UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED
MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number: 811-07245
Morgan Stanley Balanced Fund
(Exact name of registrant as specified in charter)
522 Fifth Avenue, New York, New York 10036
(Address of principal executive offices) (Zip code)
Ronald E. Robison
522 Fifth Avenue, New York, New York 10036
(Name and address of agent for service)
Registrant's telephone number, including area code: 212-296-6990
Date of fiscal year end: January 31, 2008
Date of reporting period: July 31, 2007
Item 1 - Report to Shareholders
Welcome, Shareholder:
In this report, you'll learn about how your investment in Morgan Stanley
Balanced 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, 2007
TOTAL RETURN FOR THE 6 MONTHS ENDED JULY 31, 2007
<Table>
<Caption>
LIPPER
MIXED-
ASSET
LEHMAN TARGET
RUSSELL BROTHERS ALLOCATION
1000(R) U.S. GROWTH
VALUE GOVERNMENT/ FUNDS
CLASS A CLASS B CLASS C CLASS D INDEX(1) CREDIT INDEX(2) INDEX(3)
1.86% 1.40% 1.47% 1.92% 0.04% 2.06% 3.28%
</Table>
The performance of the Fund's four share classes varies because each has
different expenses. The Fund's total returns assume the reinvestment of all
distributions but do not reflect the deduction of any applicable sales charges.
Such costs would lower performance. See Performance Summary for standardized
performance and benchmark information.
MARKET CONDITIONS
During the six-month period ended July 31, 2007, the woes of the subprime
mortgage market (which makes loans to less creditworthy borrowers) began
surfacing early in the period, and together with a sell-off in China's stock
market, sparked a precipitous decline in global stock markets at the end of
February. Although the initial disruption turned out to be temporary, subprime
fears began to overwhelm the market in June and July amid news of hedge fund
implosions and mortgage lender bankruptcies. Moreover, American Express
announced it significantly increased its cash reserves on the expectation that
account delinquencies would likely rise in the coming months. Investors feared
that the subprime contagion would spread beyond the mortgage market into other
areas of the economy, ending the easy liquidity that had fueled the markets for
the past several years and hurting both corporations and consumers' ability to
borrow and spend.
In this environment, the broad stock and bond markets barely stayed above water.
The Russell 1000 Value Index, which represents the universe of large-
capitalization value stocks in which the Fund primarily invests the equity
portion of its portfolio, was further dragged down by its considerable exposure
to financial stocks, the largest sector in the index.
In the fixed income markets, yields generally rose across the U.S. Treasury
yield curve until July, when the turmoil in the market led to a significant
re-pricing of risk which resulted in a flight-to-quality that pushed Treasury
yields lower. For the overall period, the Treasury yield curve steepened as the
rally in two-year and five-year maturities was more robust than movement on the
longer end of the curve.
After several years of relatively easy credit availability and very low spreads,
credit terms and availability became a central theme affecting the bond market
and pushed yield spreads wider in all of the non-Treasury areas.
Investment-grade corporate credit spreads widened significantly during the
period. Spreads in the major sectors -- utilities, finance, and
industrials -- rose between 30 and 60 basis points versus end-of-January levels,
although many specific credits experienced much greater spread widening. With
regard to the mortgage sector, discount and current coupon mortgages
underperformed equal-duration Treasuries for the period while higher coupon
mortgages outperformed.
PERFORMANCE ANALYSIS
All share classes of Morgan Stanley Balanced Fund outperformed the Russell
1000(R) Value Index and underperformed both the Lehman Brothers U.S.
Government/Credit Index and the Lipper Mixed-Asset
2
Target Allocation Growth Funds Index for the six months ended July 31, 2007,
assuming no deduction of applicable sales charges.
In the Fund's stock portfolio, outperformance relative to the Russell 1000 Value
Index was driven in large part by positioning in the financial services sector.
Real estate investment trusts (REITs) and regional banks performed poorly amid a
weakening housing market and the problems in the subprime mortgage market, but
the Fund had no exposure to REITs and limited exposure to regional bank stocks.
An underweight in the diversified financials industry -- which is less exposed
to the mortgage industry but declined during the period regardless -- also
bolstered relative returns during the period. In the consumer staples sector,
stock selection in the food, beverage and tobacco industry added value. A food
and beverage company in which the Fund owned a position announced a spin-off of
one of its business units, causing a rally in the share prices of the company
and in other companies across the food and beverage industry. The materials
sector also contributed positively to relative performance, primarily due to a
holding that generates more of its revenues in the health care space (i.e., the
company also has a chemicals-related business that causes it to be classified
within the materials sector).
Conversely, detractors from the Fund's performance relative to the Russell 1000
Value Index included an underweight in the energy sector. The sector has
continued to perform well, but energy stocks' expensive valuations remain
unattractive in our view. The technology sector was another area of weakness.
Selected holdings in the hardware and equipment and the software and services
industries declined due to company-specific reasons. Finally, the Fund's
holdings in the industrials sector lagged behind the Russell 1000 Value Index's
stronger performing names, which hurt relative performance.
In the bond portfolio, we maintained an overall duration* lower than that of the
Lehman Brothers U.S. Government/Credit Index. This conservative interest-rate
posture was additive to performance for most of the period as interest rates
generally rose. In July, however, when the Treasury market rallied and interest
rates fell, this positioning had a small negative effect on relative
performance, though this was cushioned somewhat by the favorable effects of the
Fund's overweight in the 7- to 10-year area of the curve and a concurrent
underweight at the longer end.
The Fund's underweight versus the Lehman Brothers U.S. Government/Credit Index
to mortgage and agency securities had a favorable effect on performance, as did
an emphasis on higher-coupon mortgages, which outperformed lower-coupon
mortgages for the overall period. However, the Fund's exposure to certain
non-agency mortgage-backed securities detracted from performance in July, more
than offsetting the benefit derived from the Fund's
- ----------------------------------------------------
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
overall mortgage sector underweight during the month.
The Fund's below-benchmark exposure to credit had a favorable impact on relative
performance during the period, including its very defensive posture regarding
banks and brokers. We maintained the Fund's below-benchmark sensitivity to
credit spreads, also known as "spread duration", which also benefited
performance. Some adverse security selection decisions, however, had a small
unfavorable effect on relative returns.
As of the end of the reporting period, the Fund held 66 percent in stocks, 28 in
bonds, and 6 percent in short-term investments.
<Table>
<Caption>
TOP 10 HOLDINGS
U.S. Treasury Securities 7.8%
Federal National Mortgage Assoc 6.8
Bayer AG (ADR) (Germany) 2.1
Schering-Plough Corp. 2.0
Wal-Mart Stores, Inc. 2.0
General Electric Co. 1.9
Time Warner, Inc. 1.9
JPMorgan Chase & Co. 1.9
Verizon Communications, Inc. 1.8
Citigroup, Inc. 1.6
</Table>
<Table>
<Caption>
PORTFOLIO COMPOSITION*
Common Stocks 64.4%
U.S. Government Agencies & Obligations 15.6
Corporate Notes/Bonds 7.6
Short-Term Investments 5.4
Asset-Backed 4.9
Collateral Mortgage Obligations 2.1
</Table>
* Does not include open long futures contracts with an underlying face value of
$47,873,626 and unrealized appreciation of $249,698, and open short futures
contracts with underlying face value of $17,984,235 and unrealized depreciation
of $262,998, and open swap contracts with net unrealized depreciation of
$319,461.
Data as of July 31, 2007. 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.
4
INVESTMENT STRATEGY
THE FUND WILL NORMALLY INVEST AT LEAST 60 PERCENT OF ITS ASSETS IN COMMON STOCKS
AND SECURITIES CONVERTIBLE INTO COMMON STOCKS AND AT LEAST 25 PERCENT OF ITS
ASSETS IN FIXED-INCOME SECURITIES. WITHIN THESE LIMITATIONS, THE FUND'S
"INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS INC., MAY PURCHASE OR
SELL SECURITIES IN ANY PROPORTION IT BELIEVES DESIRABLE BASED ON ITS ASSESSMENT
OF BUSINESS, ECONOMIC AND INVESTMENT CONDITIONS.
FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS
EACH MORGAN STANLEY FUND PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN
ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE FUND'S SECOND
AND FOURTH FISCAL QUARTERS. THE SEMIANNUAL REPORTS AND THE ANNUAL REPORTS ARE
FILED ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC) ON FORM
N-CSRS AND FORM N-CSR, RESPECTIVELY. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL
AND ANNUAL REPORTS TO FUND SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS
PUBLIC WEB SITE, WWW.MORGANSTANLEY.COM. EACH MORGAN STANLEY FUND ALSO FILES A
COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS WITH THE SEC FOR THE FUND'S FIRST AND
THIRD FISCAL QUARTERS ON FORM N-Q. MORGAN STANLEY DOES NOT DELIVER THE REPORTS
FOR THE FIRST AND THIRD FISCAL QUARTERS TO SHAREHOLDERS, NOR ARE THE REPORTS
POSTED TO THE MORGAN STANLEY PUBLIC WEB SITE. YOU MAY, HOWEVER, OBTAIN THE FORM
N-Q FILINGS (AS WELL AS THE FORM N-CSR AND N-CSRS FILINGS) BY ACCESSING THE
SEC'S WEB SITE, HTTP://WWW.SEC.GOV. YOU MAY ALSO REVIEW AND COPY THEM AT THE
SEC'S PUBLIC REFERENCE ROOM IN WASHINGTON, DC. INFORMATION ON THE OPERATION OF
THE SEC'S PUBLIC REFERENCE ROOM MAY BE OBTAINED BY CALLING THE SEC AT (800)
SEC-0330. YOU CAN ALSO REQUEST COPIES OF THESE MATERIALS, UPON PAYMENT OF A
DUPLICATING FEE, BY ELECTRONIC REQUEST AT THE SEC'S E-MAIL ADDRESS
(PUBLICINFO@SEC.GOV) OR BY WRITING THE PUBLIC REFERENCE SECTION OF THE SEC,
WASHINGTON, DC 20549-0102.
PROXY VOTING POLICY AND PROCEDURES AND PROXY VOTING RECORD
YOU MAY OBTAIN A COPY OF THE FUND'S PROXY VOTING POLICY AND PROCEDURES WITHOUT
CHARGE, UPON REQUEST, BY CALLING TOLL FREE (800) 869-NEWS OR BY VISITING THE
MUTUAL FUND CENTER ON OUR WEB SITE AT WWW.MORGANSTANLEY.COM. IT IS ALSO
AVAILABLE ON THE SECURITIES AND EXCHANGE COMMISSION'S WEB SITE AT
HTTP://WWW.SEC.GOV.
YOU MAY OBTAIN INFORMATION REGARDING HOW THE FUND VOTED PROXIES RELATING TO
PORTFOLIO SECURITIES DURING THE MOST RECENT TWELVE-MONTH PERIOD ENDED JUNE 30
WITHOUT CHARGE BY VISITING THE MUTUAL FUND CENTER ON OUR WEB SITE AT
WWW.MORGANSTANLEY.COM. THIS INFORMATION IS ALSO AVAILABLE ON THE SECURITIES AND
EXCHANGE COMMISSION'S WEB SITE AT HTTP://WWW.SEC.GOV.
HOUSEHOLDING NOTICE
TO REDUCE PRINTING AND MAILING COSTS, THE FUND ATTEMPTS TO ELIMINATE DUPLICATE
MAILINGS TO THE SAME ADDRESS. THE FUND DELIVERS A SINGLE COPY OF CERTAIN
SHAREHOLDER DOCUMENTS, INCLUDING SHAREHOLDER REPORTS, PROSPECTUSES AND PROXY
MATERIALS, TO INVESTORS WITH THE SAME LAST NAME WHO RESIDE AT THE SAME ADDRESS.
YOUR PARTICIPATION IN THIS PROGRAM WILL CONTINUE FOR AN UNLIMITED PERIOD OF TIME
UNLESS YOU INSTRUCT US OTHERWISE. YOU CAN REQUEST MULTIPLE COPIES OF THESE
DOCUMENTS BY CALLING (800) 350-6414, 8:00 A.M. TO 8:00 P.M., ET. ONCE OUR
CUSTOMER SERVICE CENTER HAS RECEIVED YOUR INSTRUCTIONS, WE WILL BEGIN SENDING
INDIVIDUAL COPIES FOR EACH ACCOUNT WITHIN 30 DAYS.
5
PERFORMANCE SUMMARY
AVERAGE ANNUAL TOTAL RETURNS -- PERIOD ENDED JULY 31, 2007
<Table>
<Caption>
CLASS A SHARES* CLASS B SHARES** CLASS C SHARES(+) CLASS D SHARES(++)
(since 07/28/97) (since 07/28/97) (since 03/28/95) (since 07/28/97)
SYMBOL BGRAX BGRBX BGRCX BGRDX
1 YEAR 10.85%(4) 9.97%(4) 10.07%(4) 11.14%(4)
5.03(5) 4.97(5) 9.07(5) --
5 YEARS 9.32(4) 8.49(4) 8.51(4) 9.59(4)
8.15(5) 8.20(5) 8.51(5) --
10 YEARS 6.44(4) 5.79(4) 5.64(4) 6.68(4)
5.87(5) 5.79(5) 5.64(5)
SINCE INCEPTION 6.61(4) 5.96(4) 8.70(4) 6.85(4)
6.03(5) 5.96(5) 8.70(5) --
</Table>
Performance data quoted represents past performance, which is no guarantee of
future results and current performance may be lower or higher than the figures
shown. For 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. Effective April 2005, Class B shares
will generally convert to Class A shares approximately eight years after the
end of the calendar month in which the shares were purchased. Performance
for periods greater than eight years reflects this conversion.
+ The maximum contingent deferred sales charge for Class C is 1.0% for shares
redeemed within one year of purchase.
++ Class D has no sales charge.
(1) The Russell 1000(R) Value Index measures the performance of those companies
in the Russell 1000(R) Index with lower price-to-book ratios and lower
forecasted growth values. The Index is unmanaged and its returns do not
include any sales charges or fees. Such costs would lower performance. It
is not possible to invest directly in an index.
(2) The Lehman Brothers U.S. Government/Credit Index tracks the performance of
government and corporate obligations, including U.S. government agency and
Treasury securities and corporate and Yankee bonds. The Index is unmanaged
and its returns do not include any sales charges or fees. Such costs would
lower performance. It is not possible to invest directly in an index.
(3) The Lipper Mixed-Asset Target Allocation Growth Funds Index is an
equally-weighted performance index of the largest qualifying funds (based
on net assets) in the Lipper Mixed-Asset Target Allocation Growth Funds
classification. The Index, which is adjusted for capital gains
distributions and income dividends, is unmanaged and should not be
considered an investment. There are currently 30 fund represented in this
Index. The Fund is in the Lipper Mixed-Asset Target Allocation Growth Funds
Index as of the date of this report.
(4) Figure shown assumes reinvestment of all distributions and does not reflect
the deduction of any sales charges.
(5) Figure shown assumes reinvestment of all distributions and the deduction of
the maximum applicable sales charge. See the Fund's current prospectus for
complete details on fees and sales charges.
6
EXPENSE EXAMPLE
As a shareholder of the Fund, you incur two types of costs: (1) transaction
costs, including sales charges (loads) on purchase payments and redemption fees;
and (2) ongoing costs, including advisory fees; distribution and service (12b-1)
fees; and other Fund expenses. This example is intended to help you understand
your ongoing costs (in dollars) of investing in the Fund and to compare these
costs with the ongoing costs of investing in other mutual funds.
The example is based on an investment of $1,000 invested at the beginning of the
period and held for the entire period 02/01/07 - 07/31/07.
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 *
------------- ------------- ---------------
02/01/07 -
02/01/07 07/31/07 07/31/07
------------- ------------- ---------------
CLASS A
Actual (1.86% return)....................................... $1,000.00 $1,018.60 $5.26
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,019.59 $5.26
CLASS B
Actual (1.40% return)....................................... $1,000.00 $1,014.00 $8.99
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,015.87 $9.00
CLASS C
Actual (1.47% return)....................................... $1,000.00 $1,014.70 $8.99
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,015.87 $9.00
CLASS D
Actual (1.92% return)....................................... $1,000.00 $1,019.20 $4.01
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,020.83 $4.01
</Table>
- ------------------
* Expenses are equal to the Fund's annualized expense ratios of 1.05%, 1.80%,
1.80% and 0.80% for Class A, Class B, Class C and Class D shares,
respectively, multiplied by the average account value over the period,
multiplied by 181/365 (to reflect the one-half year period).
7
INVESTMENT ADVISORY AGREEMENT APPROVAL
NATURE, EXTENT AND QUALITY OF SERVICES
The Board reviewed and considered the nature and extent of the investment
advisory services provided by the Investment Adviser under the Advisory
Agreement, including portfolio management, investment research and equity and
fixed income securities trading. The Board also reviewed and considered the
nature and extent of the non-advisory, administrative services provided by the
Fund's Administrator under the Administration Agreement, including accounting,
clerical, bookkeeping, compliance, business management and planning, and the
provision of supplies, office space and utilities at the Investment Adviser's
expense. (The Investment Adviser and the Administrator together are referred to
as the "Adviser" and the Advisory and Administration Agreements together are
referred to as the "Management Agreement.") The Board also compared the nature
of the services provided by the Adviser with similar services provided by
non-affiliated advisers as reported to the Board by Lipper Inc. ("Lipper").
The Board reviewed and considered the qualifications of the portfolio managers,
the senior administrative managers and other key personnel of the Adviser who
provide the advisory and administrative services to the Fund. The Board
determined that the Adviser's portfolio managers and key personnel are well
qualified by education and/or training and experience to perform the services in
an efficient and professional manner. The Board concluded that the nature and
extent of the advisory and administrative services provided were necessary and
appropriate for the conduct of the business and investment activities of the
Fund. The Board also concluded that the overall quality of the advisory and
administrative services was satisfactory.
PERFORMANCE RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS
On a regular basis, the Board reviews the performance of all funds in the Morgan
Stanley Fund Complex, including the Fund, compared to their peers, paying
specific attention to the underperforming funds. In addition, the Board
specifically reviewed the Fund's performance for the one-, three- and five-year
periods ended November 30, 2006, as shown in a report provided by Lipper (the
"Lipper Report"), compared to the performance of comparable funds selected by
Lipper (the "performance peer group"). The Board also discussed with the Adviser
the performance goals and the actual results achieved in managing the Fund. The
Board concluded that the Fund's performance was competitive with that of its
performance peer group.
FEES RELATIVE TO OTHER PROPRIETARY FUNDS MANAGED BY THE ADVISER WITH COMPARABLE
INVESTMENT STRATEGIES
The Board reviewed the advisory and administrative fee (together, the
"management fee") rate paid by the Fund under the Management Agreement. The
Board noted that the management fee rate was comparable to
8
the management fee rates charged by the Adviser to other proprietary funds it
manages with investment strategies comparable to those of the Fund.
FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS
The Board reviewed the management fee rate and total expense ratio of the Fund
as compared to the average management fee rate and average total expense ratio
for funds, selected by Lipper (the "expense peer group"), managed by other
advisers with investment strategies comparable to those of the Fund, as shown in
the Lipper Report. The Board concluded that the Fund's management fee rate and
total expense ratio were competitive with those of its expense peer group.
BREAKPOINTS AND ECONOMIES OF SCALE
The Board reviewed the structure of the Fund's management fee schedule under the
Management Agreement and noted that it includes a breakpoint. The Board also
reviewed the level of the Fund's management fee and noted that the fee, as a
percentage of the Fund's net assets, would decrease as net assets increase
because the management fee includes a breakpoint. The Board concluded that the
Fund's management fee would reflect economies of scale as assets increase.
PROFITABILITY OF THE ADVISER AND AFFILIATES
The Board considered information concerning the costs incurred and profits
realized by the Adviser and affiliates during the last year from their
relationship with the Fund and during the last two years from their relationship
with the Morgan Stanley Fund Complex and reviewed with the Adviser the cost
allocation methodology used to determine the profitability of the Adviser and
affiliates. Based on its review of the information it received, the Board
concluded that the profits earned by the Adviser and affiliates were not
excessive in light of the advisory, administrative and other services provided
to the Fund.
FALL-OUT BENEFITS
The Board considered so-called "fall-out benefits" derived by the Adviser and
affiliates from their relationship with the Fund and the Morgan Stanley Fund
Complex, such as sales charges on sales of Class A shares and "float" benefits
derived from handling of checks for purchases and sales of Fund shares, through
a broker-dealer affiliate of the Adviser and "soft dollar" benefits (discussed
in the next section). The Board also considered that a broker-dealer affiliate
of the Adviser receives from the Fund 12b-1 fees for distribution and
shareholder services. The Board concluded that the float benefits were
relatively small and the sales charges and 12b-1 fees were competitive with
those of other broker-dealers.
9
SOFT DOLLAR BENEFITS
The Board considered whether the Adviser realizes any benefits as a result of
brokerage transactions executed through "soft dollar" arrangements. Under such
arrangements, brokerage commissions paid by the Fund and/or other funds managed
by the Adviser would be used to pay for research that a securities broker
obtains from third parties, or to pay for both research and execution services
from securities brokers who effect transactions for the Fund. The Board
recognized that the receipt of such research from brokers may reduce the
Adviser's costs but concluded that the receipt of such research strengthens the
investment management resources of the Adviser, which may ultimately benefit the
Fund and other funds in the Morgan Stanley Fund Complex.
ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE FUND'S NEEDS
The Board considered whether the Adviser is financially sound and has the
resources necessary to perform its obligations under the Management Agreement.
The Board concluded that the Adviser has the financial resources necessary to
fulfill its obligations under the Management Agreement.
HISTORICAL RELATIONSHIP BETWEEN THE FUND AND THE ADVISER
The Board also reviewed and considered the historical relationship between the
Fund and the Adviser, including the organizational structure of the Adviser, the
policies and procedures formulated and adopted by the Adviser for managing the
Fund's operations and the Board's confidence in the competence and integrity of
the senior managers and key personnel of the Adviser. The Board concluded that
it is beneficial for the Fund to continue its relationship with the Adviser.
OTHER FACTORS AND CURRENT TRENDS
The Board considered the controls and procedures adopted and implemented by the
Adviser and monitored by the Fund's Chief Compliance Officer and concluded that
the conduct of business by the Adviser indicates a good faith effort on its part
to adhere to high ethical standards in the conduct of the Fund's business.
GENERAL CONCLUSION
On April 25, 2007, after considering and weighing all of the above factors, the
Board concluded that it would be in the best interest of the Fund and its
shareholders to approve renewal of the Management Agreement for another year
until April 30, 2008. On June 20, 2007, the Board again considered and weighed
all of the above factors and concluded that it would be in the best interest of
the Fund and its shareholders to approve renewal of the Management Agreement to
continue until June 30, 2008.
10
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED)
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- ----------------------------------------------------------------------------------------------------------
Common Stocks (65.7%)
Aerospace & Defense (0.9%)
61,860 Raytheon Co. ............................................................... $ 3,424,570
--------------
Beverages: Non-Alcoholic (1.3%)
95,100 Coca-Cola Co. (The)......................................................... 4,955,661
--------------
Cable/Satellite TV (1.0%)
149,443 Comcast Corp. (Class A)*.................................................... 3,925,868
--------------
Casino/Gaming (0.0%)
4,685 Fitzgeralds Gaming Corp.* (a)............................................... 0
--------------
Chemicals: Major Diversified (2.7%)
118,030 Bayer AG (ADR) (Germany).................................................... 8,352,983
47,660 E.I. du Pont de Nemours & Co. .............................................. 2,227,152
--------------
10,580,135
--------------
Computer Communications (0.4%)
54,100 Cisco Systems, Inc.*........................................................ 1,564,031
--------------
Computer Processing Hardware (0.3%)
23,932 Hewlett-Packard Co. ........................................................ 1,101,590
--------------
Discount Stores (2.0%)
168,460 Wal-Mart Stores, Inc. ...................................................... 7,740,737
--------------
Drugstore Chains (0.2%)
124,800 Rite Aid Corp.*............................................................. 687,648
--------------
Electric Utilities (3.3%)
115,970 American Electric Power Co., Inc. .......................................... 5,043,535
50,610 Entergy Corp. .............................................................. 5,058,976
46,950 FirstEnergy Corp. .......................................................... 2,852,390
--------------
12,954,901
--------------
Electronic Components (0.3%)
29,639 Tyco Electronics Ltd. ...................................................... 1,061,669
--------------
Finance/Rental/Leasing (1.4%)
96,635 Freddie Mac................................................................. 5,534,286
--------------
Financial Conglomerates (3.4%)
132,802 Citigroup, Inc. ............................................................ 6,184,589
165,872 JPMorgan Chase & Co. ....................................................... 7,300,027
--------------
13,484,616
--------------
Food: Major Diversified (2.3%)
58,910 ConAgra Foods Inc. ......................................................... 1,493,369
101,347 Kraft Foods Inc. (Class A).................................................. 3,319,114
</Table>
11
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- ----------------------------------------------------------------------------------------------------------
145,790 Unilever N.V. (NY Registered Shares) (Netherlands).......................... $ 4,411,605
--------------
9,224,088
--------------
Food: Specialty/Candy (1.0%)
76,250 Cadbury Schweppes PLC (ADR) (United Kingdom)................................ 3,791,912
--------------
Home Improvement Chains (0.7%)
75,750 Home Depot, Inc. (The)...................................................... 2,815,628
--------------
Household/Personal Care (1.5%)
33,080 Estee Lauder Companies, Inc. (The) (Class A)................................ 1,489,262
20,840 Kimberly-Clark Corp. ....................................................... 1,401,907
48,650 Procter & Gamble Co. (The).................................................. 3,009,489
--------------
5,900,658
--------------
Industrial Conglomerates (3.8%)
197,220 General Electric Co. ....................................................... 7,644,247
43,640 Siemens AG (ADR) (Germany).................................................. 5,526,133
40,547 Tyco International Ltd. (Bermuda)........................................... 1,917,468
--------------
15,087,848
--------------
Insurance Brokers/Services (1.4%)
204,510 Marsh & McLennan Companies, Inc. ........................................... 5,634,250
--------------
Integrated Oil (3.5%)
72,946 ConocoPhillips.............................................................. 5,896,955
35,050 Exxon Mobil Corp. .......................................................... 2,983,806
62,370 Royal Dutch Shell PLC (ADR) (Class A) (United Kingdom)...................... 4,839,288
--------------
13,720,049
--------------
Internet Retail (0.3%)
16,490 Amazon.com, Inc.*........................................................... 1,295,125
--------------
Internet Software/Services (0.8%)
128,808 Yahoo!, Inc.*............................................................... 2,994,786
--------------
Investment Banks/Brokers (1.1%)
134,180 Charles Schwab Corp. (The).................................................. 2,701,043
23,649 Merrill Lynch & Co., Inc. .................................................. 1,754,756
--------------
4,455,799
--------------
Life/Health Insurance (0.3%)
65,650 Aegon N.V. (NY Registered Shares) (Netherlands)............................. 1,186,952
--------------
Major Banks (1.0%)
35,528 Bank of America Corp. ...................................................... 1,684,738
34,966 PNC Financial Services Group, Inc. ......................................... 2,330,484
--------------
4,015,222
--------------
</Table>
12
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- ----------------------------------------------------------------------------------------------------------
Major Telecommunications (3.8%)
26,456 Embarq Corp. ............................................................... $ 1,634,716
81,900 France Telecom S.A. (ADR) (France).......................................... 2,225,223
196,252 Sprint Nextel Corp. ........................................................ 4,029,054
164,767 Verizon Communications, Inc. ............................................... 7,022,370
--------------
14,911,363
--------------
Managed Health Care (0.6%)
48,590 CIGNA Corp. ................................................................ 2,509,188
--------------
Media Conglomerates (3.1%)
361,410 Time Warner, Inc. .......................................................... 6,960,757
133,187 Viacom Inc. (Class B)*...................................................... 5,101,062
--------------
12,061,819
--------------
Medical Specialties (1.1%)
35,880 Applera Corp. - Applied Biosystems Group.................................... 1,120,174
124,170 Boston Scientific Corp.*.................................................... 1,632,835
40,547 Covidien Ltd. .............................................................. 1,660,400
--------------
4,413,409
--------------
Motor Vehicles (0.5%)
58,660 Honda Motor Co., Ltd. (ADR) (Japan)......................................... 2,112,933
--------------
Multi-Line Insurance (0.7%)
29,450 Hartford Financial Services Group, Inc. (The)............................... 2,705,571
--------------
Oil & Gas Pipelines (0.4%)
47,660 Williams Companies, Inc. (The).............................................. 1,537,035
--------------
Oil & Gas Production (1.0%)
13,190 Devon Energy Corp. ......................................................... 984,106
54,990 Occidental Petroleum Corp. ................................................. 3,119,033
--------------
4,103,139
--------------
Oil Refining/Marketing (0.3%)
23,330 Marathon Oil Corp. ......................................................... 1,287,816
--------------
Oilfield Services/Equipment (1.0%)
43,150 Schlumberger Ltd. (Netherlands Antilles).................................... 4,087,168
--------------
Other Consumer Specialties (0.2%)
7,550 Fortune Brands, Inc. ....................................................... 613,815
--------------
Packaged Software (0.9%)
177,747 Symantec Corp.*............................................................. 3,412,742
--------------
Pharmaceuticals: Major (9.3%)
120,030 Abbott Laboratories......................................................... 6,084,321
203,910 Bristol-Myers Squibb Co. ................................................... 5,793,083
</Table>
13
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED) continued
<Table>
<Caption>
NUMBER OF
SHARES VALUE
- ----------------------------------------------------------------------------------------------------------
102,640 Eli Lilly & Co. ............................................................ $ 5,551,798
17,060 Novartis AG (ADR) (Switzerland)............................................. 920,387
84,000 Pfizer, Inc. ............................................................... 1,974,840
38,370 Roche Holdings AG (ADR) (Switzerland)....................................... 3,413,011
25,200 Sanofi-Aventis (ADR) (France)............................................... 1,052,100
271,600 Schering-Plough Corp. ...................................................... 7,751,464
85,370 Wyeth....................................................................... 4,142,152
--------------
36,683,156
--------------
Precious Metals (0.8%)
75,550 Newmont Mining Corp. ....................................................... 3,154,212
--------------
Property - Casualty Insurers (2.9%)
74,930 Chubb Corp. (The)........................................................... 3,777,221
98,972 Travelers Companies, Inc. (The)............................................. 5,025,798
33,440 XL Capital Ltd. (Class A) (Cayman Islands).................................. 2,603,638
--------------
11,406,657
--------------
Regional Banks (0.5%)
51,655 Fifth Third Bancorp......................................................... 1,905,553
--------------
Restaurants (0.4%)
33,530 McDonald's Corp. ........................................................... 1,605,081
--------------
Semiconductors (1.0%)
94,596 Intel Corp. ................................................................ 2,234,358
138,890 Micron Technology, Inc.*.................................................... 1,648,624
--------------
3,882,982
--------------
Specialty Stores (0.3%)
44,249 Office Depot, Inc.*......................................................... 1,104,455
--------------
Telecommunication Equipment (1.2%)
390,570 Alcatel-Lucent (ADR) (France)............................................... 4,530,612
--------------
Tobacco (0.8%)
49,210 Altria Group, Inc. ......................................................... 3,270,989
--------------
Total Common Stocks (Cost $224,034,276)..................................... 258,437,724
--------------
</Table>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE
- ---------- ------ --------
Corporate Bonds (7.8%)
Aerospace & Defense (0.1%)
$ 516 Systems 2001 Asset Trust - 144A** (Cayman Islands)...... 6.664% 09/15/13 542,440
--------------
</Table>
14
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
Airlines (0.1%)
$ 425 America West Airlines, Inc. (Series 01-1)............... 7.10 % 04/02/21 $ 448,478
--------------
Beverages: Alcoholic (0.2%)
350 FBG Finance Ltd. - 144A** (Australia)................... 5.125 06/15/15 328,922
440 Miller Brewing Co. - 144A**............................. 4.25 08/15/08 433,906
--------------
762,828
--------------
Cable/Satellite TV (0.1%)
230 Comcast Cable Communications, Inc. ..................... 6.75 01/30/11 238,304
60 Comcast LCI Holdings.................................... 7.625 02/15/08 60,561
--------------
298,865
--------------
Chemicals: Major Diversified (0.1%)
240 ICI Wilmington Inc. .................................... 4.375 12/01/08 236,015
--------------
Department Stores (0.0%)
50 Federated Department Stores, Inc. ...................... 6.625 09/01/08 50,295
80 May Department Stores Co. .............................. 5.95 11/01/08 79,890
--------------
130,185
--------------
Drugstore Chains (0.1%)
180 CVS Caremark Corp. ..................................... 5.75 06/01/17 172,615
110 CVS Caremark Corp. ..................................... 5.75 08/15/11 110,448
296 CVS Lease Pass Through - 144A**......................... 6.036 12/10/28 294,195
--------------
577,258
--------------
Electric Utilities (0.7%)
320 Arizona Public Service Co. ............................. 5.80 06/30/14 316,421
360 Carolina Power & Light Co. ............................. 5.125 09/15/13 351,241
95 CenterPoint Energy Resource............................. 6.25 02/01/37 92,129
55 CenterPoint Energy Resource (Series B).................. 7.875 04/01/13 60,160
125 Consolidated Natural Gas Co. (Series C)................. 6.25 11/01/11 128,127
265 Consumers Energy Co. (Series H)......................... 4.80 02/17/09 262,530
200 Detroit Edison Co. (The)................................ 6.125 10/01/10 204,313
145 Entergy Gulf States, Inc. .............................. 3.60 06/01/08 142,773
285 Entergy Gulf States, Inc. .............................. 5.76+ 12/01/09 285,084
330 Ohio Power Company - IBC (Series K)..................... 6.00 06/01/16 332,236
205 Public Service Electric & Gas Co. (Series MTN B)........ 5.00 01/01/13 200,183
180 Texas Eastern Transmission, LP.......................... 7.00 07/15/32 198,766
315 Wisconsin Electric Power Co. ........................... 3.50 12/01/07 313,051
--------------
2,887,014
--------------
Electrical Products (0.1%)
340 Cooper Industries, Inc. ................................ 5.25 11/15/12 334,077
--------------
</Table>
15
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
Electronics/Appliances (0.1%)
$ 260 LG Electronics Inc. - 144A** (South Korea).............. 5.00 % 06/17/10 $ 253,762
--------------
Finance/Rental/Leasing (0.5%)
280 Capmark Financial Group - 144A**........................ 5.875 05/10/12 262,086
115 Capmark Financial Group - 144A**........................ 6.30 05/10/17 102,048
290 CIT Group Inc. (Series MTN)............................. 4.75 08/15/08 287,129
560 Countrywide Home Loans, Inc. (Series MTN L)............. 3.25 05/21/08 548,430
450 Nationwide Building Society - 144A** (United Kingdom)... 4.25 02/01/10 438,628
190 Residential Capital Corp. .............................. 6.375 06/30/10 178,974
355 SLM Corp. (Series MTN A)................................ 4.00 01/15/10 332,665
--------------
2,149,960
--------------
Financial Conglomerates (0.5%)
1,000 Associates Corp. of North America....................... 6.25 11/01/08 1,007,777
55 Bank One Corp. (Series A)............................... 6.00 02/17/09 55,524
55 Brookfield Asset Management Inc. (Canada)............... 5.80 04/25/17 54,396
485 Chase Manhattan Corp. .................................. 6.00 02/15/09 489,601
90 Chase Manhattan Corp. .................................. 7.00 11/15/09 93,249
245 General Electric Capital Corp. (Series MTN A)........... 4.25 12/01/10 238,260
--------------
1,938,807
--------------
Food Retail (0.1%)
330 Fred Meyer, Inc. ....................................... 7.45 03/01/08 333,561
--------------
Food: Major Diversified (0.1%)
170 ConAgra Foods, Inc. .................................... 7.00 10/01/28 174,246
105 ConAgra Foods, Inc. .................................... 8.25 09/15/30 122,536
80 Sara Lee Corp. ......................................... 6.125 11/01/32 72,581
--------------
369,363
--------------
Gas Distributors (0.1%)
285 NiSource Finance Corp. ................................. 5.93+ 11/23/09 285,221
--------------
Home Improvement Chains (0.1%)
460 Home Depot Inc. ........................................ 5.485+ 12/16/09 458,810
--------------
Household/Personal Care (0.1%)
515 Clorox Co. (The)........................................ 5.485+ 12/14/07 515,272
--------------
Industrial Conglomerates (0.1%)
295 Textron Financial Corp. ................................ 4.125 03/03/08 293,085
255 Textron Financial Corp. (Series MTN).................... 5.125 02/03/11 254,568
--------------
547,653
--------------
Insurance Brokers/Services (0.2%)
700 Farmers Exchange Capital - 144A**....................... 7.05 07/15/28 656,079
--------------
</Table>
16
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
Major Banks (0.6%)
$ 250 Bank of New York Co., Inc. (The) (Series BKN T)......... 3.80 % 02/01/08 $ 247,996
225 HSBC Finance Corp. ..................................... 6.75 05/15/11 234,335
250 Huntington National Bank (Series BKN T)................. 4.375 01/15/10 244,924
555 MBNA Corp. (Series MTN F)............................... 5.786+ 05/05/08 557,037
260 Popular North America, Inc. (Series MTN F).............. 5.65 04/15/09 259,768
685 Unicredit Luxembourg Finance S.A. - 144A**
(Luxembourg).......................................... 5.41+ 10/24/08 685,430
--------------
2,229,490
--------------
Major Telecommunications (0.5%)
350 France Telecom S.A. (France)............................ 8.50 03/01/31 439,766
230 SBC Communications, Inc. ............................... 6.15 09/15/34 221,167
110 Sprint Capital Corp. ................................... 8.75 03/15/32 121,202
210 Telecom Italia Capital SA (Luxembourg).................. 4.00 11/15/08 205,784
330 Telecom Italia Capital SA (Luxembourg).................. 4.00 01/15/10 318,271
350 Telefonica Europe BV (Netherlands)...................... 8.25 09/15/30 400,998
400 Verizon New England Inc. ............................... 6.50 09/15/11 411,903
--------------
2,119,091
--------------
Managed Health Care (0.1%)
230 UnitedHealth Group...................................... 5.44+ 03/02/09 229,853
170 UnitedHealth Group Inc. ................................ 4.125 08/15/09 166,533
30 WellPoint Inc. ......................................... 3.75 12/14/07 29,796
--------------
426,182
--------------
Media Conglomerates (0.2%)
600 Time Warner, Inc. ...................................... 5.59+ 11/13/09 600,637
315 Viacom, Inc. ........................................... 6.875 04/30/36 297,114
--------------
897,751
--------------
Motor Vehicles (0.1%)
225 DaimlerChrysler North American Holdings Co. ............ 8.50 01/18/31 279,256
--------------
Multi-Line Insurance (0.4%)
1,015 AIG SunAmerica Global Financing VI - 144A**............. 6.30 05/10/11 1,047,466
290 American General Finance Corp. (Series MTN H)........... 4.625 09/01/10 285,489
20 American General Finance Corp. (Series MTN I)........... 4.625 05/15/09 19,834
195 Equitable Co. .......................................... 6.50 04/01/08 196,236
190 International Lease Finance Corp. ...................... 3.75 08/01/07 190,000
--------------
1,739,025
--------------
Oil & Gas Pipelines (0.1%)
325 Plains All American Pipeline LP/PAA Finance Corp. ...... 6.70 05/15/36 321,887
--------------
Oil Refining/Marketing (0.1%)
245 Valero Energy Corp. .................................... 3.50 04/01/09 237,567
--------------
</Table>
17
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
Other Metals/Minerals (0.1%)
$ 405 Brascan Corp. (Canada).................................. 7.125% 06/15/12 $ 428,715
--------------
Property - Casualty Insurers (0.6%)
660 Mantis Reef Ltd. - 144A** (Cayman Islands).............. 4.692 11/14/08 654,338
135 Platinum Underwriters Finance Inc. (Series B)........... 7.50 06/01/17 141,724
335 Platinum Underwriters Holdings, Ltd. (Series B)
(Bermuda)............................................. 6.371 11/16/07 334,230
470 St. Paul Travelers Companies, Inc. (The)................ 5.01 08/16/07 469,942
630 XLLIAC Global Funding - 144A**.......................... 4.80 08/10/10 618,513
--------------
2,218,747
--------------
Railroads (0.1%)
210 Burlington North Santa Fe Railway Co. .................. 6.125 03/15/09 212,529
95 Union Pacific Corp. .................................... 6.625 02/01/08 95,526
150 Union Pacific Corp. (Series MTN E)...................... 6.79 11/09/07 150,396
--------------
458,451
--------------
Real Estate Development (0.2%)
608 World Financial Properties - 144A**..................... 6.91 09/01/13 624,807
328 World Financial Properties - 144A**..................... 6.95 09/01/13 337,309
--------------
962,116
--------------
Real Estate Investment Trusts (0.1%)
465 iStar Financial Inc. ................................... 5.71+ 03/09/10 465,910
--------------
Regional Banks (0.2%)
660 Marshall & Ilsley Bank (Series BKN T)................... 3.80 02/08/08 654,324
--------------
Restaurants (0.1%)
255 Tricon Global Restaurants, Inc. ........................ 8.875 04/15/11 282,743
--------------
Savings Banks (0.6%)
280 Household Finance Corp. ................................ 4.125 12/15/08 275,408
175 Household Finance Corp. ................................ 5.875 02/01/09 176,265
135 Household Finance Corp. ................................ 6.375 10/15/11 136,309
255 Household Finance Corp. ................................ 6.40 06/17/08 257,221
580 Sovereign BanCorp Inc. ................................. 5.59+ 03/23/10 580,097
200 Sovereign Bank (Series CD).............................. 4.00 02/01/08 198,578
290 Washington Mutual Bank.................................. 5.50 01/15/13 285,458
295 Washington Mutual Inc. ................................. 8.25 04/01/10 314,856
--------------
2,224,192
--------------
Trucks/Construction/Farm Machinery (0.2%)
110 Caterpillar Financial Services Corp. (Series MTN F)..... 3.625 11/15/07 109,424
525 Caterpillar Financial Services Corp. (Series MTN F)..... 5.43+ 08/20/07 525,026
--------------
634,450
--------------
</Table>
18
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
Wireless Telecommunications (0.1%)
$ 435 Vodafone Group PLC (United Kingdom)..................... 5.45+% 12/28/07 $ 435,205
--------------
Total Corporate Bonds (Cost $30,950,861)................................... 30,740,750
--------------
U.S. Government Obligations (7.7%)
U.S. Treasury Bonds
200 ........................................................ 6.125 08/15/29 230,266
225 ........................................................ 6.375 08/15/27 263,567
9,650 ........................................................ 7.625 02/15/25 12,561,588
6,555 ........................................................ 8.125 08/15/19 - 8,583,734
08/15/21
U.S. Treasury Notes
4,755 ........................................................ 3.125 04/15/09 1,708,301
4,755 ++...................................................... 4.25 08/15/13 4,660,965
4,190 U.S. Treasury Strips.................................... 0.00 08/15/20 2,181,188
--------------
Total U.S. Government Obligations (Cost $29,806,304)....................... 30,189,609
--------------
Mortgage-Backed Securities (7.3%)
Federal Home Loan Mortgage Corp. (ARM)
596 ........................................................ 5.64 04/01/37 594,193
895 ........................................................ 5.736 01/01/37 897,602
Federal Home Loan Mortgage Corp. Gold
125 ........................................................ 6.50 01/01/31 127,459
323 ........................................................ 7.50 08/01/11 - 336,053
06/01/32
Federal National Mortgage Assoc.
617 ........................................................ 6.50 07/01/32 628,209
1,058 ........................................................ 6.995 03/01/36 1,086,076
2,786 ........................................................ 7.00 07/01/18 - 2,884,787
11/01/35
2,437 ........................................................ 7.013 01/01/36 2,500,124
1,117 ........................................................ 7.036 03/01/36 1,145,751
1,258 ........................................................ 7.449 05/01/36 1,288,276
1,210 ........................................................ 7.461 05/01/36 1,243,529
1,720 ........................................................ 7.50 08/01/23 - 1,798,755
09/01/35
558 ........................................................ 8.00 05/01/24 - 588,661
02/01/32
8 ........................................................ 9.50 12/01/20 8,877
</Table>
19
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
Federal National Mortgage Assoc. (ARM)
$ 603 ........................................................ 6.057% 04/01/37 $ 607,138
275 ........................................................ 6.888 07/01/33 279,782
1,173 ........................................................ 6.942 10/01/35 1,206,925
1,183 ........................................................ 6.948 11/01/35 1,217,713
1,190 ........................................................ 6.977 12/01/35 1,224,436
2,356 ........................................................ 7.025 01/01/36 2,416,404
902 ........................................................ 7.479 07/01/36 927,613
1,586 ........................................................ 7.49 04/01/36 1,630,341
1,306 ........................................................ 7.498 07/01/36 1,338,135
2,404 ........................................................ 7.504 04/01/36 2,497,087
101 Federal National Mortgage Assoc. (Dwarf)................ 7.00 07/01/11 - 104,406
05/01/12
Government National Mortgage Assoc.
114 ........................................................ 7.50 08/15/25 - 119,652
06/15/27
94 ........................................................ 8.00 08/15/26 99,366
--------------
Total Mortgage-Backed Securities (Cost $28,870,776)........................ 28,797,350
--------------
Asset-Backed Securities (5.0%)
Finance/Rental/Leasing
696 Alliance Bancorp Trust - 2007-0A 1A1.................... 5.56 07/25/37 697,913
613 Banc of America Securities Auto Trust 2005-WF1 A3....... 3.99 08/18/09 610,415
620 Capital Auto Receivables Asset Trust 2005-1 A4.......... 4.05 07/15/09 617,379
975 Capital Auto Receivables Asset Trust 2006-2 A3A......... 4.98 05/15/11 972,970
250 Capital Auto Receivables Asset Trust 2006-SN1A
A3 - 144A**........................................... 5.31 10/20/09 250,001
875 Capital Auto Receivables Assets Trust 2007-SN1 A3B...... 5.38 07/15/10 874,819
270 Caterpillar Financial Asset Trust 2005-A A3............. 3.90 02/25/09 269,025
375 Caterpillar Financial Asset Trust 2006-A A3............. 5.57 05/25/10 376,505
68 CIT Equipment Collateral 2004-EF1 A3.................... 3.50 09/20/08 67,274
825 Citibank Credit Card Issuance Trust 2007-A1 A1.......... 5.345 03/22/12 825,183
257 CNH Equipment Trust 2005-A A3........................... 4.02 04/15/09 255,916
1,010 CNH Equipment Trust 2005-B A3........................... 4.27 01/15/10 1,003,684
390 DaimlerChrysler Auto Trust 2005-B A3.................... 4.04 09/08/09 388,711
167 Ford Credit Auto Owner Trust 2005-B A3.................. 4.17 01/15/09 166,990
650 Ford Credit Auto Owner Trust 2006-A A3.................. 5.05 03/15/10 649,048
968 GE Equipment Small Ticket LLC 2005-2A A3................ 4.88 10/22/09 965,020
250 GS Auto Loan Trust 2006-1 A3............................ 5.37 12/15/10 250,343
150 Harley Davidson Motorcycle Trust 2005-3 A2.............. 4.41 06/15/12 148,584
1,300 Harley-Davidson Motorcycle Trust 2005-1 A2.............. 3.76 12/17/12 1,276,370
775 Harley-Davidson Motorcycle Trust 2005-2 A2.............. 4.07 02/15/12 766,041
650 Hertz Vehicle Financing LLC 2005-2A A2 - 144A**......... 4.93 02/25/10 647,487
206 Honda Auto Receivables Owner Trust 2005-2 A3............ 3.93 01/15/09 205,637
</Table>
20
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
$ 500 Honda Auto Receivables Owner Trust 2005-3 A3............ 3.87 % 04/20/09 $ 497,207
875 Honda Auto Receivables Owner Trust 2005-6 A3............ 4.85 10/19/09 873,318
448 Hyundai Auto Receivables Trust 2005-A A3................ 3.98 11/16/09 444,786
290 MBNA Master Credit Card Trust 1999-B A.................. 5.90 08/15/11 293,911
642 Merrill Auto Trust Securitization 2005-1 A3............. 4.10 08/25/09 639,608
555 National City Auto Receivables Trust 2004-A A4.......... 2.88 05/15/11 546,766
629 Nissan Auto Receivables Owner Trust 2005-B A3........... 3.99 07/15/09 625,572
250 TXU Electric Delivery Transition Bond Co. LLC 2004-1
A2.................................................... 4.81 11/17/14 247,085
994 USAA Auto Owner Trust 2004-2 A4......................... 3.58 02/15/11 987,364
92 USAA Auto Owner Trust 2004-3 A3......................... 3.16 02/17/09 91,894
279 USAA Auto Owner Trust 2005-1 A3......................... 3.90 07/15/09 277,735
50 Volkswagen Auto Lease Trust 2005-A A3................... 3.82 05/20/08 49,826
740 Volkswagen Auto Loan Enhanced Trust 2005-1 A3........... 4.80 07/20/09 737,865
45 Wachovia Auto Owner Trust 2004-B A3..................... 2.91 04/20/09 45,295
305 Wachovia Auto Owner Trust 2005-A A3..................... 4.06 09/21/09 303,788
875 Wachovia Auto Owner Trust 2005-B A3..................... 4.79 04/20/10 873,146
--------------
Total Asset-Backed Securities (Cost $19,887,731)........................... 19,820,481
--------------
Collateralized Mortgage Obligations (3.2%)
U.S. Government Agencies (1.0%)
704 Federal Home Loan Mortgage Corp. Whole Loan 2005-S001
2A2................................................... 5.47+ 09/25/45 702,607
997 Federal National Mortgage Assoc. 2006-28 1A1............ 5.43+ 03/25/36 997,113
1,119 Federal National Mortgage Assoc. 2006-118 A2............ 5.38+ 12/25/36 1,115,983
2,142 Federal National Mortgage Assoc. 2005-68 XI (IO)........ 6.00 08/25/35 769,760
11,651 Federal National Mortgage Assoc. 2006-28 1P (IO)........ 1.381+ 03/25/36 240,292
--------------
Total U.S. Government Agencies............................................. 3,825,755
--------------
Private Issues (2.2%)
710 Adjustable Rate Mortgage Trust 2005-6A 2A1.............. 5.63 11/25/35 711,164
878 American Home Mortgage Investment Trust 2007-1 GA1C..... 5.51 05/25/47 877,758
613 Bear Stearns Mortgage Funding Trust 2006-AR4............ 5.53 12/25/36 611,367
612 Bear Stearns Mortgage Funding Trust 2006-AR5 1A1........ 5.48+ 12/25/36 613,073
989 Countrywide Alternative Loan Trust 2007-0A8 2A2......... 5.55 06/25/47 982,625
625 Countrywide Alternative Loan Trust 2007-0A1O 2A1........ 5.57 08/25/47 622,266
3,824 Countrywide Alternative Loan Trust 2006-OA17 1XP (IO)... 1.276 12/20/46 160,024
5,021 Countrywide Alternative Loan Trust 2006-0A21 X (IO)..... 1.53 03/20/47 245,141
850 Harborview Mortgage Loan Trust 2006-14 2A1A............. 5.47 03/19/38 851,198
681 Residential Accredit Loans, Inc. 2007-Q03 A3............ 5.58 03/25/47 681,066
346 Residential Accredit Loans, Inc. 2007-Q04 A1............ 5.52 05/25/47 346,659
544 Residential Accredit Loans, Inc. 2007-Q04 A2............ 5.58 05/25/47 544,451
</Table>
21
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
$ 321 Residential Accredit Loans, Inc. 2007-q04 A3............ 5.62 % 05/25/47 $ 321,895
986 Wamu Mortgage Pass-Through Certificates 2007-OA6 CA1B... 5.55 07/25/47 986,280
--------------
Total Private Issues....................................................... 8,554,967
--------------
Total Collateralized Mortgage Obligations (Cost $12,061,512)............... 12,380,722
--------------
<Caption>
NUMBER OF
CONTRACTS
- ----------
Put Options Purchased (0.0%)
41 90 day Euro $ December/2007 @ $94.75....................................... 6,150
67 90 day Euro $ March/2008 @ $94.50.......................................... 4,187
--------------
Total Put Options Purchased (Cost $16,986)................................. 10,337
--------------
</Table>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN
THOUSANDS
- ----------
Short-Term Investments (5.5%)
Investment Company (b) (5.4%)
$ 21,110 Morgan Stanley Institutional Liquidity Money Market Portfolio - Institutional
Class (Cost $21,109,686)................................................... 21,109,686
------------
U.S. Government Obligation (c) (0.1%)
650 U.S. Treasury Bill*** (Cost $635,828).................... 4.845 01/10/08 635,828
------------
</Table>
<Table>
Total Short-Term Investments (Cost $21,745,514)......................... 21,745,514
------------
Total Investments (Cost $367,373,960) (d) (e)........................... 102.2% 402,122,487
Liabilities in Excess of Other Assets................................... (2.2) (8,494,122)
----- ------------
Net Assets.............................................................. 100.0% $393,628,365
===== ============
</Table>
22
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED) continued
- ---------------------
<Table>
ADR American Depositary Receipt.
ARM Adjustable Rate Mortgage.
IO Interest Only Security.
* Non-income producing security.
** Resale is restricted to qualified institutional investors.
*** This security has been physically segregated in connection
with open futures contracts in the amount of $25,505.
+ Floating rate security. Rate shown is the rate in effect at
July 31, 2007.
++ Security purchased on a forward commitment basis.
(a) A security with a total market value equal to $0 have been
valued at its fair value as determined in good faith under
procedures established by and under the general supervision
of the Fund's Trustees.
(b) See Note 4 to the financial statements regarding Investments
in Morgan Stanley Institutional Liquidity Money Market
Portfolio - Institutional Class.
(c) Purchased on a discount basis. The interest rate shown has
been adjusted to reflect a money market equivalent yield.
(d) Securities have been designated as collateral in an amount
equal to $70,342,678 in connection with open futures
contracts, securities purchased on a forward commitment
basis and open swap contracts.
(e) The aggregate cost for federal income tax purposes
approximates the aggregate cost for book purposes. The
aggregate gross unrealized appreciation is $44,348,585 and
the aggregate gross unrealized depreciation is $9,600,058,
resulting in net unrealized appreciation of $34,748,527.
</Table>
FUTURES CONTRACTS OPEN AT JULY 31, 2007:
<Table>
<Caption>
UNREALIZED
NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE APPRECIATION
CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE (DEPRECIATION)
- ---------------------------------------------------------------------------------------
246 Long U.S. Treasury Notes 5 Year, $ 25,945,313 $ 130,183
September 2007
107 Long U.S. Treasury Notes 2 Year, 21,928,313 119,515
September 2007
25 Short U.S. Treasury Notes 10 Year, (2,685,547) (50,131)
September 2007
139 Short U.S. Treasury Bond 20 Year, (15,298,688) (212,867)
September 2007
---------
Net Unrealized Depreciation.................. $ (13,300)
=========
</Table>
23
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED) continued
CREDIT DEFAULT SWAP CONTRACTS OPEN AT JULY 31, 2007:
<Table>
<Caption>
NOTIONAL UNREALIZED
SWAP COUNTERPARTY & BUY/SELL AMOUNT PAY/RECEIVE TERMINATION APPRECIATION
REFERENCE OBLIGATION PROTECTION (000'S) FIXED RATE DATE (DEPRECIATION)
- ---------------------------------------------------------------------------------------------------------------------
Goldman Sachs International Buy $650 0.12 % December 20, 2011 $ 4,278
Hartford Financial Services
Group, Inc.
Goldman Sachs International Buy 220 0.15 December 20, 2011 2,949
Motorola Inc
Goldman Sachs International Buy 450 0.157 December 20, 2011 5,909
Motorola Inc
Goldman Sachs International Buy 700 0.22 December 20, 2011 6,693
Southwest Airlines Co.
Goldman Sachs International Buy 325 0.20 December 20, 2011 1,719
Union Pacific Corp.
Citibank, NA, New York Buy 780 0.43 March 20, 2012 8,720
Tyco International Ltd.
Citibank, NA, New York Buy 400 0.43 March 20, 2012 4,472
Tyco International Ltd.
Goldman Sachs International Buy 650 0.10 March 20, 2012 5,660
Chubb Corp
Goldman Sachs International Buy 330 0.22 March 20, 2012 272
Dell Inc
Goldman Sachs International Sell 495 0.74 June 20, 2012 (46,902)
SLM Corp.
JPMorgan Securities, Inc. Buy 115 1.18 June 20, 2014 3,156
Belo Corp.
JPMorgan Securities, Inc. Buy 330 1.30 June 20, 2014 6,884
Belo Corp.
Goldman Sachs International Sell 515 2.00 March 20, 2017 (64,467)
Residential Capital LLC
--------
Net Unrealized Depreciation............................................. $(60,657)
========
</Table>
24
See Notes to Financial Statements
Morgan Stanley Balanced Fund
PORTFOLIO OF INVESTMENTS - JULY 31, 2007 (UNAUDITED) continued
INTEREST RATE SWAP CONTRACTS OPEN JULY 31, 2007:
<Table>
<Caption>
NOTIONAL
AMOUNT PAYMENTS PAYMENTS TERMINATION UNREALIZED
COUNTERPARTY (000'S) MADE BY FUND RECEIVED BY FUND DATE DEPRECIATION
- -------------------------------------------------------------------------------------------------------------
Citibank N.A. $8,500 Fixed Rate 5.36% Floating Rate 5.337% May 24, 2017 $(105,825)
JPMorgan Chase & Co. 8,500 Fixed Rate 5.36 Floating Rate 5.34 May 24, 2017 (104,210)
Deutsche Bank 3,600 Fixed Rate 5.36 Floating Rate 5.388 May 25, 2017 (30,924)
JPMorgan Chase & Co. 4,300 Fixed Rate 5.36 Floating Rate 5.448 May 29, 2017 (17,845)
---------
Total Unrealize...............................................
$(258,804)
=========
</Table>
25
See Notes to Financial Statements
Morgan Stanley Balanced Fund
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
July 31, 2007 (unaudited)
<Table>
Assets:
Investments in securities, at value (cost $346,264,274)..... $381,012,801
Investments in affiliates (cost $21,109,686)................ 21,109,686
Unrealized appreciation on open swap contracts.............. 50,712
Cash........................................................ 3,581
Receivable for:
Investments sold........................................ 2,426,749
Interest................................................ 1,394,029
Swap contracts collateral due from broker............... 590,000
Dividends............................................... 446,582
Periodic interest receivables on swap contracts......... 248,388
Shares of beneficial interest sold...................... 89,547
Dividends from affiliate................................ 68,689
Principal paydowns...................................... 41,600
Prepaid expenses and other assets........................... 65,543
------------
Total Assets............................................ 407,547,907
------------
Liabilities:
Unrealized depreciation on open swap contracts.............. 370,173
Payable for:
Investments purchased................................... 11,957,799
Shares of beneficial interest redeemed.................. 626,577
Distribution fee........................................ 274,453
Periodic interest payments on swap contracts............ 254,018
Investment advisory fee................................. 187,080
Administration fee...................................... 28,790
Variation margin........................................ 28,453
Transfer agent fee...................................... 7,609
Accrued expenses and other payables......................... 184,590
------------
Total Liabilities....................................... 13,919,542
------------
Net Assets.............................................. $393,628,365
============
Composition of Net Assets:
Paid-in-capital............................................. $347,494,300
Net unrealized appreciation................................. 34,415,766
Accumulated undistributed net investment income............. 181,945
Accumulated undistributed net realized gain................. 11,536,354
------------
Net Assets.............................................. $393,628,365
============
Class A Shares:
Net Assets.................................................. $123,143,514
Shares Outstanding (unlimited authorized, $.01 par value)... 8,208,153
Net Asset Value Per Share............................... $15.00
============
Maximum Offering Price Per Share,
(net asset value plus 5.54% of net asset value)......... $15.83
============
Class B Shares:
Net Assets.................................................. $155,973,419
Shares Outstanding (unlimited authorized, $.01 par value)... 10,392,575
Net Asset Value Per Share............................... $15.01
============
Class C Shares:
Net Assets.................................................. $112,625,640
Shares Outstanding (unlimited authorized, $.01 par value)... 7,502,263
Net Asset Value Per Share............................... $15.01
============
Class D Shares:
Net Assets.................................................. $1,885,792
Shares Outstanding (unlimited authorized, $.01 par value)... 125,761
Net Asset Value Per Share............................... $15.00
============
</Table>
26
See Notes to Financial Statements
Morgan Stanley Balanced Fund
FINANCIAL STATEMENTS continued
Statement of Operations
For the six months ended July 31, 2007 (unaudited)
<Table>
Net Investment Income:
Income
Dividends (net of $117,093 foreign withholding tax)......... $ 3,515,415
Interest.................................................... 3,402,108
Dividends from affiliates................................... 68,689
------------
Total Income............................................ 6,986,212
------------
Expenses
Investment advisory fee..................................... 1,087,470
Distribution fee (Class A shares)........................... 156,779
Distribution fee (Class B shares)........................... 860,758
Distribution fee (Class C shares)........................... 593,034
Transfer agent fees and expenses............................ 233,641
Administration fee.......................................... 167,303
Shareholder reports and notices............................. 50,703
Professional fees........................................... 49,446
Custodian fees.............................................. 32,606
Registration fees........................................... 21,074
Trustees' fees and expenses................................. 3,565
Other....................................................... 24,371
------------
Total Expenses.......................................... 3,280,750
Less: amounts waived/reimbursed............................. (56)
Less: expense offset........................................ (1,626)
------------
Net Expenses............................................ 3,279,068
------------
Net Investment Income................................... 3,707,144
------------
Net Realized and Unrealized Gain (Loss):
Net Realized Gain (Loss) on:
Investments................................................. 26,126,992
Futures contracts........................................... (345,077)
Option contracts............................................ (118,343)
Swap contracts.............................................. (849)
------------
Net Realized Gain....................................... 25,662,723
------------
Net Change in Unrealized Appreciation/Depreciation on:
Investments................................................. (21,972,350)
Futures contracts........................................... 241,950
Swap contracts.............................................. (330,821)
Option contracts............................................ 111,696
------------
Net Change in Unrealized Appreciation/Depreciation...... (21,949,525)
------------
Net Gain................................................ 3,713,198
------------
Net Increase................................................ $ 7,420,342
============
</Table>
27
See Notes to Financial Statements
Morgan Stanley Balanced Fund
FINANCIAL STATEMENTS continued
Statements of Changes in Net Assets
<Table>
<Caption>
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
JULY 31, 2007 JANUARY 31, 2007
------------- -----------------
(unaudited)
Increase (Decrease) in Net Assets:
Operations:
Net investment income....................................... $ 3,707,144 $ 4,250,794
Net realized gain........................................... 25,662,723 22,330,301
Net change in unrealized appreciation/depreciation.......... (21,949,525) 7,806,685
------------ ------------
Net Increase............................................ 7,420,342 34,387,780
------------ ------------
Dividends and Distributions to Shareholders from:
Net investment income
Class A shares.......................................... (1,383,190) (1,292,653)
Class B shares.......................................... (1,232,957) (1,456,409)
Class C shares.......................................... (856,760) (1,159,994)
Class D shares.......................................... (25,482) (31,820)
Net realized gain
Class A shares.......................................... -- (4,941,049)
Class B shares.......................................... -- (8,342,064)
Class C shares.......................................... -- (6,103,928)
Class D shares.......................................... -- (100,627)
------------ ------------
Total Dividends and Distributions....................... (3,498,389) (23,428,544)
------------ ------------
Net increase (decrease) from transactions in shares of
beneficial interest....................................... (46,696,698) 225,411,146
------------ ------------
Net Increase (Decrease)................................. (42,774,745) 236,370,382
Net Assets:
Beginning of period......................................... 436,403,110 200,032,728
------------ ------------
End of Period
(Including accumulated undistributed net investment income
of $181,945 and dividends in excess of net investment income
of $26,810, respectively)................................... $393,628,365 $436,403,110
============ ============
</Table>
28
See Notes to Financial Statements
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2007 (UNAUDITED)
1. Organization and Accounting Policies
Morgan Stanley Balanced 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 capital growth
with reasonable current income. The Fund was organized as a Massachusetts
business trust on November 23, 1994 and commenced operations on March 28, 1995.
On July 28, 1997, the Fund converted to a multiple class share structure.
The Fund offers Class A shares, Class B shares, Class C shares and Class D
shares. The four classes are substantially the same except that most Class A
shares are subject to a sales charge imposed at the time of purchase and some
Class A shares, and most Class B shares and Class C shares are subject to a
contingent deferred sales charge imposed on shares redeemed within eighteen
months, six years and one year, respectively. Class D shares are not subject to
a sales charge. Additionally, Class A shares, Class B shares and Class C shares
incur distribution expenses.
The Fund will assess a 2% redemption fee, on Class A shares, Class B shares,
Class C shares, and Class D shares, which is paid directly to the Fund, for
shares redeemed or exchanged 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)
credit default/interest rate swaps are marked-to-market daily based upon
quotations from market makers and the change, if any, is recorded as unrealized
appreciation or depreciation in
29
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2007 (UNAUDITED) continued
the Statement of Operations; (8) when market quotations are not readily
available including circumstances under which Morgan Stanley Investment Advisors
Inc. (the "Investment Adviser") determines that the latest sale price, the bid
price or the mean between the last reported bid and asked price do not reflect a
security's market value, portfolio securities are valued at their fair value as
determined in good faith under procedures established by and under the general
supervision of the Fund's Trustees. Occasionally, developments affecting the
closing prices of securities and other assets may occur between the times at
which valuations of such securities are determined (that is, close of the
foreign market on which the securities trade) and the close of business on the
NYSE. If developments occur during such periods that are expected to materially
affect the value of such securities, such valuations may be adjusted to reflect
the estimated fair value of such securities as of the close of the NYSE, as
determined in good faith by the Fund's Trustees or by the Investment Adviser
using a pricing service and/or procedures approved by the Trustees of the Fund;
(9) certain portfolio securities may be valued by an outside pricing service
approved by the Fund's Trustees; and (10) 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 and are included in interest income. Interest income is
accrued daily.
C. 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.
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
30
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2007 (UNAUDITED) continued
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 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 or currency and the proceeds from such sale are increased by
the premium originally received. If a written put option is exercised, the
amount of the premium originally received reduces the cost of the security which
the Fund purchases upon exercise of the option.
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. Credit Default Swaps -- A credit default swap is an agreement between two
parties to exchange the credit risk of an issuer. The Fund may purchase credit
protection on the referenced obligation of the credit default swap ("Buy
Contract"), or provide credit protection on the referenced obligation of the
credit default swap ("Sale Contract"). A buyer of a credit default swap is said
to buy protection by paying periodic fees in return for a contingent payment
from the seller if the issuer has a credit event such as bankruptcy, failure to
pay outstanding obligations or deteriorating credit while the swap is
outstanding. A seller of a credit default swap is said to sell protection and
thus collects the periodic fees and profits if the credit of the issuer remains
stable or improves while the swap is outstanding. If a credit event occurs, the
seller pays to the buyer the maximum payout amount limited to the notional
amount of the swap contract as disclosed in the table following the Portfolio of
Investments. During the term of the swap agreement, the Fund receives or pays
periodic fixed payments from or to the respective counterparty calculated at the
agreed upon interest rate applied to the notional amount. These periodic
payments are accrued daily and recorded as realized gains or losses in the
Statement of Operations. In addition, upon termination of the swap contract,
gains
31
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2007 (UNAUDITED) continued
and losses are also realized. Any upfront payment received or paid by the Fund
is recorded as assets/liabilities on the Fund's books.
G. Interest Rate Swaps -- Interest rate swaps involve the exchange of
commitments to pay and receive interest based on a notional principal amount.
Net periodic interest payments to be received or paid are accrued daily and are
recorded as realized gains or losses in the Statement of Operations.
H. Federal Income Tax Policy -- It is the Fund's policy to comply with the
requirements of the Subchapter M of the Internal Revenue Code applicable to
regulated investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no provision for federal income
taxes is required. The Fund files tax returns with the U.S. Internal Revenue
Service and various states. Generally, the tax authorities can examine all tax
returns filed for the last three years. If applicable, the Fund recognizes
interest accrued related to unrecognized tax benefits in interest expense and
penalties in other expenses in the Statement of Operations. The Fund adopted the
provisions of the Financial Accounting Standards Board's (FSAB) Interpretation
number 48 Accounting for Uncertainty in Income Taxes, on June 30, 2007. As of
July 31, 2007, this did not result in an impact to the Fund's financial
statements.
I. Dividends and Distributions to Shareholders -- Dividends and distributions to
shareholders are recorded on the ex-dividend date.
J. 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, 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 Administration Agreement with Morgan Stanley Services Company Inc.
(the "Administrator"), affiliate of the Investments Adviser, the Fund pays an
administration fee, accrued daily and payable monthly, by applying the annual
rate of 0.08% to the Fund's daily net assets.
32
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2007 (UNAUDITED) continued
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 shares; (ii) Class
B -- up to 1.0% of the average daily net assets of Class B shares; and (iii)
Class C -- up to 1.0% of the average daily net assets of Class C shares.
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
$21,472,915 at July 31, 2007.
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, 2007, the
distribution fee was accrued for Class A shares and Class C shares at the annual
rate of 0.25% and 1.0%, respectively.
The Distributor has informed the Fund that for the six months ended July 31,
2007, it received contingent deferred sales charges from certain redemptions of
the Fund's Class A shares, Class B shares and Class C shares of $177, $147,482
and $3,703, respectively and received $27,503 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 Fund invests in Morgan Stanley Institutional Liquidity Money Market
Portfolio - Institutional Class, an open-end management investment company
managed by the Investment Adviser. Investment advisory fees paid by the Fund are
reduced by an amount equal to the advisory and administrative
33
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2007 (UNAUDITED) continued
services fees paid by Morgan Stanley Institutional Liquidity Money Market
Portfolio - Institutional Class with respect to assets invested by the Fund in
Morgan Stanley Institutional Liquidity Money Market Portfolio - Institutional
Class. For the six months ended July 31, 2007, advisory fees paid were reduced
by $56 relating to the Fund's investment in Morgan Stanley Institutional
Liquidity Money Market Portfolio - Institutional Class. Income distributions
earned by the Fund are recorded as dividends from affiliates in the Statement of
Operations and totaled $68,689 for the six months ended July 31, 2007. During
the six months ended July 31, 2007, cost of purchases and sales in investments
in Morgan Stanley Institutional Liquidity Money Market Portfolio - Institutional
Class aggregated $26,006,932 and $4,897,246, respectively.
The cost of purchases and proceeds from sales/prepayments of portfolio
securities, excluding short-term investments, for the six months ended July 31,
2007 aggregated $112,733,816 and $167,776,673, respectively. Included in the
aforementioned are purchases and sales of U.S. Government securities in the
amount of $58,967,572 and $64,118,018, respectively. The Fund had purchases of
$566,202 with other Morgan Stanley funds.
For the six months ended July 31, 2007, the Fund incurred brokerage commissions
of $2,085 with Morgan Stanley & Co., Inc., an affiliate of the Investment
Adviser, Administrator and Distributor, for portfolio transactions executed on
behalf of the Fund.
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 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.
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.
34
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2007 (UNAUDITED) continued
For hedging and investment purposes, the Fund may also engage in transactions in
listed and over-the-counter options.
These future and option contracts involve elements of market risk in excess of
the amount reflected in the Statement of Assets and Liabilities. The Fund bears
the risk of an unfavorable change in the value of the underlying securities.
Risk also may arise from the potential inability of the counterparties to meet
the terms of their contracts.
The Fund may enter into credit default swaps for hedging purposes to add
leverage to its portfolio or to gain exposure to a credit in which the Fund may
otherwise invest. Credit default swaps may involve greater risks than if a Fund
had invested in the issuer directly. Credit default swaps are subject to general
market risk, counterparty risk and credit risk. If the Fund is a buyer and no
credit event occurs, it will lose its investment. In addition, if the Fund is a
seller and a credit event occurs, the value of the referenced obligation
received by the Fund coupled with the periodic payments previously received may
be less than the maximum payout amount it pays to the buyer, resulting in a loss
to the Fund.
The Fund may enter into interest rate swaps and may purchase or sell interest
rate caps, floors and collars. The Fund expects to enter into these transactions
primarily to manage interest rate risk, hedge portfolio positions and preserve a
return or spread on a particular investment or portion of its portfolio. The
Fund may also enter into these transactions to protect against any increase in
the price of securities the Fund anticipates purchasing at a later date.
Interest rate swap transactions are subject to market risk, risk of default by
the other party to the transaction, risk of imperfect correlation and manager
risk. Such risks may exceed the related amounts shown in the Statement of Assets
and Liabilities.
6. 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.
35
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2007 (UNAUDITED) continued
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, 2007 JANUARY 31, 2007
------------------------- -------------------------
(unaudited)
SHARES AMOUNT SHARES AMOUNT
---------- ------------ ---------- ------------
CLASS A SHARES
Sold............................................. 208,734 $ 3,165,408 541,360 $ 7,983,706
Conversion from Class B.......................... 587,565 8,954,030 767,806 11,274,673
Shares issued in connection with the acquisition
of Morgan Stanley Balanced Income Fund and
Morgan Stanley Income Builder Fund............. -- -- 5,761,145 83,647,510
Reinvestment of dividends and distributions...... 72,870 1,102,434 360,793 5,266,799
Redeemed......................................... (1,065,692) (16,244,418) (1,306,418) (19,217,810)
---------- ------------ ---------- ------------
Net increase (decrease) - Class A................ (196,523) (3,022,546) 6,124,686 88,954,878
---------- ------------ ---------- ------------
CLASS B SHARES
Sold............................................. 249,903 3,822,691 513,859 7,552,220
Conversion to Class A............................ (587,259) (8,954,030) (767,637) (11,274,673)
Shares issued in connection with the acquisition
of Morgan Stanley Balanced Income Fund and
Morgan Stanley Income Builder Fund............. -- -- 8,934,572 129,834,129
Reinvestment of dividends and distributions...... 63,507 961,238 545,524 7,933,329
Redeemed......................................... (1,788,121) (27,232,249) (2,578,346) (37,928,547)
---------- ------------ ---------- ------------
Net increase (decrease) - Class B................ (2,061,970) (31,402,350) 6,647,972 96,116,458
---------- ------------ ---------- ------------
CLASS C SHARES
Sold............................................. 154,690 2,368,241 263,940 3,873,577
Shares issued in connection with the acquisition
of Morgan Stanley Balanced Income Fund and
Morgan Stanley Income Builder Fund............. -- -- 3,602,466 52,383,187
Reinvestment of dividends and distributions...... 46,386 702,508 447,816 6,483,127
Redeemed......................................... (986,988) (15,023,332) (1,608,685) (23,604,763)
---------- ------------ ---------- ------------
Net increase (decrease) - Class C................ (785,912) (11,952,583) 2,705,537 39,135,128
---------- ------------ ---------- ------------
CLASS D SHARES
Sold............................................. 9,408 145,647 28,513 413,318
Shares issued in connection with the acquisition
of Morgan Stanley Balanced Income Fund and
Morgan Stanley Income Builder Fund............. -- -- 114,117 1,655,608
Reinvestment of dividends and distributions...... 1,333 20,124 8,286 120,209
Redeemed......................................... (31,505) (484,990) (66,814) (984,453)
---------- ------------ ---------- ------------
Net increase (decrease) - Class D................ (20,764) (319,219) 84,102 1,204,682
---------- ------------ ---------- ------------
Net increase (decrease) in Fund.................. (3,065,169) $(46,696,698) 15,562,297 $225,411,146
========== ============ ========== ============
</Table>
36
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2007 (UNAUDITED) continued
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 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.
The Fund had a net capital loss carryforward of $12,813,359 which will expire on
January 31, 2011 to offset future capital gains to the extent provided by
regulations.
As part of the Fund's acquisition of the assets of Morgan Stanley Income Builder
Fund ("Income Builder"), the Fund obtained a net capital loss carryforward of
$18,951,808 from Income Builder. Utilization of this carryforward is subject to
limitations imposed by the Internal Revenue Code and Treasury Regulations,
reducing the total carryforward available.
As of January 31, 2007, the Fund had temporary book/tax differences primarily
attributable to mark-to-market of open futures contracts, capital loss deferrals
on straddles and wash sales and book amortization of premiums on debt
securities.
9. Accounting Pronouncement
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.
10. Fund Acquisitions
On September 18, 2006, the Fund acquired all the net assets of the Morgan
Stanley Balanced Income Fund ("Balanced Income") based on the respective
valuations as of the close of business on September 15, 2006 pursuant to a plan
of reorganization approved by the shareholders of Balanced Income on August 23,
2006. The acquisition was accomplished by a tax-free exchange of 1,501,467 Class
A shares of the Fund at a net asset value of $14.52 per share for 1,812,244
Class A shares of Balanced Income; 5,588,566 Class B shares of the Fund at a net
asset value of $14.53 per share for 6,778,119 Class B shares of Balanced Income;
2,321,112 Class C shares of the Fund at a net asset value of $14.54 per share
for 2,812,414 Class C shares of Balanced
37
Morgan Stanley Balanced Fund
NOTES TO FINANCIAL STATEMENTS - JULY 31, 2007 (UNAUDITED) continued
Income; and 59,403 Class D shares of the Fund at a net asset value of $14.51 per
share for 71,888 Class D shares of Balanced Income. The net assets of the Fund
and Balanced Income immediately before the acquisition were $180,346,678 and
$137,644,097, respectively, including unrealized appreciation of $7,514,281 for
Balanced Income.
On September 18, 2006, the Fund acquired all the net assets of Income Builder
based on the respective valuations as of the close of business on September 15,
2006 pursuant to a plan of reorganization approved by the shareholders of Income
Builder on July 17, 2006. The acquisition was accomplished by a tax-free
exchange of 4,259,678 Class A shares of the Fund at a net asset value of $14.52
per share for 5,120,077 Class A shares of Income Builder; 3,346,006 Class B
shares of the Fund at a net asset value of $14.53 per share for 4,014,655 Class
B shares of Income Builder; 1,281,354 Class C shares of the Fund at a net asset
value of $14.54 per share for 1,544,850 Class C shares of Income Builder; and
54,714 Class D shares of the Fund at a net asset value of $14.51 per share for
65,721 Class D shares of Income Builder. The net assets of the Fund and Income
Builder immediately before the acquisition were $180,346,678 and $129,876,337,
respectively, including unrealized appreciation of $12,705,752 for Income
Builder.
Immediately after both acquisitions, the combined net assets of the Fund
amounted to $447,867,112.
38
Morgan Stanley Balanced Fund
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED JANUARY 31,
MONTHS ENDED ---------------------------------------------
JULY 31, 2007 2007 2006 2005 2004 2003
------------- -------- ------- ------ ------ ------
(unaudited)
Class A Shares
Selected Per Share Data:
Net asset value, beginning of period............... $14.89 $14.57 $13.76 $12.98 $10.73 $12.82
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income++........................ 0.17 0.30 0.24 0.21 0.18 0.25
Net realized and unrealized gain (loss)........ 0.11 1.20 1.21 0.79 2.30 (2.06)
------ ------ ------ ------ ------ ------
Total income (loss) from investment operations..... 0.28 1.50 1.45 1.00 2.48 (1.81)
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income.......................... (0.17) (0.29) (0.27) (0.22) (0.23) (0.28)
Net realized gain.............................. -- (0.89) (0.37) -- -- --
------ ------ ------ ------ ------ ------
Total dividends and distributions.................. (0.17) (1.18) (0.64) (0.22) (0.23) (0.28)
------ ------ ------ ------ ------ ------
Net asset value, end of period..................... $15.00 $14.89 $14.57 $13.76 $12.98 $10.73
====== ====== ====== ====== ====== ======
Total Return+...................................... 1.86%(2) 10.54% 10.99% 7.80% 23.37% (14.27)%
Ratios to Average Net Assets(1):
Total expenses (before expense offset)............. 1.05%(3)(4) 1.14% 1.13% 1.13% 1.12% 1.10%
Net investment income.............................. 2.29%(3)(4) 2.06% 1.70% 1.61% 1.58% 2.14%
Supplemental Data:
Net assets, end of period, in thousands............ $123,144 $125,180 $33,217 $7,017 $6,663 $5,848
Portfolio turnover rate............................ 28%(2) 56% 52% 64% 117% 145%
</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) Reflects overall Fund ratios for investment income and
non-class specific expenses.
(2) Not annualized.
(3) Annualized.
(4) Reflects waivers of certain Fund expenses in connection with
the investments in Morgan Stanley institutional Liquidity
Money Market Portfolio--Institutional Class during the
period. As a result of such waivers the expenses as a
percentage of its net assets had an effect of less than
0.005%
</Table>
39
See Notes to Financial Statements
Morgan Stanley Balanced Fund
FINANCIAL HIGHLIGHTS continued
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED JANUARY 31,
MONTHS ENDED -------------------------------------------------
JULY 31, 2007 2007 2006 2005 2004 2003
------------- -------- ------- -------- -------- ------
(unaudited)
Class B Shares
Selected Per Share Data:
Net asset value, beginning of period.......... $14.90 $14.56 $13.75 $12.97 $10.73 $12.81
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income++................... 0.12 0.19 0.14 0.11 0.10 0.16
Net realized and unrealized gain (loss)... 0.10 1.22 1.20 0.79 2.28 (2.05)
------ ------ ------ ------ ------ ------
Total income (loss) from investment
operations................................... 0.22 1.41 1.34 0.90 2.38 (1.89)
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income..................... (0.11) (0.18) (0.16) (0.12) (0.14) (0.19)
Net realized gain......................... -- (0.89) (0.37) -- -- --
------ ------ ------ ------ ------ ------
Total dividends and distributions............. (0.11) (1.07) (0.53) (0.12) (0.14) (0.19)
------ ------ ------ ------ ------ ------
Net asset value, end of period................ $15.01 $14.90 $14.56 $13.75 $12.97 $10.73
====== ====== ====== ====== ====== ======
Total Return+................................. 1.40%(2) 9.80% 10.12% 6.99% 22.37% (14.86)%
Ratios to Average Net Assets(1):
Total expenses (before expense offset)........ 1.80%(3)(4) 1.89% 1.89% 1.89% 1.88% 1.87%
Net investment income......................... 1.54%(3)(4) 1.31% 0.94% 0.85% 0.82% 1.37%
Supplemental Data:
Net assets, end of period, in thousands....... $155,973 $185,534 $84,568 $110,875 $114,960 $79,631
Portfolio turnover rate....................... 28%(2) 56% 52% 64% 117% 145%
</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) Reflects overall Fund ratios for investment income and
non-class specific expenses.
(2) Not annualized.
(3) Annualized.
(4) Reflects waivers of certain Fund expenses in connection with
the investments in Morgan Stanley institutional Liquidity
Money Market Portfolio--Institutional Class during the
period. As a result of such waivers the expenses as a
percentage of its net assets had an effect of less than
0.005%
</Table>
40
See Notes to Financial Statements
Morgan Stanley Balanced Fund
FINANCIAL HIGHLIGHTS continued
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED JANUARY 31,
MONTHS ENDED ------------------------------------------------
JULY 31, 2007 2007 2006 2005 2004 2003
------------- -------- ------- ------- ------- -------
(unaudited)
Class C Shares
Selected Per Share Data:
Net asset value, beginning of period........... $14.90 $14.57 $13.76 $12.98 $10.73 $12.81
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income++.................... 0.12 0.19 0.14 0.11 0.10 0.16
Net realized and unrealized gain (loss).... 0.10 1.21 1.20 0.79 2.29 (2.05)
------ ------ ------ ------ ------ ------
Total income (loss) from investment
operations.................................... 0.22 1.40 1.34 0.90 2.39 (1.89)
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income...................... (0.11) (0.18) (0.16) (0.12) (0.14) (0.19)
Net realized gain.......................... -- (0.89) (0.37) -- -- --
------ ------ ------ ------ ------ ------
Total dividends and distributions.............. (0.11) (1.07) (0.53) (0.12) (0.14) (0.19)
------ ------ ------ ------ ------ ------
Net asset value, end of period................. $15.01 $14.90 $14.57 $13.76 $12.98 $10.73
====== ====== ====== ====== ====== ======
Total Return+.................................. 1.47%(2) 9.75% 10.15% 6.98% 22.43% (14.88)%
Ratios to Average Net Assets(1):
Total expenses (before expense offset)......... 1.80%(3) 1.89% 1.89% 1.87% 1.88% 1.87%
Net investment income.......................... 1.54%(3)(4) 1.31% 0.94% 0.87% 0.82% 1.37%
Supplemental Data:
Net assets, end of period, in thousands........ $112,626 $123,508 $81,339 $81,606 $84,840 $75,323
Portfolio turnover rate........................ 28%(2)(4) 56% 52% 64% 117% 145%
</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) Reflects overall Fund ratios for investment income and
non-class specific expenses.
(2) Not annualized.
(3) Annualized.
(4) Reflects waivers of certain Fund expenses in connection with
the investments in Morgan Stanley institutional Liquidity
Money Market Portfolio-Institutional Class during the
period. As a result of such waivers the expenses as a
percentage of its net assets had an effect of less than
0.005%
</Table>
41
See Notes to Financial Statements
Morgan Stanley Balanced Fund
FINANCIAL HIGHLIGHTS continued
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED JANUARY 31,
MONTHS ENDED ------------------------------------------
JULY 31, 2007 2007 2006 2005 2004 2003
------------- ------ ------ ------ ------ ------
(unaudited)
Class D Shares
Selected Per Share Data:
Net asset value, beginning of period.................. $14.89 $14.56 $13.76 $12.97 $10.73 $12.81
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income++........................... 0.19 0.34 0.28 0.24 0.22 0.27
Net realized and unrealized gain (loss)........... 0.11 1.21 1.19 0.80 2.28 (2.04)
------ ------ ------ ------ ------ ------
Total income (loss) from investment operations........ 0.30 1.55 1.47 1.04 2.50 (1.77)
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income............................. (0.19) (0.33) (0.30) (0.25) (0.26) (0.31)
Net realized gain................................. -- (0.89) (0.37) -- -- --
------ ------ ------ ------ ------ ------
Total dividends and distributions..................... (0.19) (1.22) (0.67) (0.25) (0.26) (0.31)
------ ------ ------ ------ ------ ------
Net asset value, end of period........................ $15.00 $14.89 $14.56 $13.76 $12.97 $10.73
====== ====== ====== ====== ====== ======
Total Return+......................................... 1.92%(2) 10.89% 11.17% 8.14% 23.56% (13.99)%
Ratios to Average Net Assets(1):
Total expenses (before expense offset)................ 0.80%(3)(4) 0.89% 0.89% 0.89% 0.88% 0.87%
Net investment income................................. 2.54%(3)(4) 2.31% 1.94% 1.85% 1.82% 2.37%
Supplemental Data:
Net assets, end of period, in thousands............... $1,886 $2,181 $909 $1,083 $1,151 $1,347
Portfolio turnover rate............................... 28%(2) 56% 52% 64% 117% 145%
</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) Reflects overall Fund ratios for investment income and
non-class specific expenses.
(2) Not annualized.
(3) Annualized.
(4) Reflects waivers of certain Fund expenses in connection with
the investments in Morgan Stanley institutional Liquidity
Money Market Portfolio--Institutional Class during the
period. As a result of such waivers the expenses as a
percentage of its net assets had an effect of less than
0.005%
</Table>
42
See Notes to Financial Statements
(This Page Intentionally Left Blank)
TRUSTEES
Frank L. Bowman
Michael Bozic
Kathleen A. Dennis
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
Chairperson of the Board
Ronald E. Robison
President and Principal Executive Officer
J. David Germany
Vice President
Dennis F. Shea
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
LEGAL COUNSEL
Clifford Chance US LLP
31 West 52nd Street
New York, New York 10019
COUNSEL TO THE INDEPENDENT TRUSTEES
Kramer Levin Naftalis & Frankel LLP
1177 Avenue of the Americas
New York, New York 10036
INVESTMENT ADVISER
Morgan Stanley Investment Advisors Inc.
522 Fifth Avenue
New York, New York 10036
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.
Morgan Stanley Distributors Inc., member NASD
(c) 2007 Morgan Stanley
[MORGAN STANLEY LOGO]
MORGAN STANLEY FUNDS
Morgan Stanley
Balanced Fund
Semiannual Report
July 31, 2007
[MORGAN STANLEY LOGO]
BGRSAN-IU07-03471P-Y07/07
Item 2. Code of Ethics.
Not applicable for semiannual reports.
Item 3. Audit Committee Financial Expert.
Not applicable for semiannual reports.
Item 4. Principal Accountant Fees and Services
Not applicable for semiannual reports.
Item 5. Audit Committee of Listed Registrants.
Not applicable for semiannual reports.
Item 6.
Refer to Item 1.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies.
Not applicable for semiannual reports.
Item 8. Portfolio Managers of Closed-End Management Investment Companies
Applicable only to reports filed by closed-end funds.
Item 9. Closed-End Fund Repurchases
Applicable to reports filed by closed-end funds.
Item 10. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 11. Controls and Procedures
(a) The Fund's principal executive officer and principal financial officer have
concluded that the Fund's disclosure controls and procedures are sufficient to
ensure that information required to be disclosed by the Fund in this Form N-CSR
was recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms, based
upon such officers' evaluation of these controls and procedures as of a date
within 90 days of the filing date of the report.
(b) There were no changes in the registrant's internal control over financial
reporting that occurred during the second fiscal quarter of the period covered
by this report that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial reporting.
Item 12. Exhibits
(a) Code of Ethics - Not applicable for semiannual reports.
(b) A separate certification for each principal executive officer and principal
financial officer of the registrant are attached hereto as part of EX-99.CERT.
2
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Morgan Stanley Balanced Fund
/s/ Ronald E. Robison
Ronald E. Robison
Principal Executive Officer
September 20, 2007
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed by the following
persons on behalf of the registrant and in the capacities and on the dates
indicated.
/s/ Ronald E. Robison
Ronald E. Robison
Principal Executive Officer
September 20, 2007
/s/ Francis Smith
Francis Smith
Principal Financial Officer
September 20, 2007
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