attached hereto as part of EX-99.CERT.
2
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and
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 Balanced Income Fund
/s/ Ronald E. Robison
Ronald E. Robison
Principal Executive Officer
September 20, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934 and
the Investment Company Act of 1940, this report has been signed by the following
persons on behalf of the registrant and in the capacities and on the dates
indicated.
/s/ Ronald E. Robison
Ronald E. Robison
Principal Executive Officer
September 20, 2005
/s/ Francis Smith
Francis Smith
Principal Financial Officer
September 20, 2005
3