UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED
MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number: 811-07243
Morgan Stanley Balanced Income Fund
(Exact name of registrant as specified in charter)
1221 Avenue of the Americas, New York, New York 10020
(Address of principal executive offices) (Zip code)
Ronald E. Robison
1221 Avenue of the Americas, New York, New York 10020
(Name and address of agent for service)
Registrant's telephone number, including area code: 212-762-4000
Date of fiscal year end: January 31, 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 Income Fund performed during the semiannual period. We will provide an
overview of the market conditions, and discuss some of the factors that affected
performance during the reporting period. In addition, this report includes the
Fund's financial statements and a list of Fund investments.
THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE FUND BEING
OFFERED.
MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE
IS NO ASSURANCE THAT THE FUND WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE FUND IS
SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF
SECURITIES OWNED BY THE FUND WILL DECLINE AND, THEREFORE, THE VALUE OF THE
FUND'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE
MONEY INVESTING IN THIS FUND. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE
INFORMATION ON INVESTMENT RISKS.
FUND REPORT
For the six months ended July 31, 2006
TOTAL RETURN FOR THE 6 MONTHS ENDED JULY 31, 2006
<Table>
<Caption>
LIPPER
MIXED-ASSET
LEHMAN TARGET
BROTHERS RUSSELL ALLOCATION LIPPER
U.S. GOV'T./ 1000(R) CONSERVATIVE INCOME
CREDIT VALUE FUNDS FUNDS
CLASS A CLASS B CLASS C CLASS D INDEX(1) INDEX(2) INDEX(3) INDEX(4)
0.76% 0.44% 0.46% 0.96% 0.32% 5.07% 0.75% 1.53%
</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
In the bond market, the six-month period provided few surprises. As was widely
expected, the Federal Open Market Committee (the "Fed") continued to raise the
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. In the Fed's view, the U.S. economy remains on solid footing, and core
inflation is still relatively low, though most measures of core inflation are
either at or above the high end of the range viewed as acceptable by the Fed.
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.
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 Fed continued to
raise the federal funds rate and indicate that future rate increases were
possible. With housing and consumer trends already showing initial signs of
deceleration, investors grew increasingly anxious about the Fed's language.
(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.
2
PERFORMANCE ANALYSIS
Morgan Stanley Balanced Income Fund outperformed the Lehman Brothers U.S.
Government/Credit Index, and underperformed the Russell 1000(R) Value Index and
the Lipper Income Funds Index for the six months ended July 31, 2006, assuming
no deduction of applicable sales charges. The Fund's Class A and D shares
outperformed and Class B and C shares underperformed the Lipper Mixed-Asset
Target Allocation Conservative Funds Index for the same period, assuming no
deduction of applicable sales charges.
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.
In the stock portion of the portfolio, the consumer discretionary sector drove
positive performance relative to the Russell 1000 Value Index during the period,
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.
During the period, we maintained the Fund's asset allocation. As of the end of
the reporting period, the Fund held 66 percent in bonds and 34 percent in
stocks.
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 20.3%
Fed. Natl. Mtge. Assoc. 15.3
USAA Auto Owner Trust 1.5
American Express Credit Acct. 1.4
JPMorgan Chase & Co. 1.2
Bayer AG (ADR) (Germany) 1.1
Honda Auto Receivables Owner Trust 1.1
Harley-Davidson Motorcycle Trust 1.0
Citigroup, Inc. 1.0
CNH Equipment Trust 0.9
</Table>
<Table>
<Caption>
PORTFOLIO COMPOSITION*
Common Stocks 34.1%
U.S. Government Agencies & Obligations 30.9
Corporate Bonds 15.5
Asset-Backed Securities 12.7
Short-Term Investments 6.8
Put Option Purchased 0.0
</Table>
* Does not include open long futures contracts with an underlying face amount of
$15,859,375 and unrealized appreciation of $92,842 and open short futures
contracts with an underlying face amount of $13,412,313 and unrealized
depreciation of $65,293.
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 80 PERCENT OF ITS ASSETS IN
INCOME-PRODUCING SECURITIES, CONSISTING OF (1) FIXED-INCOME SECURITIES AND (2)
DIVIDEND PAYING COMMON STOCKS AND SECURITIES CONVERTIBLE INTO COMMON STOCKS.
WITHIN THE LIMITATIONS DETAILED IN THE FUND'S PROSPECTUS, 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
4
(800) SEC-0330. YOU CAN ALSO REQUEST COPIES OF THESE 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
FUND PERFORMANCE
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 BINAX BINBX BINCX BINDX
1 YEAR 3.22%(5) 2.50%(5) 2.52%(5) 3.56%(5)
(2.20)(6) (2.17)(6) 1.59(6) --
5 YEARS 4.13(5) 3.35(5) 3.38(5) 4.40(5)
3.01(6) 3.01(6) 3.38(6) --
10 YEARS -- -- 6.15(5) --
-- -- 6.15(6) --
SINCE INCEPTION 5.56(5) 4.74(5) 6.79(5) 5.79(5)
4.93(6) 4.74(6) 6.79(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 Lehman Brothers U.S. Government/Credit Index tracks the performance of
government and corporate obligations, including U.S. government agency and
Treasury securities and corporate and Yankee bonds. Indexes are unmanaged
and their returns do not include any sales charges or fees. Such costs
would lower performance. It is not possible to invest directly in an index.
(2) The Russell 1000(R) Value Index measures the performance of those companies
in the Russell 1000(R) Index with lower price-to-book ratios and lower
forecasted growth values. Indexes are unmanaged and their returns do not
include any sales charges or fees. Such costs would lower performance. It
is not possible to invest directly in an index.
(3) The Lipper Mixed-Asset Target Allocation Conservative Funds Index is an
equally-weighted performance index of the largest qualifying funds (based
on net assets) in the Lipper Mixed-Asset Target Allocation Conservative
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 fund represented in this
Index. The Fund is in the Lipper Mixed-Asset Target Allocation Conservative
Funds classification as of 7/31/2006.
(4) The Lipper Income Funds Index is an equally-weighted performance index of
the largest qualifying funds (based on net assets) in the Lipper Income
Funds classification. The Index, which is adjusted for capital gains
distributions and income dividends, is unmanaged and should not be
considered an investment. There are currently 30 funds represented in this
Index.
(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 (0.76% return)....................................... $1,000.00 $1,007.60 $ 6.92
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,017.90 $ 6.95
CLASS B
Actual (0.44% return)....................................... $1,000.00 $1,004.40 $10.64
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,014.18 $10.69
CLASS C
Actual (0.46% return)....................................... $1,000.00 $1,004.60 $10.64
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,014.18 $10.69
CLASS D
Actual (0.96% return)....................................... $1,000.00 $1,009.60 $ 5.68
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,019.14 $ 5.71
</Table>
- ------------------
* Expenses are equal to the Fund's annualized expense ratios of 1.39%, 2.14%,
2.14% and 1.14% 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
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENT - JULY 31, 2006 (UNAUDITED)
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- -------------------------------------------------------------------------------------------------------
Common Stocks (32.9%)
Aerospace & Defense (0.7%)
7,740 Northrop Grumman Corp. ..................................................... $ 512,311
11,760 Raytheon Co. ............................................................... 530,023
------------
1,042,334
------------
Beverages: Alcoholic (0.3%)
6,230 Diageo PLC (ADR) (United Kingdom)........................................... 438,094
------------
Beverages: Non-Alcoholic (0.6%)
17,830 Coca-Cola Co. (The)......................................................... 793,435
------------
Broadcasting (0.7%)
32,120 Clear Channel Communications, Inc. ......................................... 929,874
------------
Cable/Satellite TV (0.2%)
9,000 Comcast Corp. (Class A)*.................................................... 309,420
------------
Chemicals: Major Diversified (1.5%)
31,530 Bayer AG (ADR) (Germany).................................................... 1,552,222
13,500 Du Pont (E.I.) de Nemours & Co. ............................................ 535,410
------------
2,087,632
------------
Computer Processing Hardware (0.1%)
4,555 Hewlett-Packard Co. ........................................................ 145,350
------------
Department Stores (0.2%)
4,130 Kohl's Corp.*............................................................... 233,882
------------
Discount Stores (0.5%)
15,630 Wal-Mart Stores, Inc. ...................................................... 695,535
------------
Electric Utilities (1.2%)
12,750 American Electric Power Co., Inc. .......................................... 460,530
9,660 Entergy Corp. .............................................................. 744,786
9,970 FirstEnergy Corp. .......................................................... 558,320
------------
1,763,636
------------
Finance/Rental/Leasing (0.6%)
15,380 Freddie Mac................................................................. 889,887
------------
Financial Conglomerates (2.6%)
28,680 Citigroup, Inc. ............................................................ 1,385,531
38,376 JPMorgan Chase & Co. ....................................................... 1,750,713
9,140 State Street Corp. ......................................................... 548,948
------------
3,685,192
------------
</Table>
See Notes to Financial Statements
8
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENT - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- -------------------------------------------------------------------------------------------------------
Food Retail (0.1%)
3,050 Kroger Co. ................................................................. $ 69,936
1,700 Safeway, Inc. .............................................................. 47,736
2,800 Supervalu, Inc. ............................................................ 75,908
------------
193,580
------------
Food: Major Diversified (0.6%)
8,600 ConAgra Foods Inc. ......................................................... 184,900
29,040 Unilever N.V. (NY Registered Shares) (Netherlands).......................... 687,667
------------
872,567
------------
Food: Specialty/Candy (0.4%)
13,340 Cadbury Schweppes PLC (ADR) (United Kingdom)................................ 523,728
------------
Household/Personal Care (0.4%)
8,810 Procter & Gamble Co. (The).................................................. 495,122
------------
Industrial Conglomerates (1.5%)
36,380 General Electric Co. ....................................................... 1,189,262
6,370 Ingersoll-Rand Co. Ltd. (Class A) (Bermuda)................................. 228,046
9,180 Siemens AG (ADR) (Germany).................................................. 741,101
------------
2,158,409
------------
Insurance Brokers/Services (0.6%)
32,000 Marsh & McLennan Companies, Inc. ........................................... 864,960
------------
Integrated Oil (2.0%)
9,700 BP PLC (ADR) (United Kingdom)............................................... 703,444
15,230 ConocoPhillips.............................................................. 1,045,387
5,170 Exxon Mobil Corp. .......................................................... 350,216
11,480 Royal Dutch Shell PLC (ADR) (Class A) (United Kingdom)...................... 812,784
------------
2,911,831
------------
Investment Banks/Brokers (1.5%)
2,070 Goldman Sachs Group, Inc. (The)............................................. 316,192
15,570 Merrill Lynch & Co., Inc. .................................................. 1,133,807
47,100 Schwab (Charles) Corp. (The)................................................ 747,948
------------
2,197,947
------------
Life/Health Insurance (0.1%)
12,510 Aegon N.V. (NY Registered Shares) (Netherlands)............................. 211,669
------------
Major Banks (1.1%)
18,152 Bank of America Corp. ...................................................... 935,372
8,260 PNC Financial Services Group................................................ 585,138
------------
1,520,510
------------
</Table>
See Notes to Financial Statements
9
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENT - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- -------------------------------------------------------------------------------------------------------
Major Telecommunications (2.0%)
5,723 Embarq Corp. ............................................................... $ 258,966
21,800 France Telecom S.A. (ADR) (France).......................................... 506,414
51,267 Sprint Nextel Corp. ........................................................ 1,015,087
30,457 Verizon Communications, Inc. ............................................... 1,030,056
------------
2,810,523
------------
Managed Health Care (0.2%)
3,090 CIGNA Corp. ................................................................ 281,962
------------
Media Conglomerates (1.7%)
24,500 Disney (Walt) Co. (The)..................................................... 727,405
66,240 Time Warner, Inc. .......................................................... 1,092,960
15,910 Viacom, Inc. (Class B)*..................................................... 554,464
------------
2,374,829
------------
Medical Specialties (0.2%)
7,460 Applera Corp. - Applied Biosystems Group.................................... 239,839
------------
Motor Vehicles (0.3%)
14,360 Honda Motor Co., Ltd. (ADR) (Japan)......................................... 473,162
------------
Multi-Line Insurance (0.3%)
5,880 Hartford Financial Services Group, Inc. (The)............................... 498,859
------------
Oil Refining/Marketing (0.1%)
1,900 Marathon Oil Corp. ......................................................... 172,216
------------
Oilfield Services/Equipment (0.4%)
8,370 Schlumberger Ltd. (Netherlands Antilles).................................... 559,535
------------
Other Consumer Services (0.0%)
1,200 Block (H.&R.), Inc. ........................................................ 27,300
------------
Packaged Software (0.7%)
53,897 Symantec Corp.*............................................................. 936,191
------------
Pharmaceuticals: Major (5.5%)
23,380 Abbott Laboratories......................................................... 1,116,863
44,600 Bristol-Myers Squibb Co. ................................................... 1,069,062
9,360 GlaxoSmithKline PLC (ADR) (United Kingdom).................................. 517,889
19,810 Lilly (Eli) & Co. .......................................................... 1,124,614
27,220 Pfizer, Inc. ............................................................... 707,448
12,080 Roche Holdings Ltd. (ADR) (Switzerland)..................................... 1,073,308
9,080 Sanofi-Aventis (ADR) (France)............................................... 430,301
54,670 Schering-Plough Corp. ...................................................... 1,117,455
15,800 Wyeth....................................................................... 765,826
------------
7,922,766
------------
</Table>
See Notes to Financial Statements
10
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENT - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- -------------------------------------------------------------------------------------------------------
Precious Metals (0.4%)
11,650 Newmont Mining Corp. ....................................................... $ 596,830
------------
Property - Casualty Insurers (1.6%)
1,380 ACE Ltd. (Cayman Islands)................................................... 71,111
15,540 Chubb Corp. (The)........................................................... 783,527
20,984 St. Paul Travelers Companies, Inc. (The).................................... 961,067
6,460 XL Capital Ltd. (Class A) (Cayman Islands).................................. 411,502
------------
2,227,207
------------
Regional Banks (0.2%)
9,300 Fifth Third Bancorp......................................................... 354,702
------------
Restaurants (0.2%)
7,070 McDonald's Corp. ........................................................... 250,207
------------
Semiconductors (0.6%)
23,877 Intel Corp. ................................................................ 429,786
27,090 Micron Technology, Inc.*.................................................... 422,333
------------
852,119
------------
Specialty Insurance (0.3%)
5,060 MGIC Investment Corp. ...................................................... 287,965
4,150 PMI Group, Inc. (The)....................................................... 176,209
------------
464,174
------------
Specialty Stores (0.1%)
5,530 Office Depot, Inc.*......................................................... 199,357
------------
Telecommunication Equipment (0.2%)
12,460 Motorola, Inc. ............................................................. 283,590
------------
Tobacco (0.4%)
6,920 Altria Group, Inc. ......................................................... 553,392
------------
Total Common Stocks (Cost $39,174,995)...................................... 47,043,354
------------
</Table>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE
- --------- ------ --------
Corporate Bonds (16.5%)
Advertising/Marketing Services (0.1%)
$ 190 WPP Finance (UK) Corp. (United Kingdom)................... 5.875% 06/15/14 186,258
------------
Aerospace & Defense (0.4%)
235 Northrop Grumman Corp. ................................... 4.079 11/16/06 233,993
370 Systems 2001 Asset Trust - 144A** (Cayman Islands)........ 6.664 09/15/13 384,731
------------
618,724
------------
</Table>
See Notes to Financial Statements
11
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENT - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Air Freight/Couriers (0.2%)
$ 225 Fedex Corp. .............................................. 2.65 % 04/01/07 $ 220,437
------------
Airlines (0.4%)
321 America West Airlines, Inc. (Series 01-1)................. 7.10 04/02/21 330,559
195 Southwest Airlines Co. (Series 01-1)...................... 5.496 11/01/06 195,133
------------
525,692
------------
Apparel/Footwear Retail (0.1%)
75 Limited Brands, Inc. ..................................... 6.95 03/01/33 72,315
------------
Beverages: Alcoholic (0.4%)
285 FBG Finance Ltd. - 144A** (Australia)..................... 5.125 06/15/15 265,166
290 Miller Brewing Co. - 144A**............................... 4.25 08/15/08 282,497
------------
547,663
------------
Cable/Satellite TV (0.2%)
135 Comcast Cable Communications, Inc. ....................... 6.75 01/30/11 140,320
40 Lenfast Communications, Inc. ............................. 7.625 02/15/08 41,089
105 TCI Communications, Inc. ................................. 7.875 02/15/26 113,582
------------
294,991
------------
Casino/Gaming (0.4%)
415 Harrah's Operating Co., Inc. ............................. 5.625 06/01/15 387,815
110 Harrah's Operating Co., Inc. ............................. 6.50 06/01/16 108,464
------------
496,279
------------
Chemicals: Major Diversified (0.1%)
170 ICI Wilmington, Inc. ..................................... 4.375 12/01/08 165,029
------------
Computer Processing Hardware (0.1%)
185 Hewlett-Packard Co. ...................................... 5.339+ 05/22/09 185,237
------------
Containers/Packaging (0.1%)
145 Sealed Air Corp. - 144A**................................. 5.625 07/15/13 140,391
------------
Department Stores (0.1%)
50 Federated Department Stores, Inc. ........................ 6.625 09/01/08 50,998
80 May Department Stores Co., Inc. .......................... 5.95 11/01/08 80,483
------------
131,481
------------
Electric Utilities (2.2%)
280 Ameren Corp. ............................................. 4.263 05/15/07 277,165
280 Arizona Public Service Co. ............................... 5.80 06/30/14 273,677
75 Arizona Public Service Co. ............................... 6.75 11/15/06 75,229
265 Carolina Power & Light Co. ............................... 5.125 09/15/13 255,510
305 CC Funding Trust I........................................ 6.90 02/16/07 306,895
100 Cincinnati Gas & Electric Co. ............................ 5.70 09/15/12 98,907
</Table>
See Notes to Financial Statements
12
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENT - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
$ 140 Consolidated Natural Gas Co. ............................. 5.00 % 12/01/14 $ 129,928
230 Consolidated Natural Gas Co. (Series C)................... 6.25 11/01/11 234,265
180 Consumers Energy Co. ..................................... 4.80 02/17/09 176,220
130 Detroit Edison Co. (The).................................. 6.125 10/01/10 132,432
90 Entergy Gulf States, Inc. ................................ 3.60 06/01/08 86,497
195 Entergy Gulf States, Inc. ................................ 5.631+ 12/01/09 193,229
250 Ohio Power Company - IBC (Series K)....................... 6.00 06/01/16 250,453
70 Panhandle Eastern Pipe Line Co. (Series B)................ 2.75 03/15/07 68,738
165 Public Service Electric & Gas Co. (Series MTNB)........... 5.00 01/01/13 159,084
155 Texas Eastern Transmission, LP............................ 7.00 07/15/32 167,000
205 Wisconsin Electric Power Co. ............................. 3.50 12/01/07 199,955
------------
3,085,184
------------
Electrical Products (0.3%)
240 Cooper Industries, Inc. .................................. 5.25 07/01/07 238,340
245 Cooper Industries, Inc. .................................. 5.25 11/15/12 239,843
------------
478,183
------------
Electronics/Appliances (0.1%)
160 LG Electronics Inc. - 144A** (South Korea)................ 5.00 06/17/10 153,166
------------
Finance/Rental/Leasing (1.5%)
240 CIT Group, Inc. .......................................... 2.875 09/29/06 239,048
190 CIT Group Inc. (Series MTN)............................... 4.75 08/15/08 187,424
350 Countrywide Home Loans, Inc. (Series MTN)................. 3.25 05/21/08 336,799
375 MBNA Corp. ............................................... 5.58+ 05/05/08 377,936
335 Nationwide Building Society - 144A** (United Kingdom)..... 4.25 02/01/10 321,591
485 Residential Capital Corp. ................................ 6.375 06/30/10 483,779
150 SLM Corp. ................................................ 4.00 01/15/10 142,872
------------
2,089,449
------------
Financial Conglomerates (0.7%)
500 Associates Corp. of North America......................... 6.25 11/01/08 508,399
315 Chase Manhattan Corp. .................................... 6.00 02/15/09 318,498
80 Chase Manhattan Corp. .................................... 7.00 11/15/09 83,417
165 General Electric Capital Corp. ........................... 4.25 12/01/10 157,840
------------
1,068,154
------------
Food Retail (0.2%)
210 Fred Meyer, Inc. ......................................... 7.45 03/01/08 215,458
------------
</Table>
See Notes to Financial Statements
13
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENT - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Food: Major Diversified (0.3%)
$ 100 ConAgra Foods, Inc. ...................................... 7.00 % 10/01/28 $ 103,367
130 ConAgra Foods, Inc. ...................................... 8.25 09/15/30 152,959
115 Kraft Foods Inc. ......................................... 5.25 06/01/07 114,509
------------
370,835
------------
Forest Products (0.0%)
19 Weyerhaeuser Co. ......................................... 6.125 03/15/07 19,022
------------
Gas Distributors (0.3%)
195 NiSource Finance Corp. ................................... 5.764+ 11/23/09 195,456
180 Sempra Energy............................................. 4.621 05/17/07 178,727
------------
374,183
------------
Home Furnishings (0.1%)
155 Mohawk Industries, Inc. (Series D)........................ 7.20 04/15/12 160,989
------------
Hotels/Resorts/Cruiselines (0.2%)
305 Hyatt Equities LLC - 144A**............................... 6.875 06/15/07 307,090
------------
Household/Personal Care (0.2%)
350 Clorox Co. (The).......................................... 5.444+ 12/14/07 350,611
------------
Industrial Conglomerates (0.3%)
200 Textron Financial Corp. .................................. 4.125 03/03/08 195,591
250 Textron Financial Corp. (Series MTN)...................... 5.125 02/03/11 245,859
------------
441,450
------------
Insurance Brokers/Services (0.4%)
570 Farmers Exchange Capital - 144A**......................... 7.05 07/15/28 554,175
------------
Major Banks (0.7%)
120 Bank of New York Co., Inc. (The).......................... 5.20 07/01/07 119,610
250 Bank of New York Co., Inc. (The) (Series BKNT)............ 3.80 02/01/08 244,311
160 HSBC Finance Corp. ....................................... 6.75 05/15/11 167,538
250 Huntington National Bank (Series BKNT).................... 4.375 01/15/10 241,078
165 Popular North America Inc. (Series MTN)................... 5.65 04/15/09 164,591
------------
937,128
------------
Major Telecommunications (1.1%)
150 Deutsche Telekom International Finance Corp. BV
(Netherlands)........................................... 8.25+ 06/15/30 175,978
295 France Telecom S.A. (France).............................. 8.50+ 03/01/31 364,992
185 SBC Communications, Inc. ................................. 6.15 09/15/34 172,508
70 Sprint Capital Corp. ..................................... 8.75 03/15/32 85,506
125 Telecom Italia Capital SA (Luxembourg).................... 4.00 11/15/08 120,530
225 Telecom Italia Capital SA (Luxembourg).................... 4.00 01/15/10 211,944
</Table>
See Notes to Financial Statements
14
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENT - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
$ 140 Telefonica Europe BV (Netherlands)........................ 8.25 % 09/15/30 $ 162,497
300 Verizon New England, Inc. ................................ 6.50 09/15/11 304,104
------------
1,598,059
------------
Media Conglomerates (0.3%)
90 News America Holdings, Inc. .............................. 7.75 02/01/24 96,468
115 News America, Inc. ....................................... 7.28 06/30/28 118,244
255 Viacom, Inc. - 144A**..................................... 6.875 04/30/36 245,307
------------
460,019
------------
Motor Vehicles (0.1%)
145 DaimlerChrysler North American Holdings Co. .............. 8.50 01/18/31 167,925
------------
Multi-Line Insurance (0.7%)
660 AIG Sun America Global Finance VI - 144A**................ 6.30 05/10/11 681,018
130 American General Finance Corp. (Series MTNH).............. 4.625 09/01/10 125,300
125 AXA Financial, Inc. ...................................... 6.50 04/01/08 126,491
135 International Lease Finance Corp. ........................ 3.75 08/01/07 132,510
------------
1,065,319
------------
Oil & Gas Pipelines (0.2%)
95 Kinder Morgan Energy Partners, L.P. ...................... 5.125 11/15/14 88,481
260 Plains All American Pipeline L.P. - 144A**................ 6.70 05/15/36 258,138
------------
346,619
------------
Other Metals/Minerals (0.2%)
260 Brascan Corp. (Canada).................................... 7.125 06/15/12 273,422
------------
Property - Casualty Insurers (1.1%)
460 Mantis Reef Ltd. - 144A** (Australia)..................... 4.692 11/14/08 448,437
175 Platinum Underwriters Finance Inc. (Series B)............. 7.50 06/01/17 173,887
220 Platinum Underwriters Holdings, Ltd. (Series B)
(Bahamas)............................................... 6.371 11/16/07 218,292
315 St. Paul Travelers Companies, Inc. (The).................. 5.01 08/16/07 311,797
420 XLLIAC Global Funding - 144A**............................ 4.80 08/10/10 406,947
------------
1,559,360
------------
Pulp & Paper (0.1%)
95 Sappi Papier Holding AG - 144A** (Austria)................ 6.75 06/15/12 89,665
------------
Railroads (0.4%)
190 Burlington North Santa Fe Railway Co. .................... 6.125 03/15/09 192,911
175 Norfolk Southern Corp. ................................... 7.35 05/15/07 177,286
35 Union Pacific Corp. ...................................... 6.625 02/01/08 35,545
110 Union Pacific Corp. (Series MTNE)......................... 6.79 11/09/07 111,488
------------
517,230
------------
</Table>
See Notes to Financial Statements
15
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENT - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Real Estate Development (0.5%)
$ 375 World Financial Properties - 144A**....................... 6.91 % 09/01/13 $ 389,679
369 World Financial Properties - 144A**....................... 6.95 09/01/13 384,216
------------
773,895
------------
Real Estate Investment Trusts (0.1%)
185 EOP Operating LP.......................................... 6.763 06/15/07 186,616
------------
Regional Banks (0.3%)
420 Marshall & Ilsley Bank (Series BKNT)...................... 3.80 02/08/08 409,677
------------
Restaurants (0.1%)
115 Tricon Global............................................. 8.875 04/15/11 128,924
------------
Savings Banks (0.7%)
195 Household Finance Corp. .................................. 4.125 12/15/08 189,420
70 Household Finance Corp. .................................. 5.875 02/01/09 70,720
70 Household Finance Corp. .................................. 6.375 10/15/11 72,276
230 Household Finance Corp. .................................. 6.40 06/17/08 233,810
100 Sovereign Bank (Series CD)................................ 4.00 02/01/08 97,562
195 Washington Mutual Bank.................................... 5.50 01/15/13 191,326
180 Washington Mutual Inc. ................................... 8.25 04/01/10 194,143
------------
1,049,257
------------
Trucks/Construction/Farm Machinery (0.3%)
70 Caterpillar Financial Services Corp. (Series MTNF)........ 3.625 11/15/07 68,373
340 Caterpillar Financial Services Corp. (Series MTNF)........ 5.259+ 08/20/07 340,407
------------
408,780
------------
Wireless Telecommunications (0.2%)
285 Vodafone Group PLC (United Kingdom)....................... 5.59+ 12/28/07 285,101
------------
Total Corporate Bonds (Cost $23,854,832)..................................... 23,509,442
------------
U.S. Government Obligations (20.0%)
U.S. Treasury Bonds
1,100 .......................................................... 6.125 08/15/29 1,243,259
5,350 .......................................................... 7.625 02/15/25 6,897,322
6,550 .......................................................... 8.125 08/15/21 8,559,009
U.S. Treasury Notes
1,250 .......................................................... 4.25 08/15/13 - 1,198,291
11/15/13
9,035 .......................................................... ++ 4.25 08/15/13 8,674,920
4,190 U.S. Treasury Strip....................................... 0.00 08/15/20 2,032,510
------------
Total U.S. Government Obligations (Cost $28,499,371)......................... 28,605,311
------------
</Table>
See Notes to Financial Statements
16
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENT - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Mortgage-Backed Securities (14.5%)
Federal Home Loan Mortgage Corp. Gold
$ 144 .......................................................... 6.50 % 01/01/31 $ 147,005
371 .......................................................... 7.50 10/01/29 - 384,585
06/01/32
Federal National Mortgage Assoc.
546 .......................................................... 6.50 08/01/32 554,436
3,159 .......................................................... 7.00 01/01/32 - 3,244,035
02/01/36
400 .......................................................... 7.00 ++ 409,875
1,323 .......................................................... 7.50 08/01/23 - 1,371,206
09/01/35
486 .......................................................... 8.00 05/01/24 - 513,115
08/01/31
Federal National Mortgage Assoc. (ARM)
972 .......................................................... 1.354 07/01/36 1,004,949
651 .......................................................... 5.358 07/01/36 673,266
417 .......................................................... 5.663 07/01/33 422,939
977 .......................................................... 6.116 03/01/36 997,594
2,083 .......................................................... 6.164 01/01/36 2,143,175
2,078 .......................................................... 6.165 01/01/36 2,134,566
965 .......................................................... 6.17 03/01/36 991,727
1,027 .......................................................... 6.389 05/01/36 1,060,976
1,227 .......................................................... 6.406 04/01/36 1,268,483
1,000 .......................................................... 6.489 05/01/36 1,033,284
2,007 .......................................................... 6.671 04/01/36 2,097,147
94 Federal National Mortgage Assoc. Dwarf.................... 7.00 07/01/11 - 96,332
06/01/12
Government National Mortgage Assoc.
84 .......................................................... 7.50 08/15/25 - 87,597
10/15/26
63 .......................................................... 8.00 06/15/26 - 66,485
07/15/26
------------
Total Mortgage-Backed Securities (Cost $20,797,594).......................... 20,702,777
------------
Asset-Backed Securities (13.5%)
Finance/Rental/Leasing
700 American Express Credit Account Master Trust 2002-3 A..... 5.479+ 12/15/09 701,085
1,275 American Express Credit Account Master Trust 2003-3 A..... 5.479+ 11/15/10 1,277,991
725 Banc of America Securities Auto Trust 2005-WF1 A3......... 3.99 08/18/09 715,379
425 Capital Auto Receivables Asset Trust 2004-2 A............. 3.35 02/15/08 422,026
725 Capital Auto Receivables Asset Trust 2005-1 A4............ 4.05 07/15/09 716,200
650 Caterpillar Financial Asset Trust 2005-A A3............... 3.90 02/25/09 642,380
</Table>
See Notes to Financial Statements
17
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENT - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
$ 184 CIT Equipment Collateral 2004-EF1 A3...................... 3.50 % 09/20/08 $ 181,621
475 CNH Equipment Trust 2005-A A3............................. 4.02 04/15/09 469,695
900 CNH Equipment Trust 2005-B A3............................. 4.27 01/15/10 884,811
575 DaimlerChrysler Auto Trust 2005-B A3...................... 4.04 09/08/09 568,628
475 Ford Credit Auto Owner Trust 2005-B A3.................... 4.17 01/15/09 471,179
425 Ford Credit Auto Owner Trust 2006-A A3.................... 5.05 03/15/10 422,868
700 GE Equipment Small Ticket LLC 2005-2A..................... 4.88 10/22/09 695,260
900 Harley-Davidson Motorcycle Trust 2005-1 A2................ 3.76 12/17/12 881,039
525 Harley-Davidson Motorcycle Trust 2005-2 A2................ 4.07 02/15/12 512,290
425 Hertz Vehicle Financing LLC 2005-2A A2.................... 4.93 02/25/10 420,052
400 Honda Auto Receivables Owner Trust 2005-2 A3.............. 3.93 01/15/09 395,660
650 Honda Auto Receivables Owner Trust 2005-3 A3.............. 3.87 04/20/09 640,464
575 Honda Auto Receivables Owner Trust 2005-6 A3.............. 4.85 10/19/09 571,227
450 Hyundai Auto Receivables Trust 2005-A A3.................. 3.98 11/16/09 442,435
140 MBNA Master Credit Card Trust 1999-B A.................... 5.90 08/15/11 142,234
800 Merrill Auto Trust Securitization 2005-1 A3............... 4.10 08/25/09 789,442
575 National City Auto Receivables Trust 2004-A A4............ 2.88 05/15/11 558,656
825 Nissan Auto Receivables Owner Trust 2005-B A3............. 3.99 07/15/09 814,733
175 TXU Electric Delivery Transition Bond Co. LLC 2004-1 A2... 4.81 11/17/14 169,645
950 USAA Auto Owner Trust 2004-2 A4........................... 3.58 02/15/11 931,903
645 USAA Auto Owner Trust 2004-3 A3........................... 3.16 02/17/09 638,060
563 USAA Auto Owner Trust 2005-1 A3........................... 3.90 07/15/09 557,491
500 Volkswagen Auto Lease Trust 2005-A A3..................... 3.82 05/20/08 496,657
750 Volkswagen Auto Loan Enhanced Trust 2005-1 A3............. 4.80 07/20/09 744,992
213 Wachovia Auto Owner Trust 2004-B A3....................... 2.91 04/20/09 210,607
400 Wachovia Auto Owner Trust 2005-A A3....................... 4.06 09/21/09 395,230
575 Wachovia Auto Owner Trust 2005-B A3....................... 4.79 04/20/10 570,656
189 World Omni Auto Receivables Trust 2004-A A3............... 3.29 11/12/08 187,707
------------
Total Asset-Backed Securities (Cost $19,438,313)............................. 19,240,303
------------
Collateralized Mortgage Obligations (1.8%)
725 Federal Home Loan Mortgage Corp. Whole Loan 2005-S001
2A2..................................................... 5.535+ 09/25/45 727,661
991 Federal National Mortgage Assoc. 2006-28 1A1.............. 5.495+ 03/25/36 991,599
11,463 Federal National Mortgage Assoc. 2006-28 1P (IO).......... 0.596+ 03/25/36 295,524
1,450 Federal National Mortgage Assoc. 2005-68 XI (IO).......... 6.00 08/25/35 569,321
------------
Total Collateralized Mortgage Obligations (Cost $2,266,376).................. 2,584,105
------------
</Table>
See Notes to Financial Statements
18
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENT - JULY 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
CONTRACTS VALUE
- -------------------------------------------------------------------------------------------------------
Put Option Purchased (0.0%)
247 90 day Euro $ June/2007 @ $94.25 (Cost $78,673)............................. $ 58,663
------------
</Table>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE
- --------- ------ ---------
Short-Term Investments (7.2%)
U.S. Government Obligation (a) (0.3%)
$ 400 U.S. Treasury Bill*** (Cost $390,782).................... 5.09 % 01/11/07 390,782
------------
Repurchase Agreement (6.9%)
9,920 Joint repurchase agreement account (dated 07/31/06;
proceeds $9,921,452) (b) (Cost $9,920,000)............. 5.27 08/01/06 9,920,000
------------
Total Short-Term Investments (Cost $10,310,782).............................. 10,310,782
------------
</Table>
<Table>
Total Investments (Cost $144,420,936) (c)(d)..................... 106.4% 152,054,737
Liabilities in Excess of Other Assets............................ (6.4) (9,088,205)
----- ------------
Net Assets....................................................... 100.0% $142,966,532
===== ============
</Table>
- ---------------------
<Table>
ADR American Depositary Receipt.
ARM Adjustable Rate Mortgage.
IO Interest Only Security.
* Non-income producing security.
** Resale is restricted to qualified institutional investors.
*** A portion of this security has been physically segregated in
connection with open futures contracts in the amount of
$380,000.
+ 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 $38,240,597 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 $10,796,868 and
the aggregate gross unrealized depreciation is $3,163,067,
resulting in net unrealized appreciation of $7,633,801.
</Table>
See Notes to Financial Statements
19
Morgan Stanley Balanced Income Fund
PORTFOLIO OF INVESTMENT - JULY 31, 2006 (UNAUDITED) continued
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)
- -------------------------------------------------------------------------------------------------
142 Long U.S. Treasury Notes 5 Year, $ 14,799,063 $ 78,338
September 2006
10 Long U.S. Treasury Notes 10 Year, 1,060,312 14,504
September 2006
13 Short U.S. Treasury Bonds 20 Year, (1,407,656) (26,130)
September 2006
59 Short U.S. Treasury Notes 2 Year, (12,004,657) (39,163)
September 2006
--------
Net Unrealized Appreciation............................ $ 27,549
========
</Table>
See Notes to Financial Statements
20
Morgan Stanley Balanced Income Fund
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
July 31, 2006 (unaudited)
<Table>
Assets:
Investments in securities, at value
(cost $144,420,936)....................................... $152,054,737
Cash........................................................ 929
Receivable for:
Interest................................................ 1,089,722
Investments sold........................................ 424,584
Shares of beneficial interest sold...................... 77,699
Dividends............................................... 50,316
Variation margin........................................ 5,124
Prepaid expenses and other assets........................... 47,252
------------
Total Assets............................................ 153,750,363
------------
Liabilities:
Payable for:
Investments purchased................................... 9,977,504
Shares of beneficial interest redeemed.................. 395,931
Distribution fee........................................ 107,179
Investment advisory fee................................. 63,539
Administration fee...................................... 9,775
Transfer agent fee...................................... 3,373
Accrued expenses and other payables......................... 226,530
------------
Total Liabilities....................................... 10,783,831
------------
Net Assets.............................................. $142,966,532
============
Composition of Net Assets:
Paid-in-capital............................................. $133,333,789
Net unrealized appreciation................................. 7,661,350
Accumulated undistributed net investment income............. 3,043
Accumulated undistributed net realized gain................. 1,968,350
------------
Net Assets.............................................. $142,966,532
============
Class A Shares:
Net Assets.................................................. $22,641,987
Shares Outstanding (unlimited authorized, $.01 par value)... 1,831,156
Net Asset Value Per Share............................... $12.36
============
Maximum Offering Price Per Share,
(net asset value plus 5.54% of net asset value)......... $13.04
============
Class B Shares:
Net Assets.................................................. $84,886,936
Shares Outstanding (unlimited authorized, $.01 par value)... 6,893,782
Net Asset Value Per Share............................... $12.31
============
Class C Shares:
Net Assets.................................................. $34,529,012
Shares Outstanding (unlimited authorized, $.01 par value)... 2,800,415
Net Asset Value Per Share............................... $12.33
============
Class D Shares:
Net Assets.................................................. $908,597
Shares Outstanding (unlimited authorized, $.01 par value)... 73,698
Net Asset Value Per Share............................... $12.33
============
</Table>
See Notes to Financial Statements
21
Morgan Stanley Balanced Income Fund
FINANCIAL STATEMENTS continued
Statement of Operations
For the six months ended July 31, 2006 (unaudited)
<Table>
Net Investment Income:
Income
Interest.................................................... $ 2,576,666
Dividends (net of $22,872 foreign withholding tax).......... 614,356
-----------
Total Income............................................ 3,191,022
-----------
Expenses
Distribution fee (Class A shares)........................... 28,258
Distribution fee (Class B shares)........................... 466,333
Distribution fee (Class C shares)........................... 186,286
Investment advisory fee..................................... 400,762
Shareholder reports and notices............................. 171,975
Transfer agent fees and expenses............................ 107,451
Administration fee.......................................... 61,656
Professional fees........................................... 58,565
Registration fees........................................... 29,255
Custodian fees.............................................. 27,644
Trustees' fees and expenses................................. 928
Other....................................................... 18,195
-----------
Total Expenses.......................................... 1,557,308
Less: expense offset........................................ (476)
-----------
Net Expenses............................................ 1,556,832
-----------
Net Investment Income................................... 1,634,190
-----------
Net Realized and Unrealized Gain (Loss):
Net Realized Gain on:
Investments................................................. 3,988,455
Futures contracts........................................... 53,858
Options..................................................... 12,242
-----------
Net Realized Gain....................................... 4,064,555
-----------
Net Change in Unrealized Appreciation/Depreciation on:
Investments................................................. (5,168,106)
Futures contracts........................................... 28,059
Options..................................................... (20,010)
-----------
Net Depreciation........................................ (5,160,057)
-----------
Net Loss................................................ (1,095,502)
-----------
Net Increase................................................ $ 538,688
===========
</Table>
See Notes to Financial Statements
22
Morgan Stanley Balanced Income 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....................................... $ 1,634,190 $ 3,339,217
Net realized gain........................................... 4,064,555 11,725,472
Net change in unrealized depreciation....................... (5,160,057) (5,507,219)
------------ ------------
Net Increase............................................ 538,688 9,557,470
------------ ------------
Dividends and Distributions to Shareholders from:
Net investment income
Class A shares.......................................... (300,411) (538,035)
Class B shares.......................................... (878,248) (2,361,571)
Class C shares.......................................... (357,089) (889,437)
Class D shares.......................................... (14,117) (41,670)
Net realized gain
Class A shares.......................................... (430,522) (1,182,901)
Class B shares.......................................... (1,715,618) (5,804,185)
Class C shares.......................................... (684,221) (2,188,127)
Class D shares.......................................... (18,066) (64,026)
------------ ------------
Total Dividends and Distributions....................... (4,398,292) (13,069,952)
------------ ------------
Net decrease from transactions in shares of beneficial
interest.................................................. (21,713,253) (26,657,384)
------------ ------------
Net Decrease............................................ (25,572,857) (30,169,866)
Net Assets:
Beginning of period......................................... 168,539,389 198,709,255
------------ ------------
End of Period
(Including accumulated undistributed net investment income
of $3,043 and
dividends in excess of net investment income of $81,282,
respectively)............................................... $142,966,532 $168,539,389
============ ============
</Table>
See Notes to Financial Statements
23
Morgan Stanley Balanced Income Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2006 (UNAUDITED)
1. Organization and Accounting Policies
Morgan Stanley Balanced Income Fund (the "Fund") is registered under the
Investment Company Act of 1940, as amended (the "Act"), as a diversified,
open-end management investment company. The Fund's investment objective is to
provide current income and moderate capital growth. The Fund was organized as a
Massachusetts business trust on November 23, 1994 and commenced operations on
March 28, 1995. On July 28, 1997, the Fund converted to a multiple class share
structure.
The Fund offers Class A shares, Class B shares, Class C shares and Class D
shares. The four classes are substantially the same except that most Class A
shares are subject to a sales charge imposed at the time of purchase and some
Class A shares, and most Class B shares and Class C shares are subject to a
contingent deferred sales charge imposed on shares redeemed within eighteen
months, six years and one year, respectively. Class D shares are not subject to
a sales charge. Additionally, Class A shares, Class B shares and Class C shares
incur distribution expenses.
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
Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") determines
that the latest sale
24
Morgan Stanley Balanced Income Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2006 (UNAUDITED) continued
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.
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
25
Morgan Stanley Balanced Income Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2006 (UNAUDITED) continued
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 or put 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 and 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.
26
Morgan Stanley Balanced Income 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 Investment Adviser, the Fund
pays an administration fee, accrued daily and payable monthly, by applying the
annual rate of 0.08% to the Fund's daily net assets.
3. Plan of Distribution
Shares of the Fund are distributed by Morgan Stanley Distributors Inc. (the
"Distributor"), an affiliate of the Investment Adviser and Administrator. The
Fund has adopted a Plan of Distribution (the "Plan") pursuant to Rule 12b-1
under the Act. The Plan provides that the Fund will pay the Distributor a fee
which is accrued daily and paid monthly at the following annual rates: (i) Class
A -- up to 0.25% of the average daily net assets of Class A; (ii) Class B -- up
to 1.0% of the average daily net assets of Class B; and (iii) Class C -- up to
1.0% of the average daily net assets of Class C.
In the case of Class B shares, provided that the Plan continues in effect, any
cumulative expenses incurred by the Distributor but not yet recovered may be
recovered through the payment of future distribution fees from the Fund pursuant
to the Plan and contingent deferred sales charges paid by investors upon
redemption of Class B shares. Although there is no legal obligation for the Fund
to 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 $5,774,985
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.
27
Morgan Stanley Balanced Income 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 B shares and Class C shares of $148,277 and $2,502,
respectively and received $9,537 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 $54,153,032 and $74,085,012, respectively. Included in
the aforementioned are purchases and sales, maturities and prepayments of U.S.
Government securities of $46,502,161 and $49,001,449, respectively. The Fund had
purchases with other Morgan Stanley funds of $24,000.
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 may also arise upon entering into these contracts from the potential
inability of the counterparties to meet the terms of their contracts.
28
Morgan Stanley Balanced Income 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.............................................. 95,160 $ 1,187,180 264,863 $ 3,475,020
Conversion from Class B........................... 235,472 2,943,127 1,302,350 16,907,628
Reinvestment of dividends and distributions....... 46,915 571,338 105,157 1,336,171
Redeemed.......................................... (353,588) (4,420,005) (514,896) (6,743,161)
---------- ------------ ---------- ------------
Net increase - Class A............................ 23,959 281,640 1,157,474 14,975,658
---------- ------------ ---------- ------------
CLASS B SHARES
Sold.............................................. 146,794 1,834,474 951,941 12,432,158
Conversion to Class A............................. (236,412) (2,943,127) (1,307,463) (16,907,628)
Reinvestment of dividends and distributions....... 161,358 1,955,714 483,645 6,120,943
Redeemed.......................................... (1,409,456) (17,555,910) (3,119,370) (40,679,978)
---------- ------------ ---------- ------------
Net decrease - Class B............................ (1,337,716) (16,708,849) (2,991,247) (39,034,505)
---------- ------------ ---------- ------------
CLASS C SHARES
Sold.............................................. 62,813 788,917 323,214 4,214,224
Reinvestment of dividends and distributions....... 73,876 896,134 206,479 2,615,217
Redeemed.......................................... (531,023) (6,621,496) (678,101) (8,831,850)
---------- ------------ ---------- ------------
Net decrease - Class C............................ (394,334) (4,936,445) (148,408) (2,002,409)
---------- ------------ ---------- ------------
CLASS D SHARES
Sold.............................................. 2,414 30,465 35,650 462,004
Reinvestment of dividends and distributions....... 2,298 27,913 6,628 84,009
Redeemed.......................................... (32,446) (407,977) (87,220) (1,142,141)
---------- ------------ ---------- ------------
Net decrease - Class D............................ (27,734) (349,599) (44,942) (596,128)
---------- ------------ ---------- ------------
Net decrease in Fund.............................. (1,735,825) $(21,713,253) (2,027,123) $(26,657,384)
========== ============ ========== ============
</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
29
Morgan Stanley Balanced Income 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.
As of January 31, 2006, the Fund had 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.
30
Morgan Stanley Balanced Income Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2006 (UNAUDITED) continued
11. Subsequent Event -- Fund Merger
On September 18, 2006, the Fund was acquired by Morgan Stanley Balanced Growth
Fund ("Balance Growth") 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 the fund on August 23, 2006. The acquisition was
accomplished by a tax-free exchange of 2,415,880 Class A shares of Balanced
Growth at a net asset of $14.52 per share for $35,074,372 Class A shares of the
Fund; 4,914,367 Class B shares of Balanced Growth at a net asset value of $14.53
per share for $71,415,649 Class B shares of the Fund; 5,008,116 Class C shares
of Balanced Growth at a net asset value of $14.54 per share for $72,798,275
Class C shares of the Fund; and 72,948 Class D shares of Balanced Growth at a
net asset value of $14.51 per share for $1,058,382 Class D shares of the Fund.
The net assets of Balanced Growth and the Fund immediately before the
acquisition were $180,346,678 and $137,644,097, respectively, including
unrealized appreciation of $7,514,281 for the Fund. Immediately after the
acquisition, the combined net assets of Balanced Growth amounted to
$317,990,775.
31
Morgan Stanley Balanced Income Fund
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED JANUARY 31,
MONTHS ENDED --------------------------------------------------
JULY 31, 2006 2006 2005 2004 2003 2002
------------- -------- -------- -------- -------- ------
(unaudited)
Class A Shares:
Selected Per Share Data:
Net asset value, beginning of period.................. $12.68 $12.98 $12.66 $11.45 $12.35 $12.42
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income++........................... 0.17 0.33 0.30 0.26 0.33 0.43
Net realized and unrealized gain (loss)........... (0.08) 0.44 0.39 1.28 (0.84) (0.06)
------ ------ ------ ------ ------ ------
Total income (loss) from investment operations........ 0.09 0.77 0.69 1.54 (0.51) 0.37
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income............................. (0.17) (0.37) (0.37) (0.33) (0.39) (0.44)
Net realized gain................................. (0.24) (0.70) -- -- -- --
------ ------ ------ ------ ------ ------
Total dividends and distributions..................... (0.41) (1.07) (0.37) (0.33) (0.39) (0.44)
------ ------ ------ ------ ------ ------
Net asset value, end of period........................ $12.36 $12.68 $12.98 $12.66 $11.45 $12.35
====== ====== ====== ====== ====== ======
Total Return+......................................... 0.76%(1) 6.05% 5.55% 13.65% (4.19)% 3.13%
Ratios to Average Net Assets(3):
Total expenses (before expense offset)................ 1.39%(2) 1.15% 1.08% 1.09% 1.08% 1.16%
Net investment income................................. 2.75%(2) 2.49% 2.39% 2.15% 2.79% 3.44%
Supplemental Data:
Net assets, end of period, in thousands............... $22,642 $22,918 $8,434 $7,318 $3,125 $2,216
Portfolio turnover rate............................... 36%(1) 78% 89% 174% 173% 99%
</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>
See Notes to Financial Statements
32
Morgan Stanley Balanced Income 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......... $12.63 $12.93 $12.61 $11.40 $12.31 $12.39
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income++.................. 0.12 0.23 0.20 0.17 0.24 0.34
Net realized and unrealized gain
(loss)................................... (0.08) 0.44 0.39 1.28 (0.85) (0.07)
------ ------ ------ ------ ------ ------
Total income (loss) from investment
operations.................................. 0.04 0.67 0.59 1.45 (0.61) 0.27
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income.................... (0.12) (0.27) (0.27) (0.24) (0.30) (0.35)
Net realized gain........................ (0.24) (0.70) -- -- -- --
------ ------ ------ ------ ------ ------
Total dividends and distributions............ (0.36) (0.97) (0.27) (0.24) (0.30) (0.35)
------ ------ ------ ------ ------ ------
Net asset value, end of period............... $12.31 $12.63 $12.93 $12.61 $11.40 $12.31
====== ====== ====== ====== ====== ======
Total Return+................................ 0.44%(1) 5.16% 4.83% 12.77% (4.98)% 2.32%
Ratios to Average Net Assets(3):
Total expenses (before expense offset)....... 2.14%(2) 1.91% 1.84% 1.86% 1.84% 1.91%
Net investment income........................ 2.00%(2) 1.73% 1.63% 1.38% 2.03% 2.68%
Supplemental Data:
Net assets, end of period, in thousands...... $84,887 $103,938 $145,072 $169,135 $135,146 $101,957
Portfolio turnover rate...................... 36%(1) 78% 89% 174% 173% 99%
</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>
See Notes to Financial Statements
33
Morgan Stanley Balanced Income 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............ $12.65 $12.95 $12.63 $11.42 $12.33 $12.41
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income++..................... 0.12 0.23 0.21 0.17 0.24 0.33
Net realized and unrealized gain (loss)..... (0.08) 0.45 0.38 1.28 (0.85) (0.05)
------ ------ ------ ------ ------ ------
Total income (loss) from investment
operations..................................... 0.04 0.68 0.59 1.45 (0.61) 0.28
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income....................... (0.12) (0.28) (0.27) (0.24) (0.30) (0.36)
Net realized gain........................... (0.24) (0.70) -- -- -- --
------ ------ ------ ------ ------ ------
Total dividends and distributions............... (0.36) (0.98) (0.27) (0.24) (0.30) (0.36)
------ ------ ------ ------ ------ ------
Net asset value, end of period.................. $12.33 $12.65 $12.95 $12.63 $11.42 $12.33
====== ====== ====== ====== ====== ======
Total Return+................................... 0.46%(1) 5.25% 4.84% 12.74% (5.00)% 2.32%
Ratios to Average Net Assets(3):
Total expenses (before expense offset).......... 2.14%(2) 1.89% 1.77% 1.85% 1.84% 1.91%
Net investment income........................... 2.00%(2) 1.75% 1.70% 1.39% 2.03% 2.68%
Supplemental Data:
Net assets, end of period, in thousands......... $34,529 $40,401 $43,308 $43,092 $32,439 $33,321
Portfolio turnover rate......................... 36%(1) 78% 89% 174% 173% 99%
</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>
See Notes to Financial Statements
34
Morgan Stanley Balanced Income 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.................. $12.65 $12.95 $12.63 $11.42 $12.33 $12.40
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income++........................... 0.19 0.36 0.33 0.29 0.34 0.45
Net realized and unrealized gain (loss)........... (0.09) 0.44 0.39 1.28 (0.83) (0.05)
------ ------ ------ ------ ------ ------
Total income (loss) from investment operations........ 0.10 0.80 0.72 1.57 (0.49) 0.40
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income............................. (0.18) (0.40) (0.40) (0.36) (0.42) (0.47)
Net realized gain................................. (0.24) (0.70) -- -- -- --
------ ------ ------ ------ ------ ------
Total dividends and distributions..................... (0.42) (1.10) (0.40) (0.36) (0.42) (0.47)
------ ------ ------ ------ ------ ------
Net asset value, end of period........................ $12.33 $12.65 $12.95 $12.63 $11.42 $12.33
====== ====== ====== ====== ====== ======
Total Return+......................................... 0.96%(1) 6.24% 5.80% 13.94% (4.04)% 3.37%
Ratios to Average Net Assets(3):
Total expenses (before expense offset)................ 1.14%(2) 0.91% 0.84% 0.86% 0.84% 0.91%
Net investment income................................. 3.00%(2) 2.73% 2.63% 2.38% 3.03% 3.68%
Supplemental Data:
Net assets, end of period, in thousands............... $909 $1,283 $1,895 $3,034 $1,476 $496
Portfolio turnover rate............................... 36%(1) 78% 89% 174% 173% 99%
</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>
See Notes to Financial Statements
35
TRUSTEES
Michael Bozic
Charles A. Fiumefreddo
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Joseph J. Kearns
Michael E. Nugent
Fergus Reid
OFFICERS
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 Income Fund
Semiannual Report
July 31, 2006
[MORGAN STANLEY LOGO]
BINSAR-38400RPT-RA06-00856P-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 Income 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