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: 811-07117
Morgan Stanley Limited Duration 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: April 30, 2007
Date of reporting period: October 31, 2006
Item 1 - Report to Shareholders
Welcome, Shareholder:
In this report, you'll learn about how your investment in Morgan Stanley Limited
Duration 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 October 31, 2006
TOTAL RETURN FOR THE 6 MONTHS ENDED OCTOBER 31, 2006
<Table>
<Caption>
MORGAN STANLEY LEHMAN BROTHERS LIPPER SHORT
LIMITED DURATION U.S. CREDIT INDEX INVESTMENT GRADE
FUND (1-5 YEAR)(1) BOND FUNDS INDEX(2)
2.28% 3.56% 2.81%
</Table>
The Fund's total return assumes the reinvestment of all distributions. See
Performance Summary for standardized performance and benchmark information.
MARKET CONDITIONS
The Federal Open Market Committee (the "Fed") raised the federal funds target
rate by 25 basis points at both the May and June meetings, but then chose to
pause at the following three meetings. Comments made by Fed members after their
May and June meetings indicated that they will rely heavily on economic data in
making future decisions concerning the direction of interest rates. In fact,
based on these comments it appears that the Fed will be driven by the weight of
the economic data more so now than perhaps at anytime over the past few years.
At first glance, the third quarter gross domestic product (GDP) report was
disappointing, with the real economy expanding at a 1.6 percent annualized rate
during the period -- its weakest showing in three years. A further analysis,
however, suggests a more favorable view of the economy.
Most observers expected that housing would be a drag on GDP, and it certainly
was to the tune of approximately one full percentage point during the period.
However, this is far from a crushing blow to an economy that had been growing at
or above its long-term potential growth rate for the past few years. There is
also evidence that home sellers are responding to the housing market correction
by either withdrawing inventory from the market or by adjusting asking
prices -- both of which may tend to limit the severity and longevity of the
housing correction. Moreover, the so-called negative wealth effect caused by
lower home prices is open to debate. Empirical evidence shows that the assumed
relationships between mortgage equity withdrawals and consumer spending are
unstable in both the short run and the long run.
A further analysis of the third quarter GDP report also revealed strong gains in
both non-residential real restate and in real equipment spending. We are not
suggesting that investors ignore the relatively weak headline GDP number;
instead, we are suggesting that there is more to the report than meets the eye,
especially when evaluated within the context of other economic barometers.
Where does all of this leave the Fed? With inflation above 2 percent and
expectations for strong growth, we believe there is little support in any of the
recent data to justify a more accommodative monetary policy. If anything, there
is cause for concern on the inflation front, especially with tight labor
markets. Accordingly, a higher federal funds rate may well be necessary to
control the level of inflation and, accordingly, nominal economic growth rates.
Within the government sector, U.S. Treasuries underperformed over the six-month
period because of
2
their high sensitivity to fluctuating interest rates and their relatively low
yields. Yield spreads (a measure of market risk) of agency debentures and
mortgages remained tight relative to Treasuries. As is typical during periods of
declining interest rates, prepayment speeds on mortgages rose, causing
lower-coupon mortgages to outperform.
Within the investment-grade portion of the corporate 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 for the period, longer dated corporate issues underperformed
shorter-dated issues.
PERFORMANCE ANALYSIS
Morgan Stanley Limited Duration Fund underperformed the Lehman Brothers U.S.
Credit Index (1-5 Year) and the Lipper Short Investment Grade Bond Funds Index
for the six months ended October 31, 2006, assuming no deduction of applicable
sales charges.
During the period, we kept the Fund's overall duration* modestly below that of
the relevant indices. This posture was beneficial as interest rates rose across
the market, especially in the short- and intermediate-portions of the yield
curve.
The portfolio had a small exposure to higher-coupon mortgage backed securities
which benefited performance. Additionally, the portfolio had significant
exposure to adjustable rate mortgages which enhanced performance.
Within the credit section of the Portfolio, we employed a defensive strategy
with a focus on higher-quality securities, which detracted from relative
performance. However, strong security selection contributed positively to
performance for the period.
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>
PORTFOLIO COMPOSITION**
Corporate Bonds 43.3%
Private Issues -- CMOs 23.4
Mortgage-Backed Securities 17.9
Asset-Backed Securities 8.2
U.S. Government Agencies -- CMOs 2.8
Short-Term Investments 4.4
</Table>
<Table>
<Caption>
LONG-TERM CREDIT ANALYSIS
Aaa/AAA 53.6%
Aa/AA 12.4
A/A 18.4
Baa/BBB 15.6
</Table>
** Does not include open long futures contracts with an underlying face amount
of $34,544,658 with unrealized appreciation of $56,537 and open short futures
contracts with an underlying face amount of $11,717,438 and unrealized
depreciation of $69,189.
Data as of October 31, 2006. Subject to change daily. All percentages for
portfolio composition are as a percentage of total investments and all
percentages for long-term credit analysis are as a percentage of total long-term
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 65 percent of its assets in securities
issued or guaranteed as to principal and interest by the U.S. Government, its
agencies or instrumentalities (including zero coupon securities), investment
grade mortgage-backed securities, including collateralized mortgage obligations,
and investment grade corporate and other types of bonds. In selecting portfolio
investments to purchase or sell, the "Investment Adviser," Morgan Stanley
Investment Advisors Inc., considers both domestic and international economic
developments, interest rate levels, the steepness of the yield curve and other
factors, and seeks to maintain an overall average duration for the Fund's
portfolio of three years or less.
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
4
quarters to shareholders, nor are the reports posted to the Morgan Stanley
public web site. You may, however, obtain the Form N-Q filings (as well as the
Form N-CSR and N-CSRS filings) by accessing the SEC's web site,
http://www.sec.gov. You may also review and copy them at the SEC's public
reference room in Washington, DC. Information on the operation of the SEC's
public reference room may be obtained by calling the SEC at (800) SEC-0330. You
can also request copies of these materials, upon payment of a duplicating fee,
by electronic request at the SEC's e-mail address (publicinfo@sec.gov) or by
writing the public reference section of the SEC, Washington, DC 20549-0102.
PROXY VOTING POLICY AND PROCEDURES AND PROXY VOTING RECORD
You may obtain a copy of the Fund's Proxy Voting Policy and Procedures without
charge, upon request, by calling toll free (800) 869-NEWS or by visiting the
Mutual Fund Center on our Web site at www.morganstanley.com. It is also
available on the Securities and Exchange Commission's Web site at
http://www.sec.gov.
You may obtain information regarding how the Fund voted proxies relating to
portfolio securities during the most recent twelve-month period ended June 30
without charge by visiting the Mutual Fund Center on our Web site at
www.morganstanley.com. This information is also available on the Securities and
Exchange Commission's Web site at http://www.sec.gov.
HOUSEHOLDING NOTICE
To reduce printing and mailing costs, the Fund attempts to eliminate duplicate
mailings to the same address. The Fund delivers a single copy of certain
shareholder documents, including shareholder reports, prospectuses and proxy
materials, to investors with the same last name who reside at the same address.
Your participation in this program will continue for an unlimited period of time
unless you instruct us otherwise. You can request multiple copies of these
documents by calling (800) 350-6414, 8:00 a.m. to 8:00 p.m., ET. Once our
Customer Service Center has received your instructions, we will begin sending
individual copies for each account within 30 days.
5
PERFORMANCE SUMMARY
AVERAGE ANNUAL TOTAL RETURNS -- PERIOD ENDED OCTOBER 31, 2006
<Table>
<Caption>
(since 01/10/94)
SYMBOL MSLDX
1 YEAR 3.93%(3)
5 YEARS 2.31(3)
10 YEARS 4.35(3)
SINCE INCEPTION 4.44(3)
</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.
(1) The Lehman Brothers U.S. Credit Index (1-5 Year) includes U.S. corporate
and specified foreign debentures and secured notes with maturities of one
to five years. 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 Lipper Short Investment Grade Bond Funds Index is an equally weighted
performance index of the largest qualifying funds (based on net assets) in
the Lipper Short Investment Grade Bond 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.
(3) Figure shown assumes reinvestment of all distributions. There are no sales
charges.
6
EXPENSE EXAMPLE
As a shareholder of the Fund, you incur two types of costs: (1) transaction
costs, including redemption fees; and (2) ongoing costs, including advisory 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 05/01/06 - 10/31/06.
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. 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 that have transactional costs, such as sales charges
(loads), redemption fees or exchange fees.
<Table>
<Caption>
BEGINNING ENDING EXPENSES PAID
ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD *
------------- ------------- ---------------
05/01/06 -
05/01/06 10/31/06 10/31/06
------------- ------------- ---------------
Actual (2.28% return)....................................... $1,000.00 $1,022.80 $4.08
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,021.17 $4.08
</Table>
- ------------------
* Expenses are equal to the Fund's annualized expense ratio of 0.80%
multiplied by the average account value over the period, multiplied by
184/365 (to reflect the one-half year period). If the Fund had borne all of
its expenses waived by the Investment Adviser and Administrator, the
annualized expense ratios for the one-half period would have been 0.87%.
7
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED)
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------
Corporate Bonds (44.8%)
Aerospace & Defense (0.6%)
$ 435 McDonnell Douglas Corp. ............................... 6.875% 11/01/06 $ 435,000
330 Northrop Grumman Corp. ................................ 4.079 11/16/06 329,833
65 Raytheon Co. .......................................... 6.15 11/01/08 66,125
55 Raytheon Co. .......................................... 6.75 08/15/07 55,522
------------
886,480
------------
Air Freight/Couriers (0.3%)
385 FedEx Corp. ........................................... 2.65 04/01/07 380,623
------------
Airlines (0.3%)
435 Southwest Airlines Co. (Series 01-1)................... 5.496 11/01/06 435,205
------------
Auto Parts: O.E.M. (0.4%)
530 Johnson Controls, Inc. ................................ 5.00 11/15/06 529,842
------------
Automotive Aftermarket (0.2%)
245 FedEx Corp. ........................................... 5.50 08/15/09 246,729
------------
Beverages: Alcoholic (0.3%)
460 Miller Brewing Co. - 144A*............................. 4.25 08/15/08 451,461
------------
Building Products (0.1%)
200 Masco Corp. ........................................... 4.625 08/15/07 198,179
------------
Cable/Satellite TV (0.8%)
710 Comcast Cable Communications, Inc. .................... 6.875 06/15/09 738,568
427 Cox Communications Inc. ............................... 5.94+ 12/14/07 429,111
------------
1,167,679
------------
Casino/Gaming (0.3%)
455 Harrahs Operating Co., Inc. ........................... 7.125 06/01/07 457,179
------------
Chemicals: Major Diversified (0.2%)
275 ICI Wilmington Inc. ................................... 4.375 12/01/08 269,187
------------
Computer Processing Hardware (0.2%)
295 Hewlett-Packard Co. ................................... 5.524+ 05/22/09 295,585
------------
Containers/Packaging (0.1%)
145 Sealed Air Corp. - 144A*............................... 6.95 05/15/09 150,007
------------
Department Stores (0.9%)
160 Federated Department Stores, Inc. ..................... 6.30 04/01/09 162,856
340 JC Penney Corp., Inc. ................................. 7.375 08/15/08 350,642
820 May Department Stores Co., Inc. ....................... 3.95 07/15/07 809,875
------------
1,323,373
------------
Drugstore Chains (0.1%)
100 CVS Corp. ............................................. 3.875 11/01/07 98,332
------------
</Table>
8
See Notes to Financial Statements
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------
Electric Utilities (7.7%)
$ 285 Ameren Corp. .......................................... 4.263% 05/15/07 $ 283,124
385 Appalachian Power Co. (Series G)....................... 3.60 05/15/08 375,355
475 Baltimore Gas & Electric Co. .......................... 6.625 03/15/08 483,015
1,175 Carolina Power & Light Company Inc. ................... 6.80 08/15/07 1,187,125
480 CC Funding Trust I..................................... 6.90 02/16/07 481,858
710 Columbus Southern Power Co. ........................... 4.40 12/01/10 686,486
110 Commonwealth Edison Co. ............................... 3.70 02/01/08 107,614
2,120 Consolidated Natural Gas Co. (Series B)................ 5.375 11/01/06 2,120,000
270 Consumers Energy Co. .................................. 4.80 02/17/09 266,837
350 Dominion Resources Inc. ............................... 5.687 05/15/08 351,609
335 Duke Energy Corp. ..................................... 3.75 03/05/08 328,685
185 Entergy Gulf States, Inc. ............................. 3.60 06/01/08 179,781
295 Entergy Gulf States, Inc. ............................. 5.80+ 12/01/09 294,469
605 FPL Group Capital Inc. ................................ 5.551 02/16/08 606,647
1,090 Pacific Gas & Electric Co. ............................ 3.60 03/01/09 1,052,699
230 Panhandle Eastern Pipe Line Co. (Series B)............. 2.75 03/15/07 227,651
595 Peco Energy Co. ....................................... 3.50 05/01/08 580,202
450 Southwestern Public Service Co. (Series A)............. 6.20 03/01/09 458,256
375 Texas-New Mexico Power Co. ............................ 6.25 01/15/09 381,759
345 Wisconsin Electric Power Co. .......................... 3.50 12/01/07 338,841
------------
10,792,013
------------
Electrical Products (0.3%)
480 Cooper Industries, Inc. ............................... 5.25 07/01/07 478,072
------------
Finance/Rental/Leasing (3.1%)
840 American Honda Finance Corp. - 144A*................... 3.85 11/06/08 819,256
710 Countrywide Home Loans, Inc. (Series MTN).............. 3.25 05/21/08 689,537
355 MBNA Corp. ............................................ 5.91+ 05/05/08 357,522
1,360 Nationwide Buildings Society - 144A* (United
Kingdom)............................................. 2.625 01/30/07 1,350,917
500 Residential Capital Corp. ............................. 6.125 11/21/08 503,014
600 SLM Corp. ............................................. 4.00 01/15/10 579,958
------------
4,300,204
------------
Financial Conglomerates (3.1%)
145 Chase Manhattan Corp. ................................. 7.00 11/15/09 152,016
695 CIT Group Inc. (Series MTN)............................ 4.75 08/15/08 689,850
485 Citigroup Inc. ........................................ 3.625 02/09/09 470,283
715 General Electric Capital Corp. ........................ 4.25 12/01/10 695,019
535 General Electric Capital Corp. ........................ 5.375 03/15/07 535,170
815 ING Security Life Institutional - 144A*................ 2.70 02/15/07 807,721
1,045 Pricoa Global Funding I - 144A*........................ 3.90 12/15/08 1,016,678
------------
4,366,737
------------
</Table>
9
See Notes to Financial Statements
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------
Food Retail (0.4%)
$ 290 Fred Meyer, Inc. ...................................... 7.45% 03/01/08 $ 297,294
290 Safeway Inc. .......................................... 7.50 09/15/09 305,907
------------
603,201
------------
Food: Major Diversified (1.3%)
565 General Mills Inc. .................................... 3.875 11/30/07 555,646
1,270 Kraft Foods Inc. ...................................... 5.25 06/01/07 1,268,123
------------
1,823,769
------------
Forest Products (0.0%)
57 Weyerhaeuser Co. ...................................... 6.125 03/15/07 57,032
------------
Gas Distributors (1.1%)
170 Keyspan Corp. ......................................... 4.90 05/16/08 169,195
320 NiSource Finance Corp. ................................ 5.968+ 11/23/09 320,237
1,025 Sempra Energy.......................................... 4.75 05/15/09 1,012,565
------------
1,501,997
------------
Home Furnishings (0.3%)
450 Mohawk Industries, Inc. (Class C)...................... 6.50 04/15/07 451,791
------------
Hotels/Resorts/Cruiselines (0.5%)
545 Hyatt Equities LLC - 144A*............................. 6.875 06/15/07 548,188
210 Starwood Hotels & Resorts Worldwide, Inc. ............. 7.375+ 05/01/07 212,362
------------
760,550
------------
Household/Personal Care (0.4%)
510 Clorox Co. (The)....................................... 5.515+ 12/14/07 511,025
------------
Industrial Conglomerates (0.3%)
400 Textron Financial Corp. ............................... 4.125 03/03/08 393,729
------------
Insurance Brokers/Services (0.9%)
1,265 Marsh & McLennan Companies Inc. ....................... 5.375 03/15/07 1,264,209
------------
Investment Banks/Brokers (1.4%)
1,055 Goldman Sachs Group Inc. (The)......................... 4.125 01/15/08 1,041,767
917 Lehman Brothers Holdings, Inc. ........................ 8.25 06/15/07 933,390
------------
1,975,157
------------
Life/Health Insurance (2.9%)
1,540 Genworth Financial, Inc. .............................. 5.54+ 06/15/07 1,542,416
585 John Hancock Financial Services, Inc. ................. 5.625 12/01/08 590,527
1,255 Met Life Global Funding I - 144A*...................... 3.375 10/05/07 1,223,020
355 Monumental Global Funding II - 144A*................... 3.85 03/03/08 348,500
350 Monumental Global Funding II - 144A*................... 4.375 07/30/09 343,213
------------
4,047,676
------------
</Table>
10
See Notes to Financial Statements
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------
Major Banks (4.0%)
$1,290 ABN Amro Bank (Netherlands)............................ 5.464+% 05/11/07 $ 1,290,668
800 Bank of America Corp. ................................. 3.375 02/17/09 771,584
285 Bank of New York Co., Inc. (The)....................... 5.20 07/01/07 284,933
755 HBOS Treasury Services PLC - 144A* (United Kingdom).... 5.625 07/20/09 763,701
315 Popular North America Inc. (Series MTN)................ 5.65 04/15/09 316,361
585 Suntrust Bank Atlanta.................................. 4.55 05/25/09 577,015
565 Unicredit Luxembourg Finance S.A. - 144A*.............. 5.426+ 10/24/08 565,219
180 Wachovia Corp. ........................................ 3.625 02/17/09 174,175
365 Wells Fargo & Co. ..................................... 3.12 08/15/08 352,272
470 World Savings Bank FSB (Series BKNT)................... 4.125 12/15/09 457,124
------------
5,553,052
------------
Major Telecommunications (1.1%)
325 Deutsche Telekom International Finance BV
(Netherlands)........................................ 8.00+ 06/15/10 355,037
385 Telecom Italia Capital SA (Luxembourg)................. 4.00 11/15/08 374,730
740 Verizon Global Funding Corp. .......................... 6.125 06/15/07 743,505
------------
1,473,272
------------
Managed Health Care (0.3%)
480 UnitedHealth Group Inc. ............................... 4.125 08/15/09 466,754
------------
Media Conglomerates (0.6%)
340 Time Warner, Inc. ..................................... 6.15 05/01/07 341,271
155 Viacom Inc. ........................................... 5.74+ 06/16/09 155,131
300 Viacom Inc. ........................................... 5.75 04/30/11 300,667
------------
797,069
------------
Medical Specialties (0.4%)
605 Baxter International Inc. ............................. 5.196 02/16/08 602,336
------------
Motor Vehicles (0.5%)
295 DaimlerChrysler North American Holdings Co. ........... 4.05 06/04/08 288,556
345 DaimlerChrysler North American Holdings Co............. 5.82+ 03/13/09 345,451
------------
634,007
------------
Multi-Line Insurance (1.0%)
125 AXA Financial, Inc. ................................... 6.50 04/01/08 127,076
490 Hartford Financial Services Group, Inc. (The).......... 5.55 08/16/08 492,855
500 International Lease Finance Corp. ..................... 3.75 08/01/07 493,795
310 International Lease Finance Corp. ..................... 4.625 06/02/08 306,853
------------
1,420,579
------------
Oil & Gas Pipelines (0.4%)
555 Enbridge Energy Partners, LP........................... 4.00 01/15/09 537,788
------------
</Table>
11
See Notes to Financial Statements
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------
Other Metals/Minerals (0.3%)
$ 340 Brascan Corp. (Canada)................................. 8.125% 12/15/08 $ 357,732
------------
Property - Casualty Insurers (1.4%)
815 Mantis Reef Ltd. - 144A* (Australia)................... 4.692 11/14/08 801,531
255 Platinum Underwriters Holdings, Ltd. (Series B)
(Bermuda)............................................ 6.371 11/16/07 253,316
405 St. Paul Travelers Companies, Inc. (The)............... 5.01 08/16/07 402,832
500 XLLIAC Global Funding - 144A*.......................... 4.80 08/10/10 491,310
------------
1,948,989
------------
Pulp & Paper (0.3%)
365 International Paper Co. ............................... 3.80 04/01/08 356,807
------------
Railroads (1.5%)
385 Burlington North Santa Fe Railway Co. ................. 6.125 03/15/09 392,779
270 Norfolk Southern Corp. ................................ 7.35 05/15/07 272,742
285 Union Pacific Corp. ................................... 3.625 06/01/10 270,077
1,120 Union Pacific Corp. (Series MTNE)...................... 6.79 11/09/07 1,131,915
------------
2,067,513
------------
Real Estate Development (0.6%)
407 World Financial Properties - 144A*..................... 6.91 09/01/13 427,961
359 World Financial Properties - 144A*..................... 6.95 09/01/13 378,204
------------
806,165
------------
Real Estate Investment Trusts (0.6%)
440 EOP Operating LP....................................... 6.763 06/15/07 443,302
330 Simon Property Group LP................................ 6.375 11/15/07 332,889
------------
776,191
------------
Regional Banks (0.4%)
510 Banco Santander Central Hispano Issuances Ltd. (Cayman
Islands)............................................. 7.625 11/03/09 544,400
------------
Savings Banks (1.5%)
420 Household Finance Corp. ............................... 4.125 12/15/08 411,944
1,010 Household Finance Corp. ............................... 6.40 06/17/08 1,029,296
150 Sovereign Bank (Series CD)............................. 4.00 02/01/08 147,543
155 Washington Mutual Inc. ................................ 4.00 01/15/09 151,372
310 Washington Mutual Inc. ................................ 8.25 04/01/10 336,364
------------
2,076,519
------------
</Table>
12
See Notes to Financial Statements
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------
Trucks/Construction/Farm Machinery (1.0%)
$ 500 Caterpillar Financial Services Corp. (Series MTNF)..... 3.625% 11/15/07 $ 491,492
525 John Deere Capital Corp. .............................. 3.375 10/01/07 515,222
360 John Deere Capital Corp. .............................. 4.50 08/22/07 357,531
------------
1,364,245
------------
Wireless Telecommunications (0.4%)
580 Vodafone Group PLC (United Kingdom).................... 5.457+ 12/28/07 580,366
------------
Total Corporate Bonds (Cost $63,299,209).................................... 62,580,807
------------
Private Issues - Collateralized Mortgage Obligations (24.2%)
999 Banc of America Funding Corp. 2006-H 3A1............... 6.239 09/20/46 1,005,965
615 Bear Stearns Alt-A Trust 2003-3 3A..................... 5.67+ 10/25/33 616,555
950 Bear Stearns Mortgage Funding Trust 2006-AR3 1A1....... 5.50+ 10/25/36 950,148
820 Bear Stearns Mortgage Funding Trust 2006-AR1 1A2....... 5.595+ 07/25/36 820,256
1,077 Countrywide Alternative Loan Trust 2005-58 A2.......... 5.71+ 12/20/35 1,082,048
864 Countrywide Alternative Loan Trust 2006-OA1 1A2........ 5.62+ 03/20/46 864,296
3,829 Countrywide Alternative Loan Trust 2005-81 X1 (IO)..... 1.566+ 02/25/37 210,002
821 Countrywide Alternative Loan Trust 2006-OA14 2A1....... 5.514+ 11/25/46 821,537
1,189 Countrywide Alternative Loan Trust 2006-OA16 A3........ 5.57+ 10/25/46 1,188,898
131 Countrywide Alternative Loan Trust NIM 2006-OA6N N1 -
144A*................................................ 5.25 07/25/46 130,237
4,986 Countrywide Alternative Loan Trust 2006-OA1 2X (IO).... 1.04+ 03/20/46 248,557
126 Countrywide Asset-Backed Certificates 2005-2N
N - 144A*............................................ 4.50 08/25/36 124,547
5,300 Countrywide Home Loans 2004-25 1X (IO)................. 1.742+ 02/25/35 122,555
1,031 DSLA Mortgage Loan Trust 2006-AR2 2A1A................. 5.52+ 11/19/37 1,033,177
84 DSLA NIM Corp. 2006-1 N1 - 144A*....................... 5.926 04/20/46 84,095
839 Greenpoint Mortgage Funding Trust 2006-AR2 4A1......... 6.664+ 03/25/36 859,040
2,363 Greenpoint Mortgage Funding Trust 2005-AR3 X1 (IO)..... 1.028+ 08/25/45 74,574
4,037 Greenpoint Mortgage Funding Trust 2005-AR4 X4 (IO)..... 1.005+ 10/25/45 126,773
129 GS Mortgage Securities Corp. 2006-NIM3 N1 - 144A*...... 6.414 06/25/46 129,098
4,923 Harborview Mortgage Loan Trust 2005-2 X (IO)........... 0.719+ 05/19/35 119,235
1,100 Harborview Mortgage Loan Trust 2006-10 2A1B............ 5.56+ 11/19/36 1,100,086
841 Harborview Mortgage Loan Trust 2006-7 2A1B............. 5.57+ 10/19/37 843,234
1,017 Harborview Mortgage Loan Trust 2006-8 2A1B............. 5.57+ 08/21/46 1,016,846
945 Harborview Mortgage Loan Trust 2006-1 2A1A............. 5.56+ 03/19/37 946,658
0 Harborview Mortgage Loan Trust 2006-5 PO2 (PO)......... 0.00 07/19/47 10
3,593 Harborview Mortgage Loan Trust 2006-5 X2 (IO).......... 1.369+ 07/19/47 135,860
3,342 Harborview Mortgage Loan Trust 2005-16 X1 (IO)......... 1.409+ 01/19/36 97,131
9,661 Harborview Mortgage Loan Trust 2005-16 X3 (IO)......... 1.334+ 01/19/36 259,628
4,060 Harborview Mortgage Loan Trust 2005-3 X2 (IO).......... 0.631+ 06/19/35 91,972
250 Harborview Mortgage Loan Trust 2005-9 B1............... 5.92+ 06/20/35 253,454
2 Harborview Mortgage Loan Trust 2006-1 PO1 (PO)......... 0.00 03/19/37 1,616
</Table>
13
See Notes to Financial Statements
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------
$1,300 Harborview Mortgage Loan Trust 2006-12 2A2B............ 5.57+% 12/19/37 $ 1,300,101
1,846 Harborview Mortgage Loan Trust 2005-16 4A1A............ 6.664+ 01/19/36 1,886,586
5,113 Harborview Mortgage Loan Trust 2006-1 X1 (IO).......... 1.636+ 03/19/37 241,259
115 Harborview NIM Corp. 2006-7A N1 - 144A*................ 6.409 09/19/36 114,653
68 Harborview NIM Corp. 2006-BU1 N1 - 144A*............... 5.926 02/20/46 68,485
381 IndyMac INDX Mortgage Loan Trust 2004-AR3 B1........... 5.82+ 07/25/34 380,885
139 IndyMac INDX NIM Corp. 2006-AR6 N1 - 144A*............. 6.654 06/25/46 138,871
138 Lehman XS Net Interest Margin Notes 2006-GP1
A1 - 144A*........................................... 6.25 05/28/46 137,777
987 Luminent Mortgage Trust 2006-6 A1...................... 5.52+ 10/25/46 987,409
873 Luminent Mortgage Trust 2006-1 A1...................... 5.56+ 04/25/36 875,447
858 Luminent Mortgage Trust 2006-2 A1B..................... 5.60+ 02/25/46 859,245
117 RALI NIM Corp. 2006-Q04 N1 - 144A*..................... 6.048 04/25/46 117,287
408 Residential Accredit Loans, Inc. 2006-Q01 1A1.......... 5.58+ 02/25/46 408,970
468 Residential Accredit Loans, Inc. 2006-Q01 2A1.......... 5.59+ 02/25/46 468,185
739 Residential Accredit Loans, Inc. 2006-Q01 2A2.......... 5.65+ 02/25/46 742,410
1,117 Residential Accredit Loans, Inc. 2006-Q06 A2........... 5.55+ 06/25/46 1,115,755
739 Structured Asset Mortgage Investments, Inc. 2006-AR1
2A2.................................................. 5.63+ 02/25/36 741,554
1,017 Structured Asset Mortgage Investments, Inc. 2006-AR2
A2................................................... 5.63+ 02/25/36 1,020,796
1,000 Structured Asset Mortgage Investments, Inc. 2006-AR8
A1A.................................................. 5.52+ 10/25/36 1,000,156
1,428 Washington Mutual 2005-AR13 A1B3....................... 5.68+ 10/25/45 1,436,522
1,454 Washington Mutual 2005-AR15 A1B3....................... 5.66+ 11/25/45 1,464,662
569 Washington Mutual 2005-AR8 2AB3........................ 5.68+ 07/25/45 572,231
1,418 Washington Mutual 2006-AR9 1A.......................... 5.664+ 08/25/46 1,421,952
4,899 Washington Mutual 2004-AR10 X (IO)..................... 0.853+ 07/25/44 88,791
6,797 Washington Mutual 2004-AR12 X (IO)..................... 0.879+ 10/25/44 121,062
2,789 Washington Mutual 2004-AR8 X (IO)...................... 0.871+ 06/25/44 50,542
751 WMALT Mortgage Pass-Through Certificates 2006-AR6 2A... 5.92+ 08/25/46 753,367
------------
Total Private Issues - Collateralized Mortgage Obligations (Cost
$34,371,234)................................................................ 33,873,048
------------
U.S. Government Agencies - Mortgage-Backed Securities (18.4%)
1,199 Federal Home Loan Mortgage Corp. ...................... 7.50 10/01/26- 1,248,960
08/01/32
780 Federal Home Loan Mortgage Corp. ARM................... 3.538 07/01/34 765,153
1,203 Federal Home Loan Mortgage Corp. ARM................... 4.161 08/01/34 1,197,488
10 Federal Home Loan Mortgage Corp. PC Gold............... 6.50 07/01/29- 10,435
09/01/29
1,669 Federal Home Loan Mortgage Corp. PC Gold............... 7.50 01/01/30- 1,735,329
07/01/32
962 Federal National Mortgage Assoc. ...................... 6.50 01/01/29- 986,889
07/01/32
4,234 Federal National Mortgage Assoc. ...................... 7.00 02/01/26- 4,373,680
09/01/35
1,300 Federal National Mortgage Assoc. ...................... 7.00 *** 1,336,969
</Table>
14
See Notes to Financial Statements
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------
$ 651 Federal National Mortgage Assoc. ...................... 7.50% 09/01/29- $ 678,543
09/01/32
853 Federal National Mortgage Assoc. ARM................... 3.607 07/01/34 854,601
475 Federal National Mortgage Assoc. ARM................... 3.761 06/01/34 476,943
1,009 Federal National Mortgage Assoc. ARM................... 4.142 09/01/34 1,003,277
1,332 Federal National Mortgage Assoc. ARM................... 4.195 05/01/35 1,330,972
1,157 Federal National Mortgage Assoc. ARM................... 4.296 04/01/35 1,149,042
1,090 Federal National Mortgage Assoc. ARM................... 4.34 05/01/35 1,087,382
810 Federal National Mortgage Assoc. ARM................... 4.487 04/01/35 800,780
1,300 Federal National Mortgage Assoc. ARM................... 4.754 07/01/35 1,286,023
1,668 Federal National Mortgage Assoc. ARM................... 4.782 09/01/35 1,646,076
885 Federal National Mortgage Assoc. ARM................... 5.908 07/01/33 896,055
1,362 Government National Mortgage Assoc. II................. 4.50+ 08/20/29- 1,367,482
09/20/29
296 Government National Mortgage Assoc. II................. 5.125+ 10/20/24- 299,085
12/20/24
1,279 Government National Mortgage Assoc. II................. 5.375+ 06/20/22- 1,286,803
05/20/23
------------
Total U.S. Government Agencies - Mortgage-Backed Securities (Cost
$26,073,403)................................................................ 25,817,967
------------
Asset-Backed Securities (8.5%)
275 Aegis Asset Backed Securities Trust 2004-2 B1.......... 7.32+ 06/25/34 278,123
350 Ameriquest Mortgage Securities Inc. 2004-R7 M5......... 6.47+ 08/25/34 352,950
1,300 Capital Auto Receivables Asset Trust 2006-SN1A A3
-144A*............................................... 5.31 10/20/09 1,302,853
1,300 Capital Auto Receivables Asset Trust 2006-1 A3......... 5.03 10/15/09 1,297,586
1,000 Caterpillar Financial Asset Trust 2006-A A3............ 5.57 05/25/10 1,008,866
1,800 Chase Manhattan Auto Owner Trust 2004-A A4............. 2.83 09/15/10 1,762,654
500 CNH Equipment Trust 2006-B A3.......................... 5.20 06/15/10 501,219
1,450 CNH Equipment Trust 2005-A A3.......................... 4.02 04/15/09 1,438,660
467 Harley-Davidson Motorcycle Trust 2002-2 A2............. 3.09 06/15/10 462,991
2,152 Harley-Davidson Motorcycle Trust 2003-3 A2............. 2.76 05/15/11 2,121,831
725 Hertz Vehicle Financing LLC 2005-2A A2 - 144A*......... 4.93 02/25/10 722,204
150 Home Equity Asset Trust 2004-3 B1...................... 7.42+ 08/25/34 152,410
425 Park Place Securities Inc. 2004-MCW1 M7................ 7.17+ 10/25/34 434,502
------------
Total Asset-Backed Securities (Cost $11,907,805)............................ 11,836,849
------------
U.S. Government Agencies - Collateralized Mortgage Obligations
(2.9%)
1,419 Federal Home Loan Mortgage Corp. 2182 ZC............... 7.50 09/15/29 1,490,395
1,575 Federal National Mortgage Assoc. 2005-27 NA (PAC)...... 5.50 01/25/24 1,573,473
995 Federal National Mortgage Assoc. 2005-27 NA (PAC)...... 6.50 06/25/35 1,031,344
------------
Total U.S. Government Agencies - Collateralized Mortgage Obligations (Cost
$4,260,035)................................................................. 4,095,212
------------
</Table>
15
See Notes to Financial Statements
Morgan Stanley Limited Duration Fund
PORTFOLIO OF INVESTMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------
Short-Term Investments (4.5%)
U.S. Government Obligation (a) (0.1%)
$ 200 U.S. Treasury Bill** (Cost $197,992)................... 5.09% 01/11/07 $ 197,992
------------
Repurchase Agreement (4.4%)
6,187 Joint repurchase agreement account (dated 10/31/06;
proceeds $6,187,910) (b) (Cost $6,187,000)........... 5.295 11/01/06 6,187,000
------------
Total Short-Term Investments (Cost $6,384,992).............................. 6,384,992
------------
</Table>
<Table>
Total Investments (Cost $146,296,678) (c) (d)..................... 103.3% 144,588,875
Liabilities in Excess of Other Assets............................. (3.3) (4,642,435)
----- ------------
Net Assets........................................................ 100.0% $139,946,440
===== ============
</Table>
- ---------------------
<Table>
ARM Adjustable Rate Mortgage. Interest rate in effect as of
October 31, 2006.
IO Interest Only Security.
PAC Planned Amortization Class.
PC Participation Certificate.
PO Principal Only 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
$23,630.
*** Securities were 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.
+ Floating rate security; rate shown is the rate in effect at
October 31, 2006.
(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 $51,800,205 in connection with securities purchased
on a forward commitment basis and open futures contracts.
(d) The aggregate cost for federal income tax purposes
approximates the aggregate cost for book purposes. The
aggregate gross unrealized appreciation is $162,913 and the
aggregate gross unrealized depreciation is $1,870,716,
resulting in net unrealized depreciation of $1,707,803.
</Table>
FUTURES CONTRACTS OPEN AT OCTOBER 31, 2006:
<Table>
<Caption>
UNREALIZED
NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE APPRECIATION
CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE (DEPRECIATION)
- ------------------------------------------------------------------------------------------
169 Long U.S. Treasury Note 2 $ 34,544,658 $ 56,537
Year,
December 2006
111 Short U.S. Treasury Note 5 (11,717,438) (69,189)
Year,
December 2006
Net Unrealized Depreciation..................... $(12,652)
========
</Table>
16
See Notes to Financial Statements
Morgan Stanley Limited Duration Fund
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
October 31, 2006 (unaudited)
<Table>
Assets:
Investments in securities, at value (cost $146,296,678)..... $144,588,875
Cash........................................................ 11,158
Receivable for:
Investments sold........................................ 1,338,658
Interest................................................ 1,207,486
Shares of beneficial interest sold...................... 49,194
Variation margin........................................ 6,659
Principal paydowns...................................... 1,788
Prepaid expenses and other assets........................... 10,990
------------
Total Assets............................................ 147,214,808
------------
Liabilities:
Payable for:
Investments purchased................................... 6,854,309
Shares of beneficial interest redeemed.................. 189,982
Dividends to shareholders............................... 73,903
Investment advisory fee................................. 54,653
Transfer agent fee...................................... 21,658
Administration fee...................................... 9,896
Accrued expenses and other payables......................... 63,967
------------
Total Liabilities....................................... 7,268,368
------------
Net Assets.............................................. $139,946,440
============
Composition of Net Assets:
Paid-in-capital............................................. $170,645,053
Net unrealized depreciation................................. (1,720,455)
Dividends in excess of net investment income................ (2,418,603)
Accumulated net realized loss............................... (26,559,555)
------------
Net Assets.............................................. $139,946,440
============
Net Asset Value Per Share,
15,532,254 shares outstanding (unlimited shares authorized
of $.01 par value).......................................... $9.01
============
</Table>
17
See Notes to Financial Statements
Morgan Stanley Limited Duration Fund
FINANCIAL STATEMENTS continued
Statement of Operations
For the six months ended October 31, 2006 (unaudited)
<Table>
Net Investment Income:
Interest Income............................................. $ 3,644,481
-----------
Expenses
Investment advisory fee..................................... 391,331
Transfer agent fees and expenses............................ 85,887
Administration fee.......................................... 60,205
Shareholder reports and notices............................. 37,000
Professional fees........................................... 35,537
Registration fees........................................... 15,838
Custodian fees.............................................. 13,136
Trustees' fees and expenses................................. 1,100
Other....................................................... 14,650
-----------
Total Expenses.......................................... 654,684
Less: amounts waived........................................ (52,248)
Less: expense offset........................................ (388)
-----------
Net Expenses............................................ 602,048
-----------
Net Investment Income................................... 3,042,433
-----------
Net Realized and Unrealized Gain (Loss):
Net Realized Gain (Loss) on:
Investments................................................. (266,995)
Futures contracts........................................... (226,024)
Options contracts........................................... 5,297
-----------
Net Realized Loss....................................... (487,722)
-----------
Net Change in Unrealized Appreciation/Depreciation on:
Investments................................................. 758,897
Futures contracts........................................... 50,028
-----------
Net Appreciation........................................ 808,925
-----------
Net Gain................................................ 321,203
-----------
Net Increase................................................ $ 3,363,636
===========
</Table>
18
See Notes to Financial Statements
Morgan Stanley Limited Duration Fund
FINANCIAL STATEMENTS continued
Statements of Changes in Net Assets
<Table>
<Caption>
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
OCTOBER 31, 2006 APRIL 30, 2006
---------------- --------------
(unaudited)
Increase (Decrease) in Net Assets:
Operations:
Net investment income....................................... $ 3,042,433 $ 7,699,849
Net realized loss........................................... (487,722) (2,966,520)
Net change in unrealized appreciation/depreciation.......... 808,925 674,043
------------ -------------
Net Increase............................................ 3,363,636 5,407,372
------------ -------------
Dividends to shareholders from net investment income........ (3,582,340) (10,065,548)
Net decrease from transactions in shares of beneficial
interest.................................................. (20,035,176) (191,265,877)
------------ -------------
Net Decrease............................................ (20,253,880) (195,924,053)
Net Assets:
Beginning of period......................................... 160,200,320 356,124,373
------------ -------------
End of Period
(Including dividends in excess of net investment income of
$2,418,603 and $1,878,696, respectively).................... $139,946,440 $ 160,200,320
============ =============
</Table>
19
See Notes to Financial Statements
Morgan Stanley Limited Duration Fund
NOTES TO FINANCIAL STATEMENTS - OCTOBER 31, 2006 (UNAUDITED)
1. Organization and Accounting Policies
Morgan Stanley Limited Duration Fund (the "Fund") is registered under the
Investment Company Act of 1940, as amended, as a diversified, open-end
management investment company. The Fund's investment objective is to provide a
high level of current income consistent with the preservation of capital. The
Fund was organized as a Massachusetts business trust on October 22, 1993 and
commenced operations on January 10, 1994.
The Fund will assess a 2% redemption fee, 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) certain portfolio securities may be valued by
an outside pricing service approved by the Fund's Trustees; (2) 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; (3)
futures are valued at the latest price published by the commodities exchange on
which they trade; (4) when market quotations are not readily available including
circumstances under which Morgan Stanley Investment Advisors Inc. (the
"Investment Adviser") determines that the market quotations are not reflective
of 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; (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; and (6) 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.
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
20
Morgan Stanley Limited Duration Fund
NOTES TO FINANCIAL STATEMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
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. Futures Contracts -- A futures contract is an agreement between two parties
to buy and sell financial instruments or contracts based on financial indices at
a set price on a future date. Upon entering into such a contract, the Fund is
required to pledge to the broker cash, U.S. Government securities or other
liquid portfolio securities equal to the minimum initial margin requirements of
the applicable futures exchange. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in the value of the contract. Such receipts or payments known as
variation margin are recorded by the Fund as unrealized gains and losses. Upon
closing of the contract, the Fund realizes a gain or loss equal to the
difference between the value of the contract at the time it was opened and the
value at the time it was closed.
E. Options -- When the Fund writes a call option, an amount equal to the premium
received is included in the Fund's Statement of Assets and Liabilities as a
liability which is subsequently marked-to-market to reflect the current market
value of the option written. If a written option either expires or the Fund
enters into a closing purchase transaction, the Fund realizes a gain or loss
without regard to any unrealized gain or loss on the underlying security or
currency and the liability related to such option is extinguished. If a written
call option is exercised, the Fund realizes a gain or loss from the sale of the
underlying security or currency and the proceeds from such sale are increased by
the premium originally received.
When the Fund purchases a call or put option, the premium paid is recorded as an
investment and is subsequently marked-to-market to reflect the current market
value. If a purchased option expires, the Fund will realize a loss to the extent
of the premium paid. If the Fund enters into a closing sale transaction, a gain
or loss is realized for the difference between the proceeds from the sale and
the cost of the option. If a put option is exercised, the cost of the security
or currency sold upon exercise will be increased by the premium originally paid.
If a call option is exercised, the cost of the security purchased upon exercise
will be increased by the premium originally paid.
F. Federal Income Tax Policy -- It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Accordingly, no federal income tax provision is required.
G. Dividends and Distributions to Shareholders -- Dividends and distributions to
shareholders are recorded on the ex-dividend date.
21
Morgan Stanley Limited Duration Fund
NOTES TO FINANCIAL STATEMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
H. Use of Estimates -- The preparation of financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts and disclosures.
Actual results could differ from those estimates.
2. Investment Advisory/Administration Agreements
Pursuant to an Investment Advisory Agreement with Morgan Stanley Investment
Adviser, the Fund pays 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% of the portion of the daily net assets
not exceeding $1 billion; 0.47% to the portion of the daily net assets exceeding
$1 billion but not exceeding $2 billion and 0.42% of the portion of the daily
net assets in excess of $2 billion.
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.
Effective November 18, 2005, the Investment Adviser has agreed to cap the Fund's
operating expenses for one year by assuming the Fund's "other expenses" and/or
waiving the Fund's advisory fees, and the Administrator has agreed to waive the
Fund's administrative fees, to the extent such operating expenses on an
annualized basis exceed 0.80% of the average daily net assets of the Fund.
3. Security Transactions and Transactions with Affiliates
The cost of purchases and proceeds from sales/maturities/prepayments of
portfolio securities, excluding short-term investments, for the six months ended
October 31, 2006 were $40,956,339, and $55,278,858, respectively. Included in
the aforementioned are purchases and sales/prepayments of U.S. Government
securities of $7,481,640 and $12,744,948, respectively.
Morgan Stanley Trust, an affiliate of the Investment Adviser and Administration,
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 he or she receives for serving on the Board of Trustees. Each eligible
Trustee generally may elect to have the deferred amounts credited with a return
equal to the total return on one or more of the Morgan Stanley funds that are
offered as investment options under the Compensation Plan.
Appreciation/depreciation and distributions received from these investments are
recorded with an offsetting increase/decrease in the deferred compensation
obligation and do not affect the net asset value of the Fund.
22
Morgan Stanley Limited Duration Fund
NOTES TO FINANCIAL STATEMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
4. Shares of Beneficial Interest
Transactions in shares of beneficial interest were as follows:
<Table>
<Caption>
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
OCTOBER 31, 2006 APRIL 30, 2006
------------------------- ---------------------------
(unaudited)
SHARES AMOUNT SHARES AMOUNT
---------- ------------ ----------- -------------
Sold............................................ 594,933 $ 5,348,340 3,479,165 $ 31,694,608
Reinvestment of dividends....................... 279,640 2,516,080 795,079 7,229,149
---------- ------------ ----------- -------------
874,573 7,864,420 4,274,244 38,923,757
Redeemed........................................ (3,101,581) (27,899,596) (25,350,341) (230,189,634)
---------- ------------ ----------- -------------
Net decrease.................................... (2,227,008) $(20,035,176) (21,076,097) $(191,265,877)
========== ============ =========== =============
</Table>
5. Expense Offset
The expense offset represents a reduction of the fees and expenses for interest
earned on cash balances maintained by the Fund with the transfer agent.
6. Purposes of and Risks Relating to Certain Financial Instruments
To hedge against adverse interest rate and market risks on portfolio positions
or anticipated positions in U.S. Government securities, the Fund may enter into
interest rate futures contracts ("futures contracts").
For hedging and investment purposes, the Fund may also engage in transactions in
listed and over-the-counter options.
These futures 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 contracts from the potential inability of counterparts
to meet the terms of their contracts.
7. Federal Income Tax Status
The amount of dividends and distributions from net investment income and net
realized capital gains are determined in accordance with federal income tax
regulations which may differ from generally accepted accounting principles.
These "book/tax" differences are either considered temporary or permanent in
nature. To the extent these differences are permanent in nature, such amounts
are reclassified within the capital accounts based on their federal tax-basis
treatment; temporary differences do not require reclassification. Dividends and
distributions which exceed net investment income and net realized capital gains
for tax purposes are reported as distributions of paid-in-capital.
23
Morgan Stanley Limited Duration Fund
NOTES TO FINANCIAL STATEMENTS - OCTOBER 31, 2006 (UNAUDITED) continued
As of April 30, 2006, the Fund had a net capital loss carryforward of
$21,831,288 of which $20,504 will expire on April 30, 2007, $51,242 will expire
on April 30, 2008, $2,035,052 will expire on April 30, 2009, $1,582,163 will
expire on April 30, 2011, $2,183,130 will expire on April 30, 2012, $11,744,997
will expire on April 30, 2013 and $4,214,200 will expire on April 30, 2014 to
offset future capital gains to the extent provided by regulations.
As of April 30, 2006, the Fund had temporary book/tax differences primarily
attributable to post-October losses (capital losses incurred after October 31
within the taxable year which are deemed to arise on the first business day of
the Fund's next taxable year), and book amortization on debt securities.
8. New Accounting Pronouncements
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 for the fiscal year ending 2008 and the impact to the Fund's
financial statements, if any, is currently being assessed.
In addition, in September 2006, Statement of Financial Accounting Standards No.
157, Fair Value Measurements (SFAS 157), was issued and is effective for fiscal
years beginning after November 15, 2007. SFAS 157 defines fair value,
establishes a framework for measuring fair value and expands disclosures about
fair value measurements. Management is currently evaluating the impact the
adoption of SFAS 157 will have on the Fund's financial statement disclosures.
24
Morgan Stanley Limited Duration 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 APRIL 30,
MONTHS ENDED -----------------------------------------------------------------
OCTOBER 31, 2006 2006 2005 2004 2003 2002
---------------- --------- --------- --------- --------- ---------
(unaudited)
Selected Per Share Data:
Net asset value, beginning of period... $9.02 $9.17 $9.41 $9.68 $9.59 $9.44
----- ----- ----- ----- ----- -----
Income (loss) from investment
operations:
Net investment income.............. 0.17 0.16 0.19 0.17 0.24 0.41
Net realized and unrealized gain
(loss)............................. 0.04 0.05 (0.08) (0.07) 0.13 0.19
----- ----- ----- ----- ----- -----
Total income from investment
operations............................ 0.21 0.21 0.11 0.10 0.37 0.60
----- ----- ----- ----- ----- -----
Less dividends from net investment
income................................ (0.22) (0.36) (0.35) (0.37) (0.28) (0.45)
----- ----- ----- ----- ----- -----
Net asset value, end of period......... $9.01 $9.02 $9.17 $9.41 $9.68 $9.59
===== ===== ===== ===== ===== =====
Total Return+.......................... 2.28%(1) 2.29% 1.20% 0.99% 3.93% 6.50%
Ratios To Average Net Assets:
Expenses (before expense offset)....... 0.80%(2)(4) 0.80%(4) 0.76%(3) 0.85%(3) 0.84%(4) 0.80%(4)
Net investment income.................. 4.04%(2)(4) 2.95%(4) 2.63% 1.75% 1.90%(4) 3.94%(4)
Supplemental Data:
Net assets, end of period, in
thousands............................ $139,946 $160,200 $356,124 $488,409 $429,409 $166,631
Portfolio turnover rate................ 28%(1) 54% 82% 240% 217% 327%
</Table>
- ---------------------
<Table>
+ Calculated based on the net asset value as of the last
business day of the period.
(1) Not annualized.
(2) Annualized.
(3) Does not reflect the effect of expense offset of 0.01%.
(4) If the Fund had borne all expenses that were assumed or
waived by the Investment Adviser and Administrator, the
annualized expense and net investment income ratios would
have been as follows:
</Table>
<Table>
<Caption>
EXPENSE NET INVESTMENT
PERIOD ENDED RATIO INCOME RATIO
------------ ------- --------------
October 31, 2006 0.87% 3.97%
April 30, 2006 0.83 2.93
April 30, 2003 0.87 1.86
April 30, 2002 0.92 3.82
</Table>
25
See Notes to Financial Statements
Morgan Stanley Limited Duration Fund
RESULTS OF SPECIAL SHAREHOLDER MEETING (UNAUDITED)
On August 1, 2006, a Special Meeting of Shareholders of the Fund was scheduled
in order to vote on the proposals set forth below. The proposals failed to
obtain the quorum necessary in order to hold the meeting, and, therefore, the
meeting was adjourned until August 23, 2006 and further adjourned to September
27, 2006 to permit further solicitation of proxies. The meeting was held on
September 27, 2006 and the voting results with respect to these proposals were
as follows:
(1) Election of Trustees:
<Table>
<Caption>
FOR WITHHOLD ABSTAIN BNV*
-------------------------------------------------
Frank L. Bowman............................................. 8,471,610 378,873 0 0
Kathleen A. Dennis.......................................... 8,460,919 389,564 0 0
James F. Higgins............................................ 8,461,508 388,975 0 0
Joseph J. Kearns............................................ 8,461,596 388,887 0 0
Michael F. Klein............................................ 8,460,290 390,193 0 0
W. Allen Reed............................................... 8,459,733 390,750 0 0
Fergus Reid................................................. 8,456,697 393,786 0 0
</Table>
(2) Elimination of certain fundamental investment restrictions:
<Table>
<Caption>
FOR AGAINST ABSTAIN BNV*
----------------------------------------------------
Elimination of the fundamental policy restricting the
Fund's ability to pledge assets......................... 7,632,626 364,794 254,546 598,517
Elimination of the fundamental policy restricting
purchases of securities on margin....................... 7,615,227 359,568 277,171 598,517
Elimination of the fundamental policy prohibiting
investments in oil, gas, and other types of minerals or
mineral leases.......................................... 7,458,791 512,364 280,811 598,517
Elimination of the fundamental policy prohibiting
investments for purposes of exercising control.......... 7,620,295 344,024 287,647 598,517
Elimination of the fundamental policy regarding
investments in unseasoned companies..................... 7,601,002 336,577 314,387 598,517
</Table>
26
Morgan Stanley Limited Duration Fund
RESULTS OF SPECIAL SHAREHOLDER MEETING (UNAUDITED) continued
(3) Modify certain fundamental investment restrictions:
<Table>
<Caption>
FOR AGAINST ABSTAIN BNV*
----------------------------------------------------
Modify fundamental policy regarding diversification....... 7,649,022 312,161 290,783 598,517
Modify fundamental policy regarding borrowing money....... 7,602,110 358,319 291,537 598,517
Modify fundamental policy regarding loans................. 7,425,832 527,030 299,104 598,517
Modify fundamental policy regarding investment in
commodities, commodity contracts and futures
contracts............................................... 7,476,634 471,386 303,946 598,517
Modify fundamental policy regarding issuance of senior
securities.............................................. 7,473,395 469,138 309,433 598,517
</Table>
(4) Reclassify certain fundamental policies as non-fundamental policies:
<Table>
<Caption>
FOR AGAINST ABSTAIN BNV*
----------------------------------------------------
Reclassification as non-fundamental the fundamental policy
regarding the short sale of securities.................. 7,438,184 501,180 312,602 598,517
Reclassification as non-fundamental the fundamental policy
prohibiting investments in other investment companies... 7,456,776 474,994 320,196 598,517
</Table>
- ------------------
* Broker "non-votes" are shares held in street name for which the broker
indicates that instructions have not been received from the beneficial
owners or other persons entitled to vote and for which the broker does not
have discretionary voting authority.
27
TRUSTEES
Frank L. Bowman
Michael Bozic
Kathleen A. Dennis
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Joseph J. Kearns
Michael F. Klein
Michael E. Nugent
W. Allen Reed
Fergus Reid
OFFICERS
Michael E. Nugent
Chairman of the Board
Ronald E. Robison
President and Principal Executive Officer
J. David Germany
Vice President
Dennis F. Shea
Vice President
Barry Fink
Vice President
Amy R. Doberman
Vice President
Carsten Otto
Chief Compliance Officer
Stefanie V. Chang Yu
Vice President
Francis J. Smith
Treasurer and Chief Financial Officer
Mary E. Mullin
Secretary
TRANSFER AGENT
Morgan Stanley Trust
Harborside Financial Center, Plaza Two
Jersey City, New Jersey 07311
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
Two World Financial Center
New York, New York 10281
INVESTMENT ADVISER
Morgan Stanley Investment Advisors Inc.
1221 Avenue of the Americas
New York, New York 10020
The financial statements included herein have been taken from the records of the
Fund without examination by the independent auditors and accordingly they do not
express an opinion thereon.
This report is submitted for the general information of the shareholders of the
Fund. For more detailed information about the Fund, its fees and expenses and
other pertinent information, please read its Prospectus. The Fund's Statement of
Additional Information contains additional information about the Fund, including
its trustees. It is available, without charge, by calling (800) 869-NEWS.
This report is not authorized for distribution to prospective investors in the
Fund unless preceded or accompanied by an effective Prospectus. Read the
Prospectus carefully before investing.
Investments and services offered through Morgan Stanley DW Inc., member SIPC.
Morgan Stanley Distributors Inc., member NASD.
(c) 2006 Morgan Stanley
[MORGAN STANLEY LOGO]
MORGAN STANLEY FUNDS
Morgan Stanley
Limited Duration Fund
Semiannual Report
October 31, 2006
[MORGAN STANLEY LOGO]
RA06-01138P-Y10/06 MALSAN SAR
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 Limited Duration Fund
/s/ Ronald E. Robison
- -------------------------------------
Ronald E. Robison
Principal Executive Officer
December 19, 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
December 19, 2006
/s/ Francis Smith
- -------------------------------------
Francis Smith
Principal Financial Officer
December 19, 2006
3