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: 811-07245
Morgan Stanley Balanced 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, 2007
Date of reporting period: July 31, 2006
Item 1 - Report to Shareholders
Welcome, Shareholder:
In this report, you'll learn about how your investment in Morgan Stanley
Balanced Fund (formerly Morgan Stanley Balanced Growth 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.
* THE FUND'S NAME CHANGED EFFECTIVE SEPTEMBER 18, 2006.
FUND REPORT
For the six months ended July 31, 2006
TOTAL RETURN FOR THE SIX MONTHS ENDED JULY 31, 2006
<Table>
<Caption>
LIPPER
MIXED-
ASSET
LEHMAN TARGET
RUSSELL BROTHERS ALLOCATION LIPPER
1000(R) U.S. GROWTH BALANCED
VALUE GOVERNMENT/ FUNDS FUNDS
CLASS A CLASS B CLASS C CLASS D INDEX(1) CREDIT INDEX(2) INDEX(3) INDEX(4)
1.57% 1.23% 1.17% 1.69% 5.07% 0.32% 1.13% 0.33%
</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
The stock market produced flat results for the six-month period overall.
Although 2006 began with a strong market rally, rising uncertainties about
inflation and economic slowdown overshadowed the market's more positive
influences. Against a backdrop of spiking commodity prices, the Federal Open
Market Committee (the "Fed") target federal funds rate by 25 basis points at
each of its meetings during the first half of the year, bringing the target rate
to 5.25 percent at the end of June. With housing and consumer trends already
showing initial signs of deceleration, investors grew increasingly anxious about
the Fed's indications that additional rate increases were possible. (Note: In
August, after the close of the reporting period, the Fed paused its series of
interest rate increases for the first time since it began monetary tightening in
June 2004.) Although corporate profits had continued to be healthy for the most
part, corporate managements began to downgrade their business outlooks in light
of a potentially slowing economy. In May and June, stocks marked a level of
price volatility not seen in several years, leading to a stock market correction
that rippled across markets worldwide. By the end of the period, however, the
markets recovered some of their lost ground. Value stocks--in which the Fund
invests--fared better than the broad market, eking out a modest gain for the six
months overall.
In the bond market, the six-month period provided few surprises, as the market
widely anticipated most of the Fed's activity. Within the government sector,
U.S. Treasuries underperformed over the six-month period because of their high
sensitivity to fluctuating interest rates and their relatively low yields. Given
ongoing concerns over inflation and increased risk in the corporate market, the
credit sector had trouble keeping pace with other fixed-income sectors, and
posted its lowest six-month return since 1999. Within the investment-grade
portion of the sector, lower-rated issues (BBB- and A-rated) outpaced
higher-rated issues (AA-rated and above). Industrials posted the highest
returns, followed by utilities and financials. Overall, longer dated corporate
issues underperformed shorter-dated issues.
PERFORMANCE ANALYSIS
Morgan Stanley Balanced Fund underperformed the Russell 1000(R) Value Index, and
outperformed the Lehman Brothers U.S. Government/Credit Index, the Lipper
Mixed-Asset Target Allocation Growth Funds Index and the Lipper Balanced Funds
Index for the six
2
months ended July 31, 2006, assuming no deduction of applicable sales charges.
In the stock portion of the portfolio, the consumer discretionary sector drove
positive performance relative to the Russell 1000 Value Index, particularly in
our selection of retail and auto stocks. The Fund's basic materials exposure
also contributed positively to relative gains due to company specific events.
Another area of strength was the Fund's positioning in the technology sector.
Although the Fund's technology holdings had a negative return overall, our
investment process led us to avoid some of the broad market's weakest performing
hardware and equipment stocks.
In contrast, telecommunication services stocks detracted most from returns
relative to the Russell 1000 Value Index. After several years of declining
performance, the telecommunication services sector began to show signs of
progress during the period. However, our selections did not perform as well as
those stocks that led the sector's turnaround. Although the financials sector
produced a positive return on an absolute basis, stock selection and an
underweight allocation caused the Fund's performance to lag that of the
benchmark sector, largely due to the Fund's lack of exposure to real estate
investment trusts and minimal exposure to regional banks. In the consumer
staples sector, stock selection in the food and staples retailing and beverage
and tobacco industries proved disadvantageous.
Within the Fund's fixed income investments, we kept the Fund's overall duration*
well below that of the Lehman Brothers U.S. Government/Credit Index during the
period. This posture was beneficial to the Fund's performance as interest rates
rose across the market, especially in the short- and intermediate-portions of
the yield curve. Our focus on higher-coupon mortgage-backed securities with slow
prepayments also added to performance, particularly in the second half of the
period when higher-coupon issues outperformed low-coupon issues. Gains from
these securities were partially offset, however, by a large underweight in
lower- and current-coupon issues, which outperformed during the first half of
the period. Within the credit section of the portfolio, we employed a defensive
strategy with a focus on higher-quality securities, which enhanced relative
performance, as did our strong security selection.
During the period, we maintained the Fund's asset allocation as a mixture of
equity and fixed income. As of the end of the reporting period, the Fund held 67
percent in stocks and 33 percent in bonds.
There is no guarantee that any sectors mentioned will continue to perform as
discussed herein or that securities in such sectors will be held by the Fund in
the future.
- ----------------------------------------------------
* A measure of the sensitivity of a bond's price to changes in interest rates,
expressed in years. Each year of duration represents an expected 1 percent
change in the price of a bond for every 1 percent change in interest rates. The
longer a bond's duration, the greater the effect of interest rate movements on
its price. Typically, funds with shorter durations perform better in rising
interest-rate environments, while funds with longer durations perform better
when rates decline.
3
<Table>
<Caption>
TOP 10 HOLDINGS
U.S. Treasury Securities 10.1%
Fed. Natl. Mtge. Assoc. 7.1
JPMorgan Chase & Co. 2.5
Bayer AG (ADR) (Germany) 2.2
Citigroup, Inc. 2.1
General Electric Co. 1.8
Merrill Lynch & Co., Inc. 1.7
Time Warner, Inc. 1.6
Roche Holdings Ltd. (ADR) (Switzerland) 1.6
Bristol-Meyers Squibb Co. 1.6
</Table>
<Table>
<Caption>
PORTFOLIO COMPOSITION*
Common Stocks 67.1%
U.S. Government Agencies & Obligations 17.1
Corporate Bonds 6.8
Asset-Backed Securities 5.5
Short-Term Investments 3.5
Put Option Purchased 0.0
</Table>
* Does not include open long futures contracts with an underlying face value of
$8,397,312 and unrealized appreciation of $82,463 and open short futures
contracts with an underlying face value of $9,624,969, and unrealized
depreciation of $60,225.
Data as of July 31, 2006. 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 60 PERCENT OF ITS ASSETS IN DIVIDEND
PAYING COMMON STOCKS AND SECURITIES CONVERTIBLE INTO COMMON STOCKS AND AT LEAST
25 PERCENT OF ITS ASSETS IN FIXED-INCOME SECURITIES. WITHIN THESE LIMITATIONS,
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. THE SEMIANNUAL REPORTS AND THE ANNUAL REPORTS ARE
FILED ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC) ON FORM
N-CSRS AND FORM N-CSR, RESPECTIVELY. 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
4
MATERIALS, UPON PAYMENT OF 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
WITHOUT CHARGE 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, 2006
<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 BGRAX BGRBX BGRCX BGRDX
1 YEAR 6.27%(5) 5.43%(5) 5.45%(5) 6.45%(5)
0.69(6) 0.49(6) 4.46(6) --
5 YEARS 4.52(5) 3.72(5) 3.71(5) 4.76(5)
3.40(6) 3.37(6) 3.71(6) --
10 YEARS -- -- 7.53(5) --
-- -- 7.53(6) --
SINCE INCEPTION 6.14(5) 5.33(5) 8.57(5) 6.38(5)
5.51(6) 5.33(6) 8.57(6) --
</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 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 1.0% for shares
redeemed within one year of purchase.
++ Class D has no sales charge.
(1) 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.
(2) 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.
(3) The Lipper Mixed-Asset Target Allocation Growth Funds Index is an
equally-weighted performance index of the largest qualifying funds (based
on net assets) in the Lipper Mixed-Asset Target Allocation Growth 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 10 funds represented in this
Index. The Fund is in the Lipper Mixed-Asset Target Allocation Growth Funds
classification as of 7/31/2006.
(4) The Lipper Balanced Funds Index is an equally-weighted performance index of
the largest qualifying funds (based on net assets) in the Lipper Balanced
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.
(5) Figure shown assumes reinvestment of all distributions and does not reflect
the deduction of any sales charges.
(6) 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 02/01/06 - 07/31/06.
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 *
------------- ------------- ---------------
02/01/06 -
02/01/06 07/31/06 07/31/06
------------- ------------- ---------------
CLASS A
Actual (1.57% return)....................................... $1,000.00 $1,015.70 $ 6.55
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,018.30 $ 6.56
CLASS B
Actual (1.23% return)....................................... $1,000.00 $1,012.30 $10.28
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,014.58 $10.29
CLASS C
Actual (1.17% return)....................................... $1,000.00 $1,011.70 $10.28
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,014.58 $10.29
CLASS D
Actual (1.69% return)....................................... $1,000.00 $1,016.90 $ 5.30
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,019.54 $ 5.31
</Table>
- ------------------
* Expenses are equal to the Fund's annualized expense ratios of 1.31%, 2.06%,
2.06% and 1.06% for Class A, Class B, Class C and Class D shares,
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 at the Investment Adviser's
expense. (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 advisory and administrative 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
On a regular basis, the Board reviews the performance of all funds in the Morgan
Stanley Fund Complex, including the Fund, compared to their peers, paying
specific attention to the underperforming funds. In addition, the Board
specifically reviewed the Fund's performance for the one-, three- and five-year
periods ended November 30, 2005, as shown in a report provided by Lipper (the
"Lipper Report"), compared to the performance of comparable funds selected by
Lipper (the "performance peer group"). The Board also discussed with the Adviser
the performance goals and the actual results achieved in managing the Fund. The
Board concluded that the Fund's performance was competitive with that of its
performance peer group.
8
FEES RELATIVE TO OTHER PROPRIETARY FUNDS MANAGED BY THE ADVISER WITH COMPARABLE
INVESTMENT STRATEGIES
The Board reviewed the advisory and administrative fee (together, the
"management fee") rate paid by the Fund under the Management Agreement. The
Board noted that the management fee rate was comparable to the management fee
rates charged by the Adviser to other proprietary funds it manages with
investment strategies comparable to those of the Fund.
FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS
The Board reviewed the management fee rate and total expense ratio of the Fund
as compared to the average management fee rate and average total expense ratio
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. The Board concluded that the Fund's management fee rate 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 THE ADVISER AND AFFILIATES
The Board considered information concerning the costs incurred and profits
realized by the Adviser and affiliates during the last year from their
relationship with the Fund and during the last two years from their relationship
with the Morgan Stanley Fund Complex and reviewed with the Adviser the cost
allocation methodology used to determine the profitability of the Adviser and
affiliates. Based on its review of the information it received, the Board
concluded that the profits earned by the Adviser and 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
affiliates from their relationship with the Fund and the Morgan Stanley Fund
Complex, such as sales charges on sales of Class A shares and "float" benefits
derived from handling of checks for purchases and sales of Fund shares, through
a broker-dealer affiliate of the Adviser and "soft dollar" benefits (discussed
in the next section). The Board also
9
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 sold a joint venture that owned an electronic
trading system network ("ECN"), which may be used by the Adviser for trading on
behalf of the Fund. As part of the sale of the joint venture, the affiliate
receives a 10-year payout based on the revenue stream from trading on the ECN.
Although the affiliate disgorges the portion of the payout that is comprised of
commissions received from trades executed by the Adviser on the ECN to a
charitable organization, the Board considered the fact that trades by the
Adviser would increase order flow, and, thus, result in a potential fall-out
benefit to the affiliate. The Board concluded that the float benefits were
relatively small, the sales charges and 12b-1 fees were competitive with those
of other broker-dealers, the affiliate disgorged revenues in connection with the
ECN-related revenue and the potential fall-out benefit from increased order flow
was relatively small.
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
10
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
that it would be in the best interest of the Fund and its shareholders to
approve renewal of the Management Agreement for another year.
11
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2006 (UNAUDITED)
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- ----------------------------------------------------------------------------------------------------------
Common Stocks (68.4%)
Aerospace & Defense (1.5%)
20,390 Northrop Grumman Corp. ..................................................... $ 1,349,614
31,660 Raytheon Co. ............................................................... 1,426,916
--------------
2,776,530
--------------
Beverages: Alcoholic (0.7%)
16,980 Diageo PLC (ADR) (United Kingdom)........................................... 1,194,034
--------------
Beverages: Non-Alcoholic (1.2%)
48,490 Coca-Cola Co. (The)......................................................... 2,157,805
--------------
Broadcasting (1.4%)
87,280 Clear Channel Communications, Inc. ......................................... 2,526,756
--------------
Cable/Satellite TV (0.4%)
23,300 Comcast Corp. (Class A)*.................................................... 801,054
--------------
Chemicals: Major Diversified (3.0%)
81,220 Bayer AG (ADR) (Germany).................................................... 3,998,461
36,100 Du Pont (E.I.) de Nemours & Co. ............................................ 1,431,726
--------------
5,430,187
--------------
Computer Processing Hardware (0.2%)
12,102 Hewlett-Packard Co. ........................................................ 386,175
--------------
Department Stores (0.3%)
10,950 Kohl's Corp.*............................................................... 620,098
--------------
Discount Stores (1.0%)
41,740 Wal-Mart Stores, Inc. ...................................................... 1,857,430
--------------
Electric Utilities (2.6%)
34,610 American Electric Power Co., Inc. .......................................... 1,250,113
25,410 Entergy Corp. .............................................................. 1,959,111
26,710 FirstEnergy Corp. .......................................................... 1,495,760
--------------
4,704,984
--------------
Finance/Rental/Leasing (1.3%)
41,950 Freddie Mac................................................................. 2,427,227
--------------
</Table>
12
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- ----------------------------------------------------------------------------------------------------------
Financial Conglomerates (5.3%)
77,020 Citigroup, Inc. ............................................................ $ 3,720,836
98,564 JPMorgan Chase & Co. ....................................................... 4,496,490
24,110 State Street Corp. ......................................................... 1,448,047
--------------
9,665,373
--------------
Food Retail (0.3%)
8,050 Kroger Co. ................................................................. 184,586
4,500 Safeway Inc. ............................................................... 126,360
7,350 Supervalu, Inc. ............................................................ 199,259
--------------
510,205
--------------
Food: Major Diversified (1.3%)
22,500 ConAgra Foods Inc. ......................................................... 483,750
78,450 Unilever N.V. (NY Registered Shares) (Netherlands).......................... 1,857,696
--------------
2,341,446
--------------
Food: Specialty/Candy (0.7%)
34,100 Cadbury Schweppes PLC (ADR) (United Kingdom)................................ 1,338,766
--------------
Household/Personal Care (0.7%)
23,500 Procter & Gamble Co. (The).................................................. 1,320,700
--------------
Industrial Conglomerates (3.2%)
98,500 General Electric Co. ....................................................... 3,219,965
16,680 Ingersoll-Rand Co. Ltd. (Class A) (Bermuda)................................. 597,144
24,460 Siemens AG (ADR) (Germany).................................................. 1,974,656
--------------
5,791,765
--------------
Insurance Brokers/Services (1.3%)
84,390 Marsh & McLennan Companies, Inc. ........................................... 2,281,062
--------------
Integrated Oil (4.2%)
25,090 BP PLC (ADR) (United Kingdom)............................................... 1,819,527
40,110 ConocoPhillips.............................................................. 2,753,150
14,050 Exxon Mobil Corp. .......................................................... 951,747
29,670 Royal Dutch Shell PLC (ADR) (Class A) (United Kingdom)...................... 2,100,636
--------------
7,625,060
--------------
Investment Banks/Brokers (3.2%)
5,510 Goldman Sachs Group, Inc. (The)............................................. 841,652
41,510 Merrill Lynch & Co., Inc. .................................................. 3,022,758
121,210 Schwab (Charles) Corp. (The)................................................ 1,924,815
--------------
5,789,225
--------------
</Table>
13
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- ----------------------------------------------------------------------------------------------------------
Life/Health Insurance (0.3%)
32,770 Aegon N.V. (NY Registered Shares) (Netherlands)............................. $ 554,468
--------------
Major Banks (2.3%)
48,155 Bank of America Corp. ...................................................... 2,481,427
22,130 PNC Financial Services Group................................................ 1,567,689
--------------
4,049,116
--------------
Major Telecommunications (4.1%)
14,586 Embarq Corp. ............................................................... 660,016
57,660 France Telecom S.A. (ADR) (France).......................................... 1,339,442
136,166 Sprint Nextel Corp. ........................................................ 2,696,087
78,830 Verizon Communications, Inc. ............................................... 2,666,031
--------------
7,361,576
--------------
Managed Health Care (0.4%)
8,270 CIGNA Corp. ................................................................ 754,637
--------------
Media Conglomerates (3.5%)
63,330 Disney (Walt) Co. (The)..................................................... 1,880,268
179,300 Time Warner, Inc. .......................................................... 2,958,450
42,050 Viacom, Inc. (Class B)*..................................................... 1,465,443
--------------
6,304,161
--------------
Medical Specialties (0.3%)
19,570 Applera Corp. -- Applied Biosystems Group................................... 629,175
--------------
Motor Vehicles (0.7%)
38,460 Honda Motor Co., Ltd. (ADR) (Japan)......................................... 1,267,257
--------------
Multi-Line Insurance (0.7%)
15,220 Hartford Financial Services Group, Inc. (The)............................... 1,291,265
--------------
Oil Refining/Marketing (0.3%)
5,070 Marathon Oil Corp. ......................................................... 459,545
--------------
Oilfield Services/Equipment (0.8%)
21,630 Schlumberger Ltd. (Netherlands Antilles).................................... 1,445,966
--------------
Other Consumer Services (0.0%)
2,700 Block (H.&R.), Inc. ........................................................ 61,425
--------------
Packaged Software (1.4%)
140,980 Symantec Corp.*............................................................. 2,448,823
--------------
</Table>
14
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- ----------------------------------------------------------------------------------------------------------
Pharmaceuticals: Major (11.3%)
58,420 Abbott Laboratories......................................................... $ 2,790,723
117,800 Bristol-Myers Squibb Co. ................................................... 2,823,666
24,410 GlaxoSmithKline PLC (ADR) (United Kingdom).................................. 1,350,605
49,490 Lilly (Eli) & Co. .......................................................... 2,809,547
72,600 Pfizer, Inc. ............................................................... 1,886,874
32,460 Roche Holdings Ltd. (ADR) (Switzerland)..................................... 2,884,071
22,680 Sanofi-Aventis (ADR) (France)............................................... 1,074,805
136,570 Schering-Plough Corp. ...................................................... 2,791,491
39,480 Wyeth....................................................................... 1,913,596
--------------
20,325,378
--------------
Precious Metals (0.9%)
31,230 Newmont Mining Corp. ....................................................... 1,599,913
--------------
Property -- Casualty Insurers (3.2%)
3,480 ACE Ltd. (Cayman Islands)................................................... 179,324
38,600 Chubb Corp. (The)........................................................... 1,946,212
55,158 St. Paul Travelers Companies, Inc. (The).................................... 2,526,236
17,310 XL Capital Ltd. (Class A) (Cayman Islands).................................. 1,102,647
--------------
5,754,419
--------------
Regional Banks (0.5%)
25,900 Fifth Third Bancorp......................................................... 987,826
--------------
Restaurants (0.4%)
19,250 McDonald's Corp. ........................................................... 681,257
--------------
Semiconductors (1.3%)
65,108 Intel Corp. ................................................................ 1,171,944
72,170 Micron Technology, Inc.*.................................................... 1,125,130
--------------
2,297,074
--------------
Specialty Insurance (0.7%)
12,710 MGIC Investment Corp. ...................................................... 723,326
10,500 PMI Group, Inc. (The)....................................................... 445,830
--------------
1,169,156
--------------
Specialty Stores (0.3%)
15,050 Office Depot, Inc.*......................................................... 542,553
--------------
Telecommunication Equipment (0.4%)
33,460 Motorola, Inc. ............................................................. 761,550
--------------
</Table>
15
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- ----------------------------------------------------------------------------------------------------------
Tobacco (0.8%)
19,040 Altria Group, Inc. ......................................................... $ 1,522,629
--------------
Total Common Stocks (Cost $103,280,527)..................................... 123,815,051
--------------
</Table>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE
- ---------- ------ ---------
Corporate Bonds (6.9%)
Advertising/Marketing Services (0.1%)
$ 105 WPP Finance (UK) Corp. (United Kingdom).................. 5.875% 06/15/14 102,932
------------
Aerospace & Defense (0.2%)
105 Northrop Grumman Corp. .................................. 4.079 11/16/06 104,550
80 Raytheon Co. ............................................ 6.15 11/01/08 81,135
201 Systems 2001 Asset Trust - 144A** (Cayman Islands)....... 6.664 09/15/13 208,396
------------
394,081
------------
Air Freight/Couriers (0.0%)
95 Fedex Corp. ............................................. 2.65 04/01/07 93,073
------------
Airlines (0.1%)
112 America West Airlines, Inc. (Series 01-1)................ 7.10 04/02/21 115,696
75 Southwest Airlines Co. (Series 01-1)..................... 5.496 11/01/06 75,051
------------
190,747
------------
Apparel/Footwear Retail (0.0%)
40 Limited Brands, Inc. .................................... 6.95 03/01/33 38,568
------------
Beverages: Alcoholic (0.2%)
150 FBG Finance Ltd. - 144A** (Australia).................... 5.125 06/15/15 139,561
150 Miller Brewing Co. - 144A**.............................. 4.25 08/15/08 146,119
------------
285,680
------------
Cable/Satellite TV (0.1%)
95 Comcast Cable Communications Inc. ....................... 6.75 01/30/11 98,744
20 Lenfest Communications, Inc. ............................ 7.625 02/15/08 20,545
80 TCI Communications, Inc. ................................ 7.875 02/15/26 86,538
------------
205,827
------------
Casino/Gaming (0.2%)
240 Harrah's Operating Co., Inc. ............................ 5.625 06/01/15 224,278
55 Harrah's Operating Co., Inc. ............................ 6.50 06/01/16 54,232
------------
278,510
------------
</Table>
16
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
Chemicals: Major Diversified (0.0%)
$ 70 ICI Wilmington Inc. ..................................... 4.375% 12/01/08 $ 67,953
------------
Computer Processing Hardware (0.1%)
95 Hewlett-Packard Co. ..................................... 5.339+ 05/22/09 95,122
------------
Containers/Packaging (0.0%)
85 Sealed Air Corp. - 144A**................................ 5.625 07/15/13 82,298
------------
Electric Utilities (0.9%)
150 Ameren Corp. ............................................ 4.263 05/15/07 148,481
145 Arizona Public Service Co. .............................. 5.80 06/30/14 141,726
45 Arizona Public Service Co. .............................. 6.75 11/15/06 45,138
150 Carolina Power & Light Co. .............................. 5.125 09/15/13 144,628
160 CC Funding Trust I....................................... 6.90 02/16/07 160,994
70 Cincinnati Gas & Electric Co. ........................... 5.70 09/15/12 69,235
80 Consolidated Natural Gas Co. ............................ 5.00 12/01/14 74,244
130 Consolidated Natural Gas Co. (Series C).................. 6.25 11/01/11 132,411
85 Consumers Energy Co. .................................... 4.80 02/17/09 83,215
70 Detroit Edison Co. (The)................................. 6.125 10/01/10 71,310
55 Entergy Gulf States, Inc. ............................... 3.60 06/01/08 52,860
90 Entergy Gulf States, Inc. ............................... 5.631+ 12/01/09 89,183
140 Ohio Power Company - IBC (Series K)...................... 6.00 06/01/16 140,254
30 Panhandle Eastern Pipe Line Co. (Series B)............... 2.75 03/15/07 29,459
100 Public Service Electric & Gas Co. (Series MTNB).......... 5.00 01/01/13 96,414
75 Texas Eastern Transmission, LP........................... 7.00 07/15/32 80,806
110 Wisconsin Electric Power Co. ............................ 3.50 12/01/07 107,293
------------
1,667,651
------------
Electrical Products (0.1%)
125 Cooper Industries, Inc. ................................. 5.25 07/01/07 124,136
135 Cooper Industries, Inc. ................................. 5.25 11/15/12 132,159
------------
256,295
------------
Electronics/Appliances (0.1%)
100 LG Electronics Inc. - 144A** (South Korea)............... 5.00 06/17/10 95,729
------------
</Table>
17
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
Finance/Rental/Leasing (0.6%)
$ 100 CIT Group, Inc. ......................................... 2.875% 09/29/06 $ 99,603
50 CIT Group, Inc. ......................................... 7.375 04/02/07 50,612
210 Countrywide Home Loans, Inc. (Series MTN)................ 3.25 05/21/08 202,080
180 MBNA Corp. .............................................. 5.58+ 05/05/08 181,409
200 Nationwide Building Society - 144A** (United Kingdom).... 4.25 02/01/10 191,995
275 Residential Capital Corp. ............................... 6.375 06/30/10 274,308
105 SLM Corp. ............................................... 4.00 01/15/10 100,010
------------
1,100,017
------------
Financial Conglomerates (0.5%)
500 Associates Corp. of North America........................ 6.25 11/01/08 508,399
55 Bank One Corp. (Series MTNA)............................. 6.00 02/17/09 55,690
170 Chase Manhattan Corp. ................................... 6.00 02/15/09 171,888
10 Chase Manhattan Corp. ................................... 7.00 11/15/09 10,427
100 CIT Group Inc. (Series MTN).............................. 4.75 08/15/08 98,644
100 General Electric Capital Corp. .......................... 4.25 12/01/10 95,661
------------
940,709
------------
Food Retail (0.1%)
120 Fred Meyer, Inc. ........................................ 7.45 03/01/08 123,119
------------
Food: Major Diversified (0.1%)
70 ConAgra Foods, Inc. ..................................... 7.00 10/01/28 72,357
65 ConAgra Foods, Inc. ..................................... 8.25 09/15/30 76,480
------------
148,837
------------
Gas Distributors (0.1%)
90 NiSource Finance Corp. .................................. 5.764+ 11/23/09 90,210
90 Sempra Energy............................................ 4.621 05/17/07 89,363
------------
179,573
------------
Home Furnishings (0.0%)
85 Mohawk Industries, Inc. (Series D)....................... 7.20 04/15/12 88,284
------------
Hotels/Resorts/Cruiselines (0.1%)
120 Hyatt Equities LLC - 144A**.............................. 6.875 06/15/07 120,822
------------
Household/Personal Care (0.1%)
165 Clorox Co. (The)......................................... 5.444+ 12/14/07 165,288
------------
Industrial Conglomerates (0.1%)
95 Textron Financial Corp. ................................. 4.125 03/03/08 92,906
155 Textron Financial Corp. (Series MTN)..................... 5.125 02/03/11 152,433
------------
245,339
------------
</Table>
18
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
Insurance Brokers/Services (0.2%)
$ 355 Farmers Exchange Capital - 144A**........................ 7.05 % 07/15/28 $ 345,144
------------
Major Banks (0.1%)
50 Bank of New York Co., Inc. (The)......................... 5.20 07/01/07 49,837
65 HSBC Finance Corp. ...................................... 6.75 05/15/11 68,062
95 Popular North America Inc. (Series MTN).................. 5.65 04/15/09 94,764
------------
212,663
------------
Major Telecommunications (0.5%)
85 Deutsche Telekom International Finance Corp. BV 8.25+ 06/15/30 99,721
(Netherlands)..........................................
155 France Telecom S.A. (France)............................. 8.50+ 03/01/31 191,775
95 SBC Communications, Inc. ................................ 6.15 09/15/34 88,585
40 Sprint Capital Corp. .................................... 8.75 03/15/32 48,861
85 Telecom Italia Capital SA (Luxembourg)................... 4.00 11/15/08 81,960
125 Telecom Italia Capital SA (Luxembourg)................... 4.00 01/15/10 117,747
80 Telefonica Europe BV (Netherlands)....................... 8.25 09/15/30 92,856
100 Verizon New England Inc. ................................ 6.50 09/15/11 101,368
------------
822,873
------------
Managed Health Care (0.0%)
30 WellPoint Inc. .......................................... 3.75 12/14/07 29,288
------------
Media Conglomerates (0.1%)
60 News America Holdings, Inc. ............................. 7.75 02/01/24 64,312
20 News America Inc. ....................................... 7.125 04/08/28 20,273
30 News America, Inc. ...................................... 7.28 06/30/28 30,846
145 Viacom, Inc. - 144A**.................................... 6.875 04/30/36 139,488
------------
254,919
------------
Motor Vehicles (0.1%)
80 DaimlerChrysler North American Holdings Co. ............. 8.50 01/18/31 92,648
------------
Multi-Line Insurance (0.4%)
355 AIG Sun America Global Finance VI - 144A**............... 6.30 05/10/11 366,305
170 American General Finance Corp. (Series MTNH)............. 4.625 09/01/10 163,854
20 American General Finance Corp. (Series MTNI)............. 4.625 05/15/09 19,534
70 AXA Financial, Inc. ..................................... 6.50 04/01/08 70,835
55 International Lease Finance Corp. ....................... 3.75 08/01/07 53,986
------------
674,514
------------
Oil & Gas Pipelines (0.1%)
55 Kinder Morgan Energy Partners, L.P. ..................... 5.125 11/15/14 51,226
145 Plains All American Pipeline L.P. - 144A**............... 6.70 05/15/36 143,961
------------
195,187
------------
</Table>
19
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
Other Metals/Minerals (0.1%)
$ 145 Brascan Corp. (Canada)................................... 7.125% 06/15/12 $ 152,485
------------
Property - Casualty Insurers (0.4%)
200 Mantis Reef Ltd. - 144A** (Australia).................... 4.692 11/14/08 194,972
90 Platinum Underwriters Finance Inc. (Series B)............ 7.50 06/01/17 89,428
115 Platinum Underwriters Holdings, Ltd. (Series B) 6.371 11/16/07 114,107
(Bahamas)..............................................
155 St. Paul Travelers Companies, Inc. (The)................. 5.01 08/16/07 153,424
210 XLLIAC Global Funding - 144A**........................... 4.80 08/10/10 203,473
------------
755,404
------------
Pulp & Paper (0.0%)
65 Sappi Papier Holding AG - 144A** (Austria)............... 6.75 06/15/12 61,350
------------
Railroads (0.2%)
110 Burlington North Santa Fe Railway Co. ................... 6.125 03/15/09 111,685
85 Norfolk Southern Corp. .................................. 7.35 05/15/07 86,110
60 Union Pacific Corp. ..................................... 6.625 02/01/08 60,934
40 Union Pacific Corp. (Series MTNE)........................ 6.79 11/09/07 40,541
------------
299,270
------------
Real Estate Development (0.2%)
310 World Financial Properties - 144A**...................... 6.91 09/01/13 322,051
------------
Regional Banks (0.1%)
240 Marshall & Ilsley Bank (Series BKNT)..................... 3.80 02/08/08 234,101
------------
Restaurants (0.0%)
65 Tricon Global............................................ 8.875 04/15/11 72,870
------------
Savings Banks (0.4%)
85 Household Finance Corp. ................................. 4.125 12/15/08 82,568
105 Household Finance Corp. ................................. 5.875 02/01/09 106,080
65 Household Finance Corp. ................................. 6.375 10/15/11 67,114
95 Household Finance Corp. ................................. 6.40 06/17/08 96,574
100 Sovereign Bank (Series CD)............................... 4.00 02/01/08 97,562
95 Washington Mutual Bank................................... 5.50 01/15/13 93,210
115 Washington Mutual Inc. .................................. 8.25 04/01/10 124,036
------------
667,144
------------
Trucks/Construction/Farm Machinery (0.1%)
40 Caterpillar Financial Services Corp. (Series MTNF)....... 3.625 11/15/07 39,070
185 Caterpillar Financial Services Corp. (Series MTNF)....... 5.259+ 08/20/07 185,222
------------
224,292
------------
</Table>
20
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
Wireless Telecommunications (0.1%)
$ 150 Vodafone Group PLC (United Kingdom)...................... 5.59 %+ 12/28/07 $ 150,053
------------
Total Corporate Bonds (Cost $12,662,097)..................................... 12,532,710
------------
U.S. Government Obligations (10.0%)
U.S. Treasury Bonds
950 ......................................................... 6.125 08/15/29 1,073,723
225 ......................................................... 6.375 08/15/27 259,541
4,300 ......................................................... 7.625 02/15/25 5,543,642
3,705 ......................................................... 8.125 08/15/19 - 4,814,687
08/15/21
U.S. Treasury Notes
2,400 ......................................................... 3.875 02/15/13 2,260,406
3,255 ++....................................................... 4.25 08/15/13 3,125,276
1,100 ......................................................... 4.25 11/15/13 1,053,723
------------
Total U.S. Government Obligations (Cost $18,355,815)......................... 18,130,998
------------
Mortgage-Backed Securities (6.7%)
63 Federal Home Loan Mortgage Corp. Gold.................... 7.50 06/01/11 - 65,059
08/01/11
Federal National Mortgage Assoc.
576 ......................................................... 6.389 05/01/36 595,182
210 ......................................................... 6.50 07/01/32 212,974
1,723 ......................................................... 7.00 07/01/18 - 1,771,895
10/01/35
550 ......................................................... 7.00 ++ 563,578
1,037 ......................................................... 7.50 08/01/25 - 1,075,410
09/01/35
307 ......................................................... 8.00 05/01/24 - 324,710
02/01/32
15 ......................................................... 9.50 12/01/20 16,407
Federal National Mortgage Assoc. (ARM)
549 ......................................................... 1.354 07/01/36 566,895
213 ......................................................... 5.663 07/01/33 215,616
401 ......................................................... 5.358 07/01/36 414,318
652 ......................................................... 6.116 03/01/36 665,063
1,114 ......................................................... 6.164 01/01/36 1,146,349
1,149 ......................................................... 6.165 01/01/36 1,180,290
544 ......................................................... 6.17 03/01/36 559,436
726 ......................................................... 6.406 04/01/36 750,735
550 ......................................................... 6.489 05/01/36 568,306
1,140 ......................................................... 6.671 04/01/36 1,190,972
</Table>
21
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
$ 43 Federal National Mortgage Assoc. Dwarf................... 7.00 % 03/01/12 - $ 43,715
06/01/12
Government National Mortgage Assoc.
85 ......................................................... 7.50 09/15/25 - 88,926
06/15/27
93 ......................................................... 8.00 04/15/26 - 98,356
08/15/26
------------
Total Mortgage-Backed Securities (Cost $12,139,435).......................... 12,114,192
------------
Asset-Backed Securities (5.6%)
Finance/Rental/Leasing
300 American Express Credit Account Master Trust 2002-3 A.... 5.479+ 12/15/09 300,465
600 American Express Credit Account Master Trust 2003-3 A.... 5.479+ 11/15/10 601,407
350 Banc of America Securities Auto Trust 2005-WF1 A3........ 3.99 08/18/09 345,355
175 Capital Auto Receivables Asset Trust 2004-2 A............ 3.35 02/15/08 173,775
350 Capital Auto Receivables Asset Trust 2005-1 A4........... 4.05 07/15/09 345,752
300 Caterpillar Financial Asset Trust 2005-A A3.............. 3.90 02/25/09 296,483
375 Caterpillar Financial Asset Trust 2006-AA3............... 5.57 05/25/10 376,748
92 CIT Equipment Collateral 2004-EF1 A3..................... 3.50 09/20/08 90,810
225 CNH Equipment Trust 2005-A A3............................ 4.02 04/15/09 222,487
450 CNH Equipment Trust 2005-B A3............................ 4.27 01/15/10 442,406
275 DaimlerChrysler Auto Trust 2005-B A3..................... 4.04 09/08/09 271,952
225 Ford Credit Auto Owner Trust 2005-B A3................... 4.17 01/15/09 223,190
225 Ford Credit Auto Owner Trust 2006-A A3................... 5.05 03/15/10 223,871
375 GE Equipment Small Ticket LLC - 2005-2A A3............... 4.88 10/22/09 372,461
250 GS Auto Loan Trust 2006-1 AB............................. 5.37 12/15/10 249,980
400 Harley-Davidson Motorcycle Trust 2005-1 A2............... 3.76 12/17/12 391,573
250 Harley-Davidson Motorcycle Trust 2005-2 A2............... 4.07 02/15/12 243,948
150 Harley Davidson Motorcycle Trust 2005-3 A2............... 4.41 06/15/12 147,631
225 Hertz Vehicle Financing LLC 2005-2A A2................... 4.93 02/25/10 222,380
200 Honda Auto Receivables Owner Trust 2005-2 A3............. 3.93 01/15/09 197,830
325 Honda Auto Receivables Owner Trust 2005-3 A3............. 3.87 04/20/09 320,232
300 Honda Auto Receivables Owner Trust 2005-6 A3............. 4.85 10/19/09 298,032
225 Hyundai Auto Receivables Trust 2005-A A3................. 3.98 11/16/09 221,218
150 MBNA Master Credit Card Trust 1999-B A................... 5.90 08/15/11 152,394
400 Merrill Auto Trust Securitization 2005-1 A3.............. 4.10 08/25/09 394,721
275 National City Auto Receivables Trust 2004-A A4........... 2.88 05/15/11 267,183
400 Nissan Auto Receivables Owner Trust 2005-B A3............ 3.99 07/15/09 395,022
75 TXU Electric Delivery Transition Bond Co. LLC 2004-1 4.81 11/17/14 72,705
A2.....................................................
450 USAA Auto Owner Trust 2004-2 A4.......................... 3.58 02/15/11 441,428
287 USAA Auto Owner Trust 2004-3 A3.......................... 3.16 02/17/09 283,582
269 USAA Auto Owner Trust 2005-1 A3.......................... 3.90 07/15/09 266,626
250 Volkswagen Auto Lease Trust 2005-A A3.................... 3.82 05/20/08 248,329
</Table>
22
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
$ 375 Volkswagen Auto Loan Enhanced Trust 2005-1 A3............ 4.80 % 07/20/09 $ 372,496
98 Wachovia Auto Owner Trust 2004-B A3...................... 2.91 04/20/09 97,203
200 Wachovia Auto Owner Trust 2005-A A3...................... 4.06 09/21/09 197,615
300 Wachovia Auto Owner Trust 2005-B A3...................... 4.79 04/20/10 297,733
95 World Omni Auto Receivables Trust 2004-A A3.............. 3.29 11/12/08 93,853
------------
Total Asset-Backed Securities (Cost $10,255,251)............................. 10,160,876
------------
Collateralized Mortgage Obligations (0.8%)
373 Federal Home Loan Mortgage Corp. Whole Loan 2005-S001 5.535+ 09/25/45 374,856
2A2....................................................
545 Federal National Mortgage Assoc. 2006-28 1A1............. 5.495+ 03/25/36 545,379
6,490 Federal National Mortgage Assoc. 2006 -28 1P (IO)........ 0.596+ 03/25/36 167,319
725 Federal National Mortgage Assoc. 2005-68 XI (IO)......... 6.00 08/25/35 284,661
------------
Total Collateralized Mortgage Obligations (Cost $1,213,788).................. 1,372,215
------------
<Caption>
NUMBER OF
CONTRACTS
- ----------
Put Option Purchased (0.0%)
140 90 day Euro $ June/2007 @ $94.25 (Cost $44,510).............................. 33,250
------------
</Table>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN
THOUSANDS
- ----------
Short-Term Investments (3.5%)
U.S. Government Obligation (a) (0.1%)
$ 250 U.S. Treasury Bill*** (Cost $244,238).................... 5.09 01/11/07 244,238
------------
Repurchase Agreement (3.4%)
6,188 Joint repurchase agreement account (dated 07/31/06;
proceeds $6,188,906) (b) (Cost $6,188,000)............. 5.27 08/01/06 6,188,000
------------
Total Short-Term Investments (Cost $6,432,238)........... 6,432,238
------------
Total Investments (Cost $164,383,661) (c) (d)............ 101.9% 184,591,530
Liabilities in Excess of Other Assets.................... (1.9) (3,510,868)
----- ------------
Net Assets............................................... 100.0% $181,080,662
===== ============
</Table>
23
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2006 (UNAUDITED) continued
- ---------------------
<Table>
ADR American Depositary Receipt.
ARM Adjustable Rate Mortgage.
IO Interest Only Security.
* Non-income producing security.
** Resale is restricted to qualified institutional investors.
*** This security has been physically segregated in connection
with open futures contracts in the amount of $237,500.
+ Floating rate security; rate shown is the rate in effect at
July 31, 2006.
++ Security purchased on a forward commitment basis with an
approximate principal amount and no definite maturity date;
the actual principal amount and maturity date will be
determined upon settlement.
++ Security purchased on a forward commitment basis.
(a) Purchased on a discount basis. The interest rate shown has
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 $21,584,493 in connection with open futures
contracts and securities purchased on a forward commitment
basis.
(d) The aggregate cost for federal income tax purposes
approximates the aggregate cost for book purposes. The
aggregate gross unrealized appreciation is $25,453,866 and
the aggregate gross unrealized depreciation is $5,245,997,
resulting in net unrealized appreciation of $20,207,869.
</Table>
FUTURES CONTRACTS OPEN AT JULY 31, 2006:
<Table>
<Caption>
UNREALIZED
NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE APPRECIATION
CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE (DEPRECIATION)
- --------------------------------------------------------------------------------------
47 Long U.S. Treasury Notes 5 $ 4,898,281 $ 38,811
Year, September 2006
33 Long U.S. Treasury Notes 10 3,499,031 43,652
Year, September 2006
25 Short U.S. Treasury Bonds 20 (2,707,031) (39,491)
Year, September 2006
34 Short U.S. Treasury Notes 2 (6,917,938) (20,734)
Year, September 2006
--------
Net Unrealized Appreciation................. $ 22,238
========
</Table>
24
See Notes to Financial Statements
Morgan Stanley Balanced Fund
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
July 31, 2006 (unaudited)
<Table>
Assets:
Investments in securities, at value
(cost $164,383,661)....................................... $184,591,530
Cash........................................................ 1,724
Receivable for:
Investments sold........................................ 692,886
Interest................................................ 691,154
Dividends............................................... 132,500
Shares of beneficial interest sold...................... 102,537
Variation margin........................................ 2,171
Prepaid expenses and other assets........................... 23,754
------------
Total Assets............................................ 186,238,256
------------
Liabilities:
Payable for:
Investments purchased................................... 4,517,325
Shares of beneficial interest redeemed.................. 194,177
Distribution fee........................................ 130,696
Investment advisory fee................................. 79,542
Administration fee...................................... 12,237
Transfer agent fee...................................... 7,241
Accrued expenses and other payables......................... 216,376
------------
Total Liabilities....................................... 5,157,594
------------
Net Assets.............................................. $181,080,662
============
Composition of Net Assets:
Paid-in-capital............................................. $153,118,363
Net unrealized appreciation................................. 20,230,107
Accumulated undistributed net investment income............. 297,960
Accumulated undistributed net realized gain................. 7,434,232
------------
Net Assets.............................................. $181,080,662
============
Class A Shares:
Net Assets.................................................. $34,569,361
Shares Outstanding (unlimited authorized, $.01 par value)... 2,417,436
Net Asset Value Per Share............................... $14.30
============
Maximum Offering Price Per Share,
(net asset value plus 5.54% of net asset value)......... $15.09
============
Class B Shares:
Net Assets.................................................. $72,927,487
Shares Outstanding (unlimited authorized, $.01 par value)... 5,099,943
Net Asset Value Per Share............................... $14.30
============
Class C Shares:
Net Assets.................................................. $72,558,199
Shares Outstanding (unlimited authorized, $.01 par value)... 5,072,510
Net Asset Value Per Share............................... $14.30
============
Class D Shares:
Net Assets.................................................. $1,025,615
Shares Outstanding (unlimited authorized, $.01 par value)... 71,747
Net Asset Value Per Share............................... $14.29
============
</Table>
25
See Notes to Financial Statements
Morgan Stanley Balanced Fund
FINANCIAL STATEMENTS continued
Statement of Operations
For the six months ended July 31, 2006 (unaudited)
<Table>
Net Investment Income:
Income
Dividends (net of $60,542 foreign withholding tax).......... $ 1,565,576
Interest.................................................... 1,511,198
-----------
Total Income............................................ 3,076,774
-----------
Expenses
Investment advisory fee..................................... 490,270
Distribution fee (Class A shares)........................... 41,805
Distribution fee (Class B shares)........................... 387,637
Distribution fee (Class C shares)........................... 383,211
Shareholder reports and notices............................. 166,629
Transfer agent fees and expenses............................ 126,201
Professional fees........................................... 77,231
Administration fee.......................................... 75,426
Custodian fees.............................................. 25,945
Registration fees........................................... 19,491
Trustees' fees and expenses................................. 1,325
Other....................................................... 20,155
-----------
Total Expenses.......................................... 1,815,326
Less: expense offset........................................ (591)
-----------
Net Expenses............................................ 1,814,735
-----------
Net Investment Income................................... 1,262,039
-----------
Net Realized and Unrealized Gain (Loss):
Net Realized Gain on:
Investments................................................. 8,156,664
Futures contracts........................................... 98,126
Options contracts........................................... 6,495
-----------
Net Realized Gain....................................... 8,261,285
-----------
Net Change in Unrealized Appreciation/Depreciation on:
Investments................................................. (6,770,739)
Futures contracts........................................... 20,340
Options contracts........................................... (11,260)
-----------
Net Depreciation........................................ (6,761,659)
-----------
Net Gain................................................ 1,499,626
-----------
Net Increase................................................ $ 2,761,665
===========
</Table>
26
See Notes to Financial Statements
Morgan Stanley Balanced Fund
FINANCIAL STATEMENTS continued
Statements of Changes in Net Assets
<Table>
<Caption>
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
JULY 31, 2006 JANUARY 31, 2006
------------- ----------------
(unaudited)
Increase (Decrease) in Net Assets:
Operations:
Net investment income....................................... $ 1,262,039 $ 2,078,509
Net realized gain........................................... 8,261,285 18,758,188
Net change in unrealized depreciation....................... (6,761,659) (1,831,283)
------------ ------------
Net Increase............................................ 2,761,665 19,005,414
------------ ------------
Dividends and Distributions to Shareholders from:
Net investment income
Class A shares.......................................... (293,403) (452,694)
Class B shares.......................................... (367,536) (1,020,328)
Class C shares.......................................... (371,159) (914,587)
Class D shares.......................................... (9,382) (19,399)
Net realized gain
Class A shares.......................................... (912,337) (782,903)
Class B shares.......................................... (2,049,104) (2,185,194)
Class C shares.......................................... (2,008,583) (2,040,106)
Class D shares.......................................... (26,052) (22,958)
------------ ------------
Total Dividends and Distributions....................... (6,037,556) (7,438,169)
------------ ------------
Net decrease from transactions in shares of beneficial
interest.................................................. (15,676,175) (12,116,316)
------------ ------------
Net Decrease............................................ (18,952,066) (549,071)
Net Assets:
Beginning of period......................................... 200,032,728 200,581,799
------------ ------------
End of Period
(Including accumulated undistributed net investment income
of $297,960 and
$77,401, respectively).................................... $181,080,662 $200,032,728
============ ============
</Table>
27
See Notes to Financial Statements
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2006 (UNAUDITED)
1. Organization and Accounting Policies
Morgan Stanley Balanced Fund (the "Fund"), formerly Morgan Stanley Balanced
Growth Fund (the Fund's name changed effective September 18, 2006), 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 capital growth with reasonable current income. 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.
The Fund will assess 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, subject to certain exceptions.
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) listed options are valued at the
latest sale price on the exchange on which they are listed unless no sales of
such options have taken place that day, in which case they are valued at the
mean between their latest bid and asked price; (6) futures are valued at the
latest price published by the commodities exchange on which they trade; (7) when
market quotations are not readily available including circumstances under which
28
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2006 (UNAUDITED) continued
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 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; (8) certain portfolio
securities may be valued by an outside pricing service approved by the Fund's
Trustees; and (9) 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.
29
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2006 (UNAUDITED) continued
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 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. Options -- When the Fund writes a call option, an amount equal to the premium
received is included in the Fund's Statement of Assets and Liabilities as a
liability which is subsequently marked-to-market to reflect the current market
value of the option written. If a written option either expires or the Fund
enters into a closing purchase transaction, the Fund realizes a gain or loss
without regard to any unrealized gain or loss on the underlying security or
currency and the liability related to such option is extinguished. If a written
call option is exercised, the Fund realizes a gain or loss from the sale of the
underlying security or currency and the proceeds from such sale are increased by
the premium originally received.
When the Fund purchases a call or put option, the premium paid is recorded as an
investment and is subsequently marked-to-market to reflect the current market
value. If a purchased option expires, the Fund will realize a loss to the extent
of the premium paid. If the Fund enters into a closing sale transaction, a gain
or loss is realized for the difference between the proceeds from the sale and
the cost of the option. If a put option is exercised, the cost of the security
or currency sold upon exercise will be increased by the premium originally paid.
If a call option is exercised, the cost of the security purchased upon exercise
will be increased by the premium originally paid.
G. 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.
H. Dividends and Distributions to Shareholders -- Dividends and distributions to
shareholders are recorded on the ex-dividend date.
I. 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.
30
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2006 (UNAUDITED) continued
2. Investment Advisory/Administration Agreements
Pursuant to an Investment Advisory Agreement, the Fund pays the Investment
Adviser an advisory fee, accrued daily and payable monthly, by applying the
following annual rates to the net assets of the Fund determined as of the close
of each business day: 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 Investments 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 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 $1,738,529
at July 31, 2006.
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 and other authorized
financial representatives at the time of sale may be reimbursed in the
subsequent calendar year. For the six months ended July 31, 2006, the
distribution fee was accrued for Class A shares and Class C shares at the annual
rate of 0.25% and 1.0%, respectively.
31
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2006 (UNAUDITED) continued
The Distributor has informed the Fund that for the six months ended July 31,
2006, it received contingent deferred sales charges from certain redemptions of
the Fund's Class A shares, Class B shares and Class C shares of $2,924, $125,245
and $1,862, respectively and received $31,694 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, maturities, and prepayments of
portfolio securities, excluding short-term investments, for the six months ended
July 31, 2006 aggregated $37,265,148 and $51,711,709, respectively. Included in
the aforementioned are purchases and sales of U.S. Government securities of
$23,740,565 and $23,875,734, respectively.
Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and
Distributor, is the Fund's transfer agent.
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 they receive for serving on the Board of Trustees. Each eligible
Trustee generally may elect to have their 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.
5. Purposes of and Risks Relating to Certain Financial Instruments
The Fund may purchase and sell interest rate and index futures ("futures
contracts") to facilitate trading; increase or decrease Fund's market exposure,
seek higher investment returns, or to protect against a decline in the value of
the Fund's securities or an increase in prices of securities that may be
purchased.
For hedging and investment purposes, the Fund may also engage in transactions in
listed and over-the-counter options.
These future and option 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 also may arise upon entering into these contracts from the potential
inability of the counterparties to meet the terms of their contracts.
32
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2006 (UNAUDITED) continued
6. Expense Offset
The expense offset represents a reduction of the transfer agent fees and
expenses for earnings on cash balances maintained by the Fund.
7. 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, 2006 JANUARY 31, 2006
------------------------- -------------------------
(unaudited)
SHARES AMOUNT SHARES AMOUNT
---------- ------------ ---------- ------------
CLASS A SHARES
Sold............................................. 202,439 $ 2,924,557 490,716 $ 7,057,986
Conversion from Class B.......................... 272,758 3,938,380 1,649,854 23,001,214
Reinvestment of dividends and distributions...... 74,498 1,035,175 73,309 1,054,840
Redeemed......................................... (412,249) (5,944,017) (443,744) (6,388,604)
---------- ------------ ---------- ------------
Net increase - Class A........................... 137,446 1,954,095 1,770,135 24,725,436
---------- ------------ ---------- ------------
CLASS B SHARES
Sold............................................. 215,271 3,125,345 1,236,638 17,572,599
Conversion to Class A............................ (272,778) (3,938,380) (1,649,990) (23,001,214)
Reinvestment of dividends and distributions...... 151,778 2,105,038 193,148 2,774,543
Redeemed......................................... (800,901) (11,568,974) (2,034,354) (29,042,425)
---------- ------------ ---------- ------------
Net decrease - Class B........................... (706,630) (10,276,971) (2,254,558) (31,696,497)
---------- ------------ ---------- ------------
CLASS C SHARES
Sold............................................. 118,745 1,724,544 531,681 7,619,616
Reinvestment of dividends and distributions...... 155,767 2,161,152 184,017 2,646,264
Redeemed......................................... (784,640) (11,370,307) (1,062,378) (15,180,965)
---------- ------------ ---------- ------------
Net decrease - Class C........................... (510,128) (7,484,611) (346,680) (4,915,085)
---------- ------------ ---------- ------------
CLASS D SHARES
Sold............................................. 19,323 277,368 16,327 235,071
Reinvestment of dividends and distributions...... 2,430 33,742 2,786 39,913
Redeemed......................................... (12,429) (179,798) (35,423) (505,154)
---------- ------------ ---------- ------------
Net increase (decrease) - Class D................ 9,324 131,312 (16,310) (230,170)
---------- ------------ ---------- ------------
Net decrease in Fund............................. (1,069,988) $(15,676,175) (847,413) $(12,116,316)
========== ============ ========== ============
</Table>
8. 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
33
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2006 (UNAUDITED) continued
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.
At January 31, 2006, the Fund had a temporary book/tax differences primarily
attributable to capital loss deferrals on wash sales and straddles,
mark-to-market of open futures contracts and book amortization of premiums on
debt securities.
9. 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. On March 9, 2005, Plaintiffs sought leave to supplement their complaint
to assert claims on behalf of other investors, which motion defendants opposed.
On April 14, 2006, the Court granted defendants' motion to dismiss in its
entirety. Additionally, the Court denied Plaintiff's motion to supplement their
complaint. This matter is now concluded.
10. New Accounting Pronouncement
In July 2006, the Financial Accounting Standards Board (FASB) issued
Interpretation 48, Accounting for Uncertainty in Income Taxes -- an
interpretation of FASB Statement 109 (FIN 48). FIN 48 clarifies the accounting
for income taxes by prescribing the minimum recognition threshold a tax position
must meet before being recognized in the financial statements. FIN 48 is
effective for fiscal years beginning after December 15, 2006. The Fund will
adopt FIN 48 during 2007 and the impact to the Fund's financial statements, if
any, is currently being assessed.
34
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2006 (UNAUDITED) continued
11. Subsequent Event -- Fund Acquisitions
On September 18, 2006, the Fund acquired all the net assets of the Morgan
Stanley Balanced Income Fund ("Balanced Income") based on the respective
valuations as of the close of business on September 15, 2006 pursuant to a plan
of reorganization approved by the shareholders of Balanced Income on August 23,
2006. The acquisition was accomplished by a tax-free exchange of 1,812,244 Class
A shares of the Fund at a net asset value of $12.03 per share for $21,797,565
Class A shares of Balanced Income; 6,778,119 Class B shares of the Fund at a net
asset value of $11.98 per share for $81,232,874 Class B share of Balanced
Income; 2,812,414 Class C shares of the Fund at a net asset value of $12.00 per
share for $33,751,807 Class C share of Balanced Income; and 71,888 Class D
shares of the Fund at a net asset value of $11.99 per share for $861,851 Class D
share of Balanced Income. The net assets of the Fund and Balanced Income
immediately before the acquisition were $180,346,678 and $137,644,097,
respectively, including unrealized appreciation of $145,559 for Balanced Income.
Immediately after the acquisition, the combined net assets of the Fund amounted
to $317,990,775.
On September 18, 2006, the Fund acquired all the net assets of the Morgan
Stanley Income Builder Fund ("Income Builder") based on the respective
valuations as of the close of business on September 15, 2006 pursuant to a plan
of reorganization approved by the shareholders of Income Builder on July 17,
2006. The acquisition was accomplished by a tax-free exchange of 5,120,077 Class
A shares of the Fund at a net asset value of $12.08 per share for $61,849,945
Class A shares of Income Builder; 4,014,655 Class B shares of the Fund at a net
asset value of $12.11 per share for $48,601,255 Class B share of Income Builder;
1,544,850 Class C shares of the Fund at a net asset value of $12.06 per share
for $18,631,381 Class C share of Income Builder; and 65,721 Class D shares of
the Fund at a net asset value of $12.08 per share for $793,756 Class D share of
Income Builder. The net assets of the Fund and Income Builder immediately before
the acquisition were $180,346,678 and $129,876,337, respectively, including
unrealized appreciation of $336,829 for Income Builder. Immediately after the
acquisition, the combined net assets of the Fund amounted to $310,223,015.
35
Morgan Stanley Balanced 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, 2006 2006 2005 2004 2003 2002
------------- --------- -------- -------- -------- --------
(unaudited)
Class A Shares
Selected Per Share Data:
Net asset value, beginning of period... $14.57 $13.76 $12.98 $10.73 $12.82 $13.29
------ ------ ------ ------ ------ ------
Income (loss) from investment
operations:
Net investment income ++........... 0.14 0.24 0.21 0.18 0.25 0.33
Net realized and unrealized gain
(loss)............................. 0.12 1.21 0.79 2.30 (2.06) (0.42)
------ ------ ------ ------ ------ ------
Total income (loss) from investment
operations............................ 0.26 1.45 1.00 2.48 (1.81) (0.09)
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income.............. (0.13) (0.27) (0.22) (0.23) (0.28) (0.38)
Net realized gain.................. (0.40) (0.37) -- -- -- --
------ ------ ------ ------ ------ ------
Total dividends and distributions...... (0.53) (0.64) (0.22) (0.23) (0.28) (0.38)
------ ------ ------ ------ ------ ------
Net asset value, end of period......... $14.30 $14.57 $13.76 $12.98 $10.73 $12.82
====== ====== ====== ====== ====== ======
Total Return+.......................... 1.57%(1) 10.99% 7.80% 23.37% (14.27)% (0.53)%
Ratios to Average Net Assets(3):
Total expenses (before expense
offset)............................... 1.31%(2) 1.13% 1.13% 1.12% 1.10% 1.07%
Net investment income.................. 1.95%(2) 1.70% 1.61% 1.58% 2.14% 2.56%
Supplemental Data:
Net assets, end of period, in
thousands............................. $34,569 $33,217 $7,017 $6,663 $5,848 $6,259
Portfolio turnover rate................ 20%(1) 52% 64% 117% 145% 67%
</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 Fund
FINANCIAL HIGHLIGHTS continued
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED JANUARY 31
MONTHS ENDED ------------------------------------------------------------------
JULY 31, 2006 2006 2005 2004 2003 2002
------------- -------- --------- --------- -------- --------
(unaudited)
Class B Shares
Selected Per Share Data:
Net asset value,
beginning of period.... $14.56 $13.75 $12.97 $10.73 $12.81 $13.28
------ ------ ------ ------ ------ ------
Income (loss) from
investment operations:
Net investment
income ++........... 0.09 0.14 0.11 0.10 0.16 0.23
Net realized and
unrealized gain
(loss).............. 0.12 1.20 0.79 2.28 (2.05) (0.42)
------ ------ ------ ------ ------ ------
Total income (loss) from
investment operations.. 0.21 1.34 0.90 2.38 (1.89) (0.19)
------ ------ ------ ------ ------ ------
Less dividends and
distributions from:
Net investment
income.............. (0.07) (0.16) (0.12) (0.14) (0.19) (0.28)
Net realized gain... (0.40) (0.37) -- -- -- --
------ ------ ------ ------ ------ ------
Total dividends and
distributions.......... (0.47) (0.53) (0.12) (0.14) (0.19) (0.28)
------ ------ ------ ------ ------ ------
Net asset value, end of
period................. $14.30 $14.56 $13.75 $12.97 $10.73 $12.81
====== ====== ====== ====== ====== ======
Total Return+........... 1.23%(1) 10.12% 6.99% 22.37% (14.86)% (1.32)%
Ratios to Average Net
Assets(3):
Total expenses (before
expense offset)........ 2.06%(2) 1.89% 1.89% 1.88% 1.87% 1.83%
Net investment income... 1.20%(2) 0.94% 0.85% 0.82% 1.37% 1.80%
Supplemental Data:
Net assets, end of
period, in thousands... $72,927 $84,568 $110,875 $114,960 $79,631 $92,009
Portfolio turnover
rate................... 20%(1) 52% 64% 117% 145% 67%
</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>
37
See Notes to Financial Statements
Morgan Stanley Balanced Fund
FINANCIAL HIGHLIGHTS continued
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED JANUARY 31
MONTHS ENDED --------------------------------------------------------------
JULY 31, 2006 2006 2005 2004 2003 2002
------------- -------- -------- -------- -------- ---------
(unaudited)
Class C Shares
Selected Per Share Data:
Net asset value, beginning of period...... $14.57 $13.76 $12.98 $10.73 $12.81 $13.28
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income++............... 0.09 0.14 0.11 0.10 0.16 0.23
Net realized and unrealized gain
(loss)................................ 0.11 1.20 0.79 2.29 (2.05) (0.42)
------ ------ ------ ------ ------ ------
Total income (loss) from investment
operations............................... 0.20 1.34 0.90 2.39 (1.89) (0.19)
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income................. (0.07) (0.16) (0.12) (0.14) (0.19) (0.28)
Net realized gain..................... (0.40) (0.37) -- -- -- --
------ ------ ------ ------ ------ ------
Total dividends and distributions......... (0.47) (0.53) (0.12) (0.14) (0.19) (0.28)
------ ------ ------ ------ ------ ------
Net asset value, end of period............ $14.30 $14.57 $13.76 $12.98 $10.73 $12.81
====== ====== ====== ====== ====== ======
Total Return+............................. 1.17%(1) 10.15% 6.98% 22.43% (14.88)% (1.34)%
Ratios to Average Net Assets(3):
Total expenses (before expense offset).... 2.06%(2) 1.89% 1.87% 1.88% 1.87% 1.83%
Net investment income..................... 1.20%(2) 0.94% 0.87% 0.82% 1.37% 1.80%
Supplemental Data:
Net assets, end of period, in thousands... $72,558 $81,339 $81,606 $84,840 $75,323 $106,002
Portfolio turnover rate................... 20%(1) 52% 64% 117% 145% 67%
</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>
38
See Notes to Financial Statements
Morgan Stanley Balanced Fund
FINANCIAL HIGHLIGHTS continued
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED JANUARY 31
MONTHS ENDED ----------------------------------------------------------------
JULY 31, 2006 2006 2005 2004 2003 2002
------------- -------- -------- -------- -------- --------
(unaudited)
Class D Shares
Selected Per Share Data:
Net asset value, beginning of period.... $14.56 $13.76 $12.97 $10.73 $12.81 $13.28
------ ------ ------ ------ ------ ------
Income (loss) from investment
operations:
Net investment income++............. 0.16 0.28 0.24 0.22 0.27 0.37
Net realized and unrealized gain
(loss).............................. 0.11 1.19 0.80 2.28 (2.04) (0.43)
------ ------ ------ ------ ------ ------
Total income (loss) from investment
operations............................. 0.27 1.47 1.04 2.50 (1.77) (0.06)
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income............... (0.14) (0.30) (0.25) (0.26) (0.31) (0.41)
Net realized gain................... (0.40) (0.37) -- -- -- --
------ ------ ------ ------ ------ ------
Total dividends and distributions....... (0.54) (0.67) (0.25) (0.26) (0.31) (0.41)
------ ------ ------ ------ ------ ------
Net asset value, end of period.......... $14.29 $14.56 $13.76 $12.97 $10.73 $12.81
====== ====== ====== ====== ====== ======
Total Return+........................... 1.69%(1) 11.17% 8.14% 23.56% (13.99)% (0.32)%
Ratios to Average Net Assets(3):
Total expenses (before expense
offset)................................ 1.06%(2) 0.89% 0.89% 0.88% 0.87% 0.83%
Net investment income................... 2.20%(2) 1.94% 1.85% 1.82% 2.37% 2.80%
Supplemental Data:
Net assets, end of period, in
thousands.............................. $1,026 $ 909 $1,083 $1,151 $1,347 $1,244
Portfolio turnover rate................. 20%(1) 52% 64% 117% 145% 67%
</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>
39
See Notes to Financial Statements
TRUSTEES
Frank L. Bowman
Michael Bozic
Kathleen A. Dennis
Charles A. Fiumefreddo
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Joseph J. Kearns
Michael F. Klein
Michael E. Nugent
W. Allen Reed
Fergus Reid
OFFICERS
Michael E. Nugent
Chairman of the Board
Ronald E. Robison
President and Principal Executive Officer
J. David Germany
Vice President
Dennis F. Shea
Vice President
Barry Fink
Vice President
Amy R. Doberman
Vice President
Carsten Otto
Chief Compliance Officer
Stefanie V. Chang Yu
Vice President
Francis J. Smith
Treasurer and Chief Financial Officer
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) 2006 Morgan Stanley
[MORGAN STANLEY LOGO]
MORGAN STANLEY FUNDS
Morgan Stanley
Balanced Fund
Semiannual Report
July 31, 2006
[MORGAN STANLEY LOGO]
BGRSAR-37896RPT-RA06-00832P-Y07/06
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 second fiscal quarter of the period covered
by this 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 Fund
/s/ Ronald E. Robison
Ronald E. Robison
Principal Executive Officer
September 21, 2006
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 21, 2006
/s/ Francis Smith
Francis Smith
Principal Financial Officer
September 21, 2006
3